Do you know enough about the directors running your investments?
In the search for good investment opportunities most investors concentrate mainly on analysing the current and forecast financial performance of companies. Articles in the financial press are usually littered with price earnings ratios, dividends, balance sheets and trading prospects.
However when you spend your money on buying shares, you are effectively (albeit indirectly) handing it over to the care of the directors of the company to look after. But how much research have you done on them? Do you normally trust your life savings to people you know nothing about?
In recent times private investors have been rocked by the failures of apparently successful companies such as AT Communications Group (LSE: ATCG) and Aero Inventory (LSE: AI).
Let's face it, few directors, steeped in the cut and thrust of business competition, are likely to be motivated purely by charity and altruism. They are mostly driven by the same things we are; money. And where there is money there is self interest.
The Good
It's fair to say that there are companies with directors who are focussed on delivering shareholder value rather than just looking after their own interests.
An old favourite of mine, for example, is Hansard Global (LSE: HSD). Last year its Executive Chairman and 42 per cent shareholder, Leonard Polonsky, drew a salary of just £1. To recognise difficult market conditions, directors and senior executives also agreed to take a 5 percent pay cut and a one year holiday in pension contributions.
In contrast shareholders got a 5 percent increase in their dividend. There were no bonuses, fancy extras or big share option awards. That's an admirable order of priorities.
The Bad
It's a lesson that gambling operator Gaming VC Holdings (LSE: GVC) could certainly learn. On 27 January 2010 the company announced a new expansion strategy. However the announcement also revealed that "the level of Gaming VC's future dividends will be affected by the Group's new investments as profits in 2010 are expected to be materially lower than in 2009".
Unsurprisingly over the next three weeks the share price slid 20 percent from 209 pence to 168 pence (although it has subsequently partly recovered).
However, at the same time, the company announced that it was paying the Chief Executive and the Finance Director £721,000 for waiving options (using a share price of 211 pence to value them), with further £975,000 payments in recognition of their importance to the business and lack of participation to date in a Long-Term Incentive Plan. In total, that's a cool £1.7 million from a company valued at only £65 million. I'm afraid that just looks to me like directors lining their pockets at the expense of shareholders.
And the Ugly
Unfortunately some directors appear to have shareholder value well down their list of priorities. Now some private shareholders are starting to demand something better.
Shareholders in Tandem (LSE: TND) are one such bunch. It had been a long road for long-term holders. In the last eight years the share price has gone nowhere and no dividends have been paid. Despite this the remuneration of the three directors has soared by over 78 percent to £565,000. Not bad for a company valued at only £5.5 million.
Shareholders complain that they are left in the dark about the company's performance. There are no broker forecasts for the company or meaningful trading updates. The accounts give little narrative on the results or strategy and the company web site provides the bare minimum of information. The company has only one non executive director; the 79 year old chairman, who has held that position for 14 years.
Some private shareholders are now registering their discontent. If you are one such holder and wish to do likewise, there is now a web site for you to do it. With a new activist private shareholder having recently taken a stake, it looks like things are about to change.
Alignment
In good companies the interests of the directors are aligned with those of the shareholders.
That may mean directors with significant investment in the company's shares. At the very least it should mean a significant proportion of directors' pay should come from bonus schemes which focus on long term shareholder returns, not just short term share price increases.
Better still if these bonuses are paid in shares, which they have to hold for a minimum period.
Transparency
Shareholders have a right to know how directors are remunerated. Not just how much they are paid, but (especially in respect of bonuses) how this is set.
The recent decision by the London Stock Exchange to force AIM companies to disclose details of directors' remuneration is extremely welcome. It's a move posters on the Motley Fool's bulletin boards have long argued for.
Balance
Finally, executive directors should not be allowed to set the terms of their own remuneration or have free rein over strategy and the running of the company. That is why it is important to have strong non executive directors on the board, who are independent of the executives and able to stand up to them.
At the end of the day it's your money they are looking after.
More from Steve Scott:
Steve holds shares in Hansard Global and Tandem.
