A Closer Look at Executive Compensation

We read a lot about corporate governance and executive compensation these days, in the wake of last year's economic collapse. Many politicians are now jumping into the fray, saying we need to legislate certain governance requirements, such as splitting the roles of CEO and chairman or lowering CEO pay. Although philosophically I support many of these arguments, it turns out that many of these prescriptions have no long-term relationship with an increase in a company's stock price. Which of these governance and executive pay factors should you pay attention to as an investor?

As any good investor knows, there's no silver-bullet metric (such as P/E ratio or price-to-book or leverage ratio) that, on its own, predicts a stock future increase or decrease. Even if you take a number of internal factors into account, your perfect analysis can be thrown out the window by an industry downturn or some random comment by Tim Geithner on his trip to Asia.

With this in mind, I believe you can improve your investment batting average by paying attention to two factors relating to corporate governance and executive compensation that most people overlook.

Two Kinds of Insider Stock

First, how much stock do the company's directors own? In a big long study I took part in several years ago, we scoured company's proxy statements and examined how a bunch of so-called "good" corporate governance factors were actually linked to longer-term stock returns. Almost all of them (such as whether there was a split CEO and chairman, or if the board had a number of "independent" directors or not) had no correlation with stock price increases. However, we found one variable that had a whopping link: whether a company had a lot of directors who had dug into their own pockets and actually bought stock in the company. This is different from a case in which stock ownership in the company was only due to stock grants or stock options.

---

At the time of publication, Jackson's fund held a net short position in LVS and a short position in HPQ.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.