Cove Street Capital June Letter below
We are just about done with Proxy Season and with summer in full swing, there is nothing more that we would like to do than kick back and indulge in the 75 pages of shame, greed, ignorance, and political correctness-with only the occasional bright light of shareholder friendly corporate governance-that make up SEC Form 14A, aka the Proxy Statement. I would postulate that this document remains an underrated and under-read part of the investment puzzle as it is the factual record of management’s incentives. We must not forget that financial incentives remain the primary carrot for senior executives once they are done saving the environment, fixing the federal deficit, and shattering any number of diversity ceilings.
For innocent bystanders, let us backtrack a bit. We remain of the opinion that shares of stock represent actual pieces of ownership of actual companies, and thus investment success is predicated on a generally correct assessment of the interplay between the nature of the business (think Return on Capital); valuation (multivariate); and the competence of (and the incentives that motivate) the people running the company.
Now that we are comfortably ensconced in the 21st century, I think we can generally agree that people outside of the Nation’s capital are pretty good at figuring out what is in their best interest. If you incent a CEO to aggressively grow sales, you don’t have to lose much sleep worrying that he/she will not be out making acquisitions and throwing money at top line growth. If you incent working capital management, you can be pretty sure that cash flow will improve and debt will be paid down in the process. If your Change in Control Agreement gives the CEO $55mm to hand over the keys with a tax gross-up cherry on top, you better believe that executive will be taking calls from investment bankers.