J.P. Morgan: "No, sir; the first thing is character."
Untermeyer: "Before money or property?"
J.P. Morgan: "Before money or anything else. Money cannot buy it.”
From J.P. Morgan’s testimony before the House Committee on Banking and Currency in December 1912.
“It is not so much that too many of our principals, our business leaders, seen less ethical, it is that our principles seem less ethical, somehow diluted. There seem to be far fewer absolute standards in the conduct of our affairs - the things that one just doesn’t do. Rather, we rely too heavily on relative standards - “Everyone else is doing it, so I can do it, too” - a concept that would have appalled the Reverends Makemie, Edwards, and Witherspoon, as well as our founding fathers.”
- John C. Bogle
As an investment manager I spend an inordinate mount of time reading annual and quarterly reports that tell me quite about the operations of the company, its financial strength, risks, etc. While I can glean some information about management in the way they write, there really isn’t a great process to get a better understanding of the managers themselves. If the first thing is character – as J.P. Morgan believed – then how do you go about understanding a company’s leadership character?
What is Management Character?
It really doesn’t matter how large margins have expanded, or revenue grown, or costs cut if management lacks character. Without it, management can make decisions adverse to shareholders, enrich themselves from company coffers, be unable to see facts clearly, and develop strategies on completely flawed premises. When I look for character in management, four major themes guide my evaluation.
A Foundation of Fiduciary Responsibility: The Board of Directors of a company - elected by its shareholders - hire a chief executive officer to carry out a company’s strategy and operations that will maximize shareholder value. At the base of every action is the strong set of values reflecting fiduciary responsibility to his/her shareholders. Without this foundation, companies can be easily led astray. Just ask the shareholders of Enron, Lehman Brothers, Waste Management, or HealthSouth. Warren Buffett has famously said that when he finds one cockroach, there are generally many more. If senior management turns a blind eye to fiduciary responsibility, it won’t be long before it works its way deeper into the organization.
An Ability to Hear, Speak, and Act on the Truth: An area where my company has substantial knowledge – pharmaceuticals – has a long track record of remarkable failures in ethical leadership. Even large fines seem to make little impact on their behavior. GlaxoSmithKline ($3B), Pfizer ($2.3B), Johnson & Johnson ($2.2B), Abbott ($1.5B) have all been caught promoting drugs when the FDA has not approved them for a specific use. The scope of these illegal operations frequently goes to the top of the organization. If management is unwilling to act on knowledge of such behaviors, then what else will they do to maximize profits?
Their Word is Their Bond: I remember once listening in to an earnings conference call when the management team announced the prudent use of cash on the balance sheet precluded any big M&A deals as they “almost always cost shareholders value”. Less than six months later, this same team announced an acquisition that would use nearly the entire cash balance. Within the first two years of closing, roughly 90% of the deal would be written off as good will. One thing was certain - if their word was their bond, then it was selling at a pretty large discount by year’s end.
Treating All With Respect: When I see companies where CEO’s have outrageous compensation packages (including cash, options, warrants, deferred compensation, jet use, private security…..the list goes on and on), I believe this shows complete disrespect to employees (almost always these companies have the largest gap between the highest paid and lowest paid employees) as well as disrespect to shareholders. Respect can be reflected in policies that show fairness to employees no matter the level or position. It can also mean utilizing the annual meeting to genuinely listen to shareholder concerns. Study after study show that companies with satisfied employees and active shareholders are generally the most successful.
How to Find It
The question of course is how do you find great management? If you focus solely on corporate performance you might end up with a company like Enron and Ken Lay as CEO of the year. If you focus solely on a CEO known as great person you might end up with tech start-up with its own employee barista and swimming pool that flames out in spectacular fashion. Neither one is likely to lead to outstanding investment returns. So where to look? I suggest the following.
Previous Management Performance: The first of course is to see how the individual has performed in the past. If the individual has a history of growing revenue, increasing profitability, and retaining staff then that’s a good start. Reading through 10-Ks and 10Qs can give investors a pretty good idea about this information. A word of caution: those glossy Annual Reports drafted by agencies filled with glitzy graphics don’t hold a candle to a simple report written by the CEO themselves. For a contrast take a look at any Enron Annual Report versus Berkshire Hathaway’s.
Direct Conversation: If the company is small enough, then you might be fortunate enough to talk directly to the CEO. Sometimes you can speak to other senior executives. Either way, be prepared to have a list of questions that you can run through without hesitation. (For some thoughts on this see my article “Interviewing Management: Core Concepts”, June 2016) No senior executive likes to waste their time.
Scuttlebutt: Another great source is Phil Fisher’s classic scuttlebutt. There are a host of websites (examples include “Glass Ceiling” for equal pay, “Fierce Biotech” for Biotechnology business news, and CafePharma for all kinds of business and personnel scuttlebutt) for each industry that generally dish everything from potential deals to reports on individuals (it was actually posted on one site that I had died until I confirmed I was quite alive!). Some sites have far greater credibility than others so use your discretion and try to multi-source any stories.
Partnering with outstanding management is a multi-pronged approach. You are looking for great allocators of capital, individuals with sound judgement, great business acumen, outstanding intrapersonal skills, and a strong strategic vision of the business and industry. Is it possible to find any one person with all these skills? It’s unlikely, but possible. Over time, you will have to create a hierarchy of importance. For me, capital allocation comes first combined with a strong strategic vision. Yours may be strong personnel skills and outstanding business acumen. One thing is certain though: picking a bad manager outweighs almost any positive characteristics of the company. As J.P. Morgan said, money and assets cannot trump character. And it’s hard to find fault in his results.
As always, I look forward to your thoughts and comments.
 Money Trust Investigation : Investigation of Financial and Monetary Conditions in the United States Under House Resolutions Nos. 429 and 504 Before a Subcommittee of the Committee on Banking and Currency, House of Representatives, (1912-1913)
 John C. Bogle, “Don’t Count On It!”, John Wiley & Sons, 2011