Is Cooperative Bank an exception? Weak management and its impact on returns

4th December 2013

To what extent does management behaviour influence the success or otherwise of a company? It is a question worth asking in the wake of the Rev Paul Flowers scandal at the Co-operative Bank, when analysts have drawn an easy parallel between the weakness of the bank and the flakiness of its chairman. Do management teams really hold the sword of Damocles over businesses?

There are plenty of fund managers who believe that good management can make a difference. For example, Margaret Lawson, manager of the SVM UK Growth fund, believes strong, proven management can transform a business. For example, she has long backed Charles Wilson, who took over the management of Booker in 2005, taking it from a cash and carry business focused on low margin drink and tobacco to a goods services business. His customers now include cinema groups and brewers, and he has taken the sales from around £1bn to £4bn.

There are other examples of ‘transforming’ managers. Bart Becht’s legacy at Reckitt Benckiser may be tainted by the size of his compensation package, but there is little doubt that he was an excellent steward of the business.

However, perhaps more important is identifying weak management. Bad management and the culture that it creates in a company seems to have contributed significantly to the decline of certain companies than good management has to the growth of others. Equally, the stakes are higher – if a business fails, shareholders get nothing.

Enron is perhaps the most obvious example. As this New York Times article suggests: “the company’s spending reflected a go-go corporate culture, former employees said, in which top executives cast traditional business controls by the wayside. And that — from top officers who insisted they were unaware of financial details to a relaxed attitude about conflicts that let executives sit on both sides of multimillion-dollar deals — figured heavily in Enron’s collapse.”

But this also happens in a less dramatic way. For example, Lawson highlights companies such as Dixons, where poor management saw the group over-expand ultimately with grim results.

Tim Gregory, head of global equities at Psigma points to gold mining companies: “Gold companies did not invest their cash well when the gold price was high. They need to be more discriminating with their capital going forward.” The sell-off in the shares has been painful for investors. On the other hand, the management of a number of metals mining companies has been replaced over the last 18 months and Gregory believes that may generate a turnaround in the sector.

Alistair Mundy, head of contrarian investing at Investec Asset Management has long been a sceptic on management. In his book “You say Tomayto” he says: “Company management, while not necessarily mendacious, may prefer to answer difficult questions with approximations or semantics. The chief executive of one horrifyingly disappointing company told us we hadn’t asked quite the right questions before investing.”

His argument is not necessarily that there is no good or bad corporate management, but more that they are simply very difficult to spot: “It is very hard to accurately assess whether a company’s management is exceptionally good, or if they are merely smooth-talking snake oil salesman. For example, even if the team’s explanation of the company’s success is plausible, they may have just taken the helm at a fortuitous time in the company’s business cycle.”

Nevertheless, he believes it is worth trying to identify bad management. He believes in monitoring large share sales, or non-ownership of company stock. Director largesse is also a red flag, as is previous failed companies. Merger and acquisition activity, particularly ego-driven expansion, is often a prelude to failure.

Less directly, City economist Andrew Smithers, in his book The Road to Recovery: How and Why Economic Policy Must Change discussed here on the Economist argues that the structure of executive compensation packages – in particular the link to share prices – has incentivised management to focus on short-term profits at the expense of investment. He says that this has halted economic recovery and stalled the growth of companies. In this way, therefore, management can also have a negative impact.

A final point is that it is unlikely to be one person that ultimately kills or cures a business. The very skilled manager may be able to install a culture of success, while a weak manager may bring down those around him, but the Rev Flowers did not kill the Co-op. As Martin Vander Weyer points out in this piece in the Spectator, the culture at the Co-op was weak. There were plenty of people other than Rev Flowers who should have spotted the problems.

There are undoubtedly very good managers, who can transform businesses and there are very bad managers, who throw risk controls to the wind, over-expand, over-leverage and generally mess up a business. The rest are somewhere in between – not exactly incompetent and not exactly brilliant. As an investor, to spot the extremes is handy as it can have a meaningful effect on returns.

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