Evaluating a Stock: Compensation and Governance Matters

The following commentary is from an investment professional with Clear Harbor Asset Management who is a participant in TheStreet's expert contributor program.

NEW YORK (TheStreet) -- The recent parade of corporate chiefs rewarded with vast riches in return for abysmal failure has vaulted the debate over executive compensation practices and corporate governance into the arena of mainstream political discourse. But don't count on our broken politics to bring sensible policy solutions in this area. Discerning investors have long had some ability to protect themselves from these potential pitfalls.

After all, if you avoid owning stock in companies with spineless boards of directors and flawed compensation practices, then you will minimize your risk of having your investments plundered by management teams that are either incompetent or have misplaced priorities.

The Securities and Exchange Commission requires public companies to disclose details about their executive compensation policies and practices annually in their proxy statements for good reason. The information provides an imperfect but often revealing portrait of a board of directors' ability to do its job -- namely, to represent the interests of shareholders.

Meanwhile, corporate executives and board members are required to disclose their own equity ownership levels in the companies they're running, which demonstrates the degree to which their interests are aligned with the shareholders at large. This too is a crucial piece of information for investors, but it's also imperfect. It's a good sign when corporate executives own a substantial equity stake in the company they run, but still, their interests don't always line up well with outside shareholders, and it's the duty of the board of directors to account for this.

Shareholders are the owners of corporations, and the directors they elect to oversee their corporations are tasked with assembling and maintaining quality management teams that are properly incentivized to work for shareholders and execute a strategy that will generate superior investment returns.

This basic concept is one that is too often ignored. It is, however, as fundamental to capitalism as the separation of government powers is to democracy. But while disenfranchised citizens in a democracy often face long odds in overcoming their predicament, shareholders that lack the resources to wage an effective proxy fight to oust members of a delinquent corporate board can always just sell their stake in the company and move on to greener pastures. They may have to swallow a loss, but that's not exactly persecution -- particularly if it can be used to offset gains for tax purposes.