Companies may be able to survive a bad CEO, but rarely do they thrive under one. It’s crucial, therefore, that before you invest your money in a company, you take a long look at the person who is running it. Outlined below are the various ways in which a bad CEO could end up costing you in your investments as well as tips for recognizing poor leadership before you fall victim to it.
Performance-Based Compensation Vs High Base Salaries
Complacency is the enemy of success, and CEOs who are paid an extremely high base salary are going to be more likely to become complacent than CEOs who earn their wages through performance-based compensation. While a CEO who takes an excessively high salary does not automatically equate to a bad CEO, it does directly draw from the money of investors while at the same time providing CEOs with less incentive to go out and perform well.
Warren Buffett’s 2018 Activist Investment
If possible, look for companies whose CEOs are given performance-based bonuses. These men and women are sure to be more driven to make their company successful than those whose performance does not really affect their bottom-line.
The Cost of Poor Integrity
Evaluating a CEO's integrity is just as important if not more important than evaluating their performance. You don't have to look very hard to find examples of where a crooked CEO got caught in underhanded or outright illegal activities and caused the stock of their company to plummet.
Unfortunately, judging the integrity of a CEO isn't always such an easy task. The ones who do lack integrity didn't make it as far as they have by broadcasting the fact that they're crooked for all the world to see. When evaluating the integrity of a CEO, you'll have to look for subtle signs as well as trust your instincts.
One subtle way that you can judge a CEO's integrity is to look at their shareholder letter. If their shareholder letter sounds more like a sales pitch than it does an honest and useful report, steer clear. Good CEOs will communicate openly and honestly with their shareholders rather than turning their shareholder letter into something that bears more resemblance to a late-night infomercial. The bottom line is if they're willing to lie to the shareholders to sell more stocks, they'll be willing to lie and cheat in other situations as well.
Another red flag that a CEO may not be on the up-and-up is if they are selling stocks that are "undervalued". If a CEO sells stock for $1.50 a share that was originally worth $2.00 a share, they are essentially robbing their shareholders of what they own. While jumping on board a company that is selling its stock for less than what it is worth may be tempting, CEOs that will do this lack integrity and are best avoided.
Other than checking the shareholder letter and avoiding CEOs who sell "undervalued" stock, the best way to evaluate the integrity of a CEO is to study them closely and trust your instinctual impressions. Again, there probably won't be any flashing neon signs no matter how hard you look, but just raw feelings about a person are often more accurate than one might think.
The Catch-22 of Firing a Bad CEO
If a company discovers that its CEO is hurting the company, firing them and immediately repairing the damage they've caused is not always so easy. For one, CEOs are often protected by costly contractual elements known as "golden parachutes" that can end up costing investors millions when they are ousted. For example, when Pfizer's CEO Henry McKinnel was forced to leave the company, he took with him a $213 million retirement package. This is money that comes straight out of the pocket of investors.
What's even worse, though, is the image that firing a CEO presents. Nothing says "our company is in a downward spiral" like firing the person who is in charge of the company. When a company is forced to fire their CEO, investors will typically start bailing on the company en masse. As you are probably well aware, this isn't good news if you own stocks in said company.
All of this just hammers home how important it is to avoid companies with poor leadership. Not only will a poor leader hurt the company and its shareholders for as long as they are in control, even the act of ousting them can end up being incredibly costly. For this reason, as well as all the others outlined above, carefully studying a company's CEO and entire leadership is an incredibly important step to take before investing your money in a company.
About Phil Town – Phil Town is the founder of Rule One Investing, hedge fund manager, two-time NY Times best-selling author, ex-Grand Canyon river guide and a former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence. You can follow him on Facebook, Twitter, and YouTube.