BOSTON ( TheStreet) -- Investors and company management have an inherently strained relationship.Management is supposed to be shareholders' proxy, acting on their behalf to guide the company to success. Yet it's often in management's interest to take risks that are incongruent with its main responsibility. Because of this problem, it's important for companies to follow strong corporate-governance practices to protect shareholders and keep management in line. Studies have shown that superior investment gains are correlated with strict corporate governance. Practices such as independent board control, separation of the chairman and chief executive officer positions and appropriate compensation packages are important to align management and shareholders. Many companies have the most obvious parts of good corporate governance under control, thanks, in part, to regulations from stock-market exchanges and other governing bodies. Ideally, about 75% of board members should be independent, meaning they're not connected to management in any way. That could lead to unsavory quid-pro-quo behavior. The audit, compensation and nominating committees should comprise only independent members. These committees are vital because they monitor the company's financial reporting, set compensation levels and elect board members. Apple ( AAPL), General Electric ( GE) and ExxonMobil ( XOM) have these practices under control, but General Electric and Exxon violate another important rule. Their CEOs also serve as chairman of the board. Strong corporate governance systems would separate these duties to prevent the CEO from having too much influence on the supposedly independent board. Many studies have suggested that it's a benefit to a company's share-price performance to separate the positions. Investors should also consider the manner in which board members are elected. Many companies employ a staging procedure, which puts up two directors for nomination every year. This is a tactic to help defend a company against a hostile takeover, since the acquirer would have to wait years to gain control of the board. However, this is less than advantageous to stock holders since it makes getting rid of bad directors and management more difficult. Some activist investors' actions are in the best interest of the company because they would allow shareholders to toss out bad management.
Activist investors can force proper action by management. While staggered boards may protect against corporate raiders, it also insulates management from the consequences of bad behavior. Most importantly, investors should consider compensation structures when analyzing corporate governance. If management is compensated solely with salary and bonus based on short-term performance, management will be more likely to engage in excessive risk taking and accounting malfeasance. The heightened risk may have a large downside, but managers don't share in the losses - they're rewarded richly when the gambles pay off. This is exactly what led to massive risk taking on Wall Street, which undermined the global financial system and threw dozens of countries into recession. Tying compensation to long-term performance is crucial. Management should have a significant amount of their compensation be paid in stock options and restricted stock awards. The board of directors should also be compensated in this way. Much of the performance of a company is driven by management. Without a solid framework governing actions, a company is exposed to the human flaws of self-interest. Every public company makes disclosures about their corporate governance practice online and in their financial statements. Review this information and question companies that appear to be lax. Those practices are your own personal safeguards against corruption, fraud and poor management. -- Reported by David MacDougall in Boston.