Do you consciously evaluate the management of a company before you invest?
I don't.
Sure I read the annual report, I read what management says to make sure it makes sense, I check to see that they keep their promises and I look at salary and option levels to make sure they are not excessive.
Should I be uncomfortable with any of these factors the company has to be extremely undervalued for me to invest.
But I never consciously evaluated the management as such.
I knew I had to do this in a more structured way but I never took the time to build a checklist or similar tool.
Fortunately I stumbled onto something that will make evaluation of management a lot more structured and scientific.
I discovered a book called Why Smart Executives Fail written by Professor Sydney Finkelstein a professor of management at Dartmouth College in the USA.
I have not read the book (it is on my reading list) but I found an excellent summary here: Why Smart Executives Fail - Presentation (pdf).
Prof. Finkelstein wrote the book after he, over a 6 year period evaluated 51 corporate failures and conducted over 200 interviews to determine the reasons for the failures.
The surprising finding of the study was that, even though the companies were all different and in different industries, and had nothing in common, they all failed for the same reasons.
This means that the failures could have been prevented and avoided.
The findings in the book are thus the 80/20 principle of management evaluation. The 20% you can do to accomplish 80% of what you need to do, to accurately evaluate company management.
The study determined that in all cases management was intelligent, saw the failure coming, had good track records and had all the necessary facts, but they either did not act or acted wrongly.
The book identified the following four major themes present in the management of the 51 failed companies:
1. Executive mindset failures
Management got a strategy of the company completely wrong and even though it may not have been enough to make the company fail it put the company on the road to possible failure. An example was the blow up of the hedge fund Long Term Capital Management after they failed to allow for disruptions in different markets at the same time and used excessive leverage.
2. Delusions of a dream company
The organizational culture of the companies was such that nobody ever questioned anything, mistakes were never raised and nothing was ever criticized.
3. Organisational breakdowns
The companies’ operations were simply wrong. It wasn't that the company didn't carry out its operations badly they carried out the wrong activities and had the wrong incentive systems.
4. Leadership pathologies - The seven bad habits
This is probably the most important part of the study and the most helpful for you as investor. It gives you the seven bad habits management exhibited, which led to the downfall of the companies.
I have turned the seven bad habits above into the checklist below that I am going to add to the checklist I use when evaluating companies. You may want to do the same.
Management evaluation checklist:
Profitable investing
Tim du Toit
I don't.
Sure I read the annual report, I read what management says to make sure it makes sense, I check to see that they keep their promises and I look at salary and option levels to make sure they are not excessive.
Should I be uncomfortable with any of these factors the company has to be extremely undervalued for me to invest.
But I never consciously evaluated the management as such.
I knew I had to do this in a more structured way but I never took the time to build a checklist or similar tool.
Fortunately I stumbled onto something that will make evaluation of management a lot more structured and scientific.
I discovered a book called Why Smart Executives Fail written by Professor Sydney Finkelstein a professor of management at Dartmouth College in the USA.
I have not read the book (it is on my reading list) but I found an excellent summary here: Why Smart Executives Fail - Presentation (pdf).
Prof. Finkelstein wrote the book after he, over a 6 year period evaluated 51 corporate failures and conducted over 200 interviews to determine the reasons for the failures.
The surprising finding of the study was that, even though the companies were all different and in different industries, and had nothing in common, they all failed for the same reasons.
This means that the failures could have been prevented and avoided.
The findings in the book are thus the 80/20 principle of management evaluation. The 20% you can do to accomplish 80% of what you need to do, to accurately evaluate company management.
The study determined that in all cases management was intelligent, saw the failure coming, had good track records and had all the necessary facts, but they either did not act or acted wrongly.
The book identified the following four major themes present in the management of the 51 failed companies:
1. Executive mindset failures
Management got a strategy of the company completely wrong and even though it may not have been enough to make the company fail it put the company on the road to possible failure. An example was the blow up of the hedge fund Long Term Capital Management after they failed to allow for disruptions in different markets at the same time and used excessive leverage.
2. Delusions of a dream company
The organizational culture of the companies was such that nobody ever questioned anything, mistakes were never raised and nothing was ever criticized.
3. Organisational breakdowns
The companies’ operations were simply wrong. It wasn't that the company didn't carry out its operations badly they carried out the wrong activities and had the wrong incentive systems.
4. Leadership pathologies - The seven bad habits
This is probably the most important part of the study and the most helpful for you as investor. It gives you the seven bad habits management exhibited, which led to the downfall of the companies.
- They saw themselves and their companies as dominating their environment is, not simply responding to developments in those environments
- They identified so strongly with the company that there was no clear boundary between their personal and corporate interests
- They seem to have all the answers, often surprising people with the speed and decisiveness with which they dealt with challenging issues
- They made sure that everyone was hundreds percent behind them, they ruthlessly eliminating anyone who might undermine their efforts
- They were skilful company spokespersons, often devoting a large portion of their efforts to managing and developing the company image
- They treated difficult obstacles as temporary hurdles to be removed or overcome
- They never hesitated to return to the strategies and tactics that made them and their companies successful in the first place[/b]
I have turned the seven bad habits above into the checklist below that I am going to add to the checklist I use when evaluating companies. You may want to do the same.
Management evaluation checklist:
- Does management see their companies dominating their market without the need to adapt all the time?
- I there no clear boundary between management’s personal interests and that of the company?
- Does management have all the answers, even on difficult strategic issues where the outcome is at best uncertain?
- Does management not allow healthy debate on important issues in the company? Do they eliminating anyone who might undermine their efforts including reporters and analysts?
- Does management excessively promote the company image?
- Does management treat difficult obstacles lightly, as temporary roadblocks to be easily removed or overcome?
- Does management plan to return to the strategies and activities that made them and their companies successful in the first place? Is this realistic considering changed markets, customers and technology?
Profitable investing
Tim du Toit
