As a regular feature, we’ll be highlighting aspects of ESG investing, an approach that takes into account risks relating to Environmental, Social, and Governance factors. It is important to note that ESG is not about personal or political values, but rather about considering risks that have historically been overlooked and that empirical evidence says either improves returns or (more commonly) reduces risk in a portfolio. We’ll start with my favorite subcategory in Governance: management compensation.As a regular feature, we’ll be highlighting aspects of ESG investing, an approach that takes into account risks relating to Environmental, Social, and Governance factors. It is important to note that ESG is not about personal or political values, but rather about considering risks that have historically been overlooked and that empirical evidence says either improves returns or (more commonly) reduces risk in a portfolio. We’ll start with my favorite subcategory in Governance: management compensation.
News tends to slow down in the summer, and that makes it my favorite season to read proxy filings (What, doesn’t everyone?)! US companies must issue this document every year-- Form DEF14A, for us SEC wonks-- that includes proposals up for shareholder votes, changes to the board of directors, and information on how management is compensated.
I like to operate under the cynical assumption that CEOs are “coin-operated”: they’ll do what they are paid to do, usually via the shortest route possible. Are they incentivized on sales growth? Expect acquisitions! How about if the board sets a target of “adjusted Earnings Per Share”? Expect a lot of normal costs to be adjusted out! Short-term stock performance? Do not expect that CEO to reinvest a penny of this quarter’s profits into longer-term growth initiatives that could pay off in a few years. Even with a very capable CEO, the wrong incentives create higher risk for shareholders.
