Individual investors wonder what to look for in a company’s board members. The most important thing is to find directors who look out for shareholder interests. The strongest objective signal of this is their ownership of a significant long-term stake in the company.
It stands to reason. Directors will act most like shareholders when they are shareholders; the higher the stakes, the more passionate the stewardship. One proving ground is venture capital, where the effects of a company’s major shareholder-directors are clear.
The standard-bearer here is the legendary George Ohrstrom (1927-2005). Through his venture firm, Ohrstrom sagely guided the incubation of such durable companies as Carlisle
and Roper Technologies
. While no intelligent investor blindly follows others or simplistic formulas, paying attention to what the Ohrstroms of the world do pays.
Beyond venture capital, research indicates that among large public companies today, a high proportion of patient and focused shareholders — “quality shareholders” — correlates with superior corporate performance. In companies that lead the charts in both shareholder quality and performance, a common feature is at least one director with large long-term personal stakes.
Some CEOs publicly attest to the value of such directors. One is Mike Jackson, CEO for more than 20 years at AutoNation
. The company, owner of a vast network of car dealers, attracted an impressive list of quality shareholders over those decades. From among these, two joined the board, whom Jackson credits with vastly improved corporate performance. Each held 15%-16% of the stock for more than a decade: investor Eddie Lampert tutored board colleagues on capital allocation and Michael Larson of the Gates Foundation counseled them on disciplined, patient long-term thinking.
The board of Credit Acceptance Corporation
, lender to sub-prime borrowers, boasts two quality shareholders: Scott Vassalluzzo, of Prescott General Partners, which owns 10% of the stock, and Tom Tryforos, who teaches the fundamentals of traditional investing at Columbia Business School. CEO Brett Roberts attests to the enduring value of their board service, stressing in a shareholder letter how Tryforos’s perspective as an investor helped managers appreciate that all corporate decisions must be tested in terms of a minimum return on capital.
Many other companies adept at attracting quality shareholders have named some to their boards: Berkshire Hathaway
in 2005 appointed Sandy Gottesman of First Manhattan, since 1966 the company’s largest shareholder after Warren Buffett; Constellation Software
has since going public in 2006 benefited from the board service of Steve Scotchmer, a distinguished Canadian investor and owner of a large personal stake in the company for decades; and for many years Enstar Group’s
board included Chuck Akre, a distinguished quality shareholder.
Through 2013 when The Washington Post Company sold its flagship newspaper, the company had since 1976 saved almost $1 billion in pension-plan costs thanks to savvy investment advice given by the prominent investors Sandy Gottesman and Bill Ruane. Those mavens were suggested and introduced to the company by one of its earliest and revered QSs: Buffett. Another WaPo veteran is Alan Spoon, of Polaris Partners, also a shareholder-oriented director adding value at such companies as Cable One
Each of the 12 companies mentioned so far lead the ranks of those combining shareholder quality, corporate performance and director share ownership, according to research of the Quality Shareholders Initiative at George Washington University at George Washington University. Another 12 follow — all worth a look:
• Abbott Laboratories
• Aptar Group
• Bright Horizons Family Solutions
• Cincinnati Financial
• Gartner Inc.
• General Dynamics
• Illinois Tool Works
• Jack Henry & Associates
• O’Reilly Automotive
• Public Storage
• Ross Stores
• Selective Insurance Group
Identifying companies with such outstanding directors is not as easy as it should be. You might expect them to be identified by activist shareholders in contested director elections squaring off with incumbents. But such fights often pivot instead on specific strategy and executive leadership and the challengers rarely acquire large stakes on spec.
It would be helpful if large institutional investors rated director share ownership highly in their assessments, but that is unfortunately not the case. The guidelines of many indexers and advisors, for instance, emphasize instead features such as director independence from management, meeting attendance records, and number of other boards a director serves on.
The governance community has successfully advocated for corporate policies requiring or exhorting minimum director stock ownership. A common benchmark is to own shares worth triple the annual board retainer, within a few years of starting service — a goal increasingly facilitated by board compensation paid in shares. (For a window into directors’ share ownership, check the “Security Ownership of Certain Beneficial Owners and Management” found in a company’s annual proxy statement (Schedule 14A). SEC forms 3, 4 and 5 as well Schedule 13D and 13G also track corporate insider transactions.)
While this is probably desirable, the strongest signal of alignment is directors who, on their own rather than due to company policy, buy a substantial stake in the company they serve. The logic is as easy as the simple slogan “We eat our own cooking.”
Lawrence A. Cunningham is a professor and director of the Quality Shareholders Initiative at George Washington University. His books include Quality Shareholders; Dear Shareholder; and The Essays of Warren Buffett.
Register for his Cunningham’s free book talk hosted by the Museum of American Finance and Fordham University here. Cunningham owns stock in Berkshire and is a shareholder, director and vice chairman of the board of Constellation Software.
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