Why Investors Should Have a Healthy Distrust of Management

|
 |  Includes: AAPL, AEO, BAC, JNS
by: Benjamin Taylor


Source: Flickr by marcopako

A few happenings with CEOs had me thinking. Valuing management in the investment decision is important as management has a lot though not ultimate influence over the success or failure of a business. Thus much attention needs to be given to who is at the helm of the businesses in which an investor has placed his money.

Some stories that caught my attention over the past couple of days:

  • Wednesday, Apple Computer (NASDAQ:AAPL) founder and CEO, Steve Jobs, announced he would be taking a leave from the CEO post due to pre-existing health issues that suddenly became more serious than he had originally thought they were. The stock had to be halted in trading for a time and ultimately dropped from $85 to $81 on Thursday. Prior to this Jobs and Apple had insisted he was in perfect health.
  • Late last year, Ken Lewis, CEO of Bank of America (NYSE:BAC) offered to buy Merrill Lynch and insisted his bank was financially stable. According to the Wall Street Journal, Lewis was simultaneously negotiating $20 billion in TARP funds with the Treasury department.
  • American Eagle Outfitters (NYSE:AEO) had a conference last week in which CEO Jim O’Donnell assured investors the company was well positioned for the coming future despite the tough holiday season. About a year ago, O’Donnell said he did not think we were in a consumer led recession.

Candor is among the rarest of traits amongst people and CEOs and management of large corporations are no exception. Sometimes it is simply not being forthright. Other times it is outright lying. Even the most sophisticated of investors can succumb placing more trust in the CEO than they ever should. I can recall an article in which managers of mutual fund company Janus had to explain why the firm as a whole owned over 40 million shares of Enron even as the company filed for bankruptcy. Their answer essentially came down to they believed the pack of lies Enron management told them.

Bottom line is that while an investor should assess management, everything management says should be verified in the numbers. If management’s words do not show up in performance of the company, then their words are meaningless. And if management cannot be honest about its CEO’s health, or deals they are negotiating, or is eternally optimistic despite the evidence of a tough market, then they should be viewed with even greater skepticism.

Disclosure: I and the clients of Brick Financial Management owned shares of American Eagle at the time of this writing. But positions can change at any time.