We’ve known a CEO or two or three, actually many, who’ve made mistakes—catastrophic mistakes that cost people their jobs and 401(k)s. But then, that is why there are boards of directors—to safeguard shareholders from disastrous CEOs, hire good ones, guide strategy, and keep management from wrecking companies and decimating shareholder value. Right?
As shareholders, that’s what we hope for, but it’s also what we should expect. Unfortunately, it’s not always what we get.
Frankly, boards of directors make costly decisions because they don’t do their jobs as individuals and as a board. You know some of the worst of them—Enron, Adelphia, Tyco, and WorldCom are notorious. The jury is still out on whether those failures were due to incompetence, corruption, or even criminal negligence on the part of board members.
Regardless, those and many more examples in recent years have shined a light on corporate governance, revealing the critical role the board of directors plays in creating (or destroying) shareholder value.
What Exactly is the Role of the Board of Directors?
Generally, the board of directors is elected by shareholders to fulfill their fiduciary duties and keep the best interests of their shareholders top-of-mind when making critical decisions for the company.
Among the more important decisions made by the board have to do with allocating capital, such as how profits should be used—to grow the business or returned to shareholders as dividends. Or should they be used to buy back shares to increase shareholder value? Or should they be used to acquire another company? These are critical decisions because of their impact on investment returns and shareholder value.
The Role of Shareholders
Members of the board of directors are elected by the shareholders. The board of directors decides who to hire (or fire) as CEO. So, theoretically, shareholders are at the top of the pecking order, holding board members accountable for their decisions, with the CEO reporting to the board.
While shareholders have limited power to intervene in corporate decisions, they can make waves with the board. When company performance declines, shareholders can and do step in to ask questions. They can ask questions anytime they want to affirm that the board and senior management are doing what’s best to increase shareholder value and keep the board accountable. Shareholders have a right to ensure the board of directors is on the same page as them concerning the company’s mission, vision, values, and culture.
However, sometimes shareholders don’t ask enough questions or not enough of the right ones, allowing the board of directors to get away with bad decisions. Before shareholders catch on, the damage is already done.
The Yahoo Fiasco that Ruined a Company
For example, you may remember the fiasco that engulfed Yahoo in 2007 when the board fired the CEO and hired the company’s co-founder Jerry Yang to turn the company around. But, Jerry Yang had zero experience running a company. During Yang’s tenure, highlighted by the company’s boneheaded decision to reject a $33 per share acquisition offer from Microsoft, the company lost tens of billions in value.
But it didn’t stop there. The board quickly hired and then fired a new CEO and replaced her with someone who resigned after three months for lying on his resume.
That was not just sheer incompetence; there was no corporate strategy to guide either the CEOs or the board, which was negligence. Where were the company’s shareholders that whole time? Were they paying attention, or were they misled?
The $50 Billion AT&T Debacle
A more recent example of corporate ineptitude was the AT&T acquisition of DirectTV. Essentially, AT&T spent nearly $70 billion on a bet it could become a dominant player in the digital media marketplace. After spending another $150 billion to make the merger work, the result is 55,000 lost jobs and a valuation of DirectTV, after it was spun off, of $17 billion, of which AT&T holds a 70% stake.
The deal was nothing more than trying to add growth for growth’s sake, taking AT&T well beyond its core business and comfort zone. But the company was stagnating, and shareholder value was at risk, only held in check by an unsustainably high dividend. So, it took a risk—approved by the board of directors.
When Boards of Directors go Rogue Shareholders Suffer
There’s a fairly common theme that runs through many of the corporate debacles. They tend to occur when business performance lags for a period of time, causing shareholder value to erode. That increases the pressure for management and the board to make something happen quickly, for which they must increase risk and make bold decisions—often self-serving decisions.
If a company believes that it has to acquire itself to profitability or growth, it raises the question of how sound or viable is its core business. That’s when an acquisition, such as AT&T’s, appears more speculative than a smart investment decision. Acquisitions made in an attempt to turn a company around, generate cost savings, or make a hard pivot away from the core business, as in the case of AT&T, typically don’t work. Invariably in situations like that, the company destroys shareholder capital without making any further inroads with their core business.
When Boards of Directors Get it Right, Shareholders Flourish
If the board does its job by mandating solid operational performance and ensuring the right leadership team is in place, overseeing a sustainable long-term growth strategy prior to things going south, the need for risky decisions can be avoided.
Fortunately, there are many companies with boards of directors who get it right. You’ll recognize the difference because they understand that it’s their core business that got them to where they are, and their decisions shouldn’t dilute their strengths; instead, they should build on them.
As a case in point, you can look to Sturm Ruger (RGR), one of our holdings. Ruger is a high-quality company, one of the top gun manufacturers in the country. In 2020, Ruger acquired Marlin Firearms from the bones of a bankrupt Remington Outdoor. For Ruger, it was an opportunity to expand the market for their core business. And, with Marlin’s highly popular rifles, it was like adding a new line of products. The acquisition wasn’t just about building a bigger business; it was a targeted purchase that would increase their return on equity, which is a good thing for shareholders. That’s why the acquisition was successful.
So, we are not against acquisitions, which are major capital allocation decisions made by a board of directors. But it has to be done responsibly, with the right motives—not just to build a bigger mountain for the CEO to stand on.
Shareholders are Responsible Too
Shareholders also have a responsibility to the company—to hold the board of directors accountable for their decisions. They need to ask questions and, if they determine the board is violating their fiduciary duty to act in their best interests, they should be willing to vote board members out.
But the ultimate power shareholders hold over the board is their ability to divest themselves of the company’s stock—no sense riding on the back of a board intent on running the company into the ground.
