Over the past few decades the spread between the salaries of the lowest paid employees and the C-level employees has been growing further and further apart. It's as if we're just hiring mercenaries to run the companies.
Follow the Scent
By Chris Mayer
I often think of good investing as the accumulation of small advantages. You want as many of these advantages working for you as possible. So here is one that a lot of investors don't pay any attention to -- insider ownership -- and it turns out that it has a big effect on returns over time.
A new paper by Ulf von Lilienfeld-Toal and Stefan Ruenzi states: "Firms in which the CEO voluntarily holds a nontrivial fraction of the company's stock outperform the market significantly…. The effect is most pronounced among firms that are characterized by large managerial discretion of the CEO."
They go on to conclude:
"We find that value-weighted portfolios consisting of S&P 500 stocks in which the CEO holds more than 5% or 10% of the firm's outstanding shares generate statistically and economically significant abnormal returns of 9.2% p.a. and 13.0 percent per annum, respectively. For S&P 1500 firms, the effect is only slightly smaller, with abnormal returns of 8.5% per annum and 12.1% per annum, for a 5% and 10% cutoff for managerial ownership, respectively."
One of the many problems with today's market is the fact that the people running companies are not owners. A typical American CEO owns hardly any of the company he runs. Whatever shares he has he gets through stock options, which he does not pay for. In addition, he gets paid an enormous sum of money in salary and bonus.
I read proxy statements. Very few do. Most investors probably don't even know what one looks like, which is a shame. And it explains why corporate execs lavish so freely on themselves. The owners aren't paying attention.
Anyway, proxy statements reveal to you the compensation of the management team and directors. It also shows you how many shares each of them owns. I'm always amazed at what some of these guys make. And I always get a little annoyed when I see how little they have at risk in their own firms.
There was a time when this situation would not have been tolerated. There is a quote from Frederick Lewis Allen that I like, which I reprinted in my book Invest Like a Dealmaker:
"In 1900, capitalism was capitalism indeed. Businesses were run by their owners, the people who had put or had acquired capital with which to finance them… It would seem wildly irrational that a man should manage the destinies of a corporation while owning only a minute fraction of the stock, as so frequently happens today."
After I listen to some presentation by a CEO telling me how great his stock is, I always wonder to myself: "Then why don't you buy shares?" I never come up with a good answer. If a guy is gonna get all gung-ho on his stock, yet he doesn't own any, then I’ve got a beef with him.
It is true that in our aging modern industrial society, it is hard for a CEO to own a large percentage of some of our multibillion- dollar corporations. But he should own enough relative to his own salary and net worth that it makes him sweat. And he should buy shares out of pocket, and not have shares handed to him for free.
Intuitively, I've long believed that companies with insider ownership do better. I agree with the old money manager Martin Sosnoff, who once observed, “My experience as a money manager suggests that entrepreneurial instinct equates with sizable equity ownership."
Often, the most creative and value-creating moves are made by management teams who own shares. Conversely, the stupid and value- destroying moves are often made by managers who don't own shares.
Thoughts like this are what led me to include "owner-operators" among what I look for when investing in a stock. Most of the stocks I have recommended over the years have had significant insider ownership. The people running the companies have their money at risk just like us.
It doesn't mean that every stock with high insider ownership outperforms. It means that as a group, these stocks have done better than those with little insider ownership.
This trait is something to look for when investing in stocks.