Why we should want to see directors put their own money on the line: Gottliebsen

It’s time to stand up for public company directors. From time to time they are deservedly in the gun for strategic mistakes, lack of disclosure and other errors.

But in The Australian this week Rebecca Urban has opened up a new line of attack that is not only unfair but, if pursued, could over time discourage directors from buying shares which align their interests with shareholders. Under the heading “Directors Hit Gold in Takeovers”, The Australian says that directors are set to “pocket” more than $360 million in cash if the current rush of takeover deals get the go-ahead from investors.

Although it is not spelt out, the casual reader would smell a rip-off.

I know one investment manager who starts his analysis of companies by looking at whether the directors have “skin in the game” and in particular whether they have been buying shares. The strategy does not always work, but directors who have used their own savings to buy a worthwhile parcel of shares will have their interests absolutely aligned with shareholders.

Sometimes their shares are bought via some form of salary sacrifice or option deal, but even then they have reduced their free cash and put their money into corporate stock.

And unlike ordinary investors they can only buy and sell stock in small windows of time when the market is fully informed. If a bad report comes in they cannot bail out and all shareholders must be aware of any good news before directors are allowed to buy.

It’s true that when there is a takeover they win, but so do all the shareholders. Among those The Australian selects for special mention is Fairfax Media director Linda Nicholls, who is chairman of Healthscope, where it seems she used her own money to buy shares. There are few directors who watch the governance situation more closely than Nicholls and the fact that she risked her money on Healthscope shares and is now making a profit is a perfect illustration of the benefits of buying shares when directors are shareholders. In the Healthscope case the chief executive will also be a big winner. Hallelujah.

But Nicholls also illustrates how directors can lose money buying shares in their company. She is a director of Sigma and acquired part of her Sigma shareholding because a portion of her director’s fees were applied to buying shares on the market. Sigma has hit trouble and the directors have had to work long hours to restructure top management. Sigma directors have received a takeover offer, but long-serving directors would have been better to take their fees in cash.

You can criticise Sigma directors for strategic mistakes that led to the current situation. With or without shares they will do their best for shareholders, but if they have shares there is an added comfort that they will not simply recommend a low bid to get the company off their worry list. Once again their interests and shareholders’ interests are aligned.

To suggest there is a pot of gold is applying tabloid journalism to a broadsheet.

Finally, Harold Mitchell, who built the family company up, floated the electronic operation and then merged the two enterprises, will make a lot of money out of the Aegis takeover. And so he should.

This article first appeared on Business Spectator.