VALUE: After Hours (S07 E16): Why Skin in the Game Changes Boardroom Dynamics

During their recent episode, Taylor, Carlisle, and Steven Wood discussed Why Skin in the Game Changes Boardroom Dynamics. Here’s an excerpt from the episode:

Steven: This is more speculation. I think the reason it works is when you have skin in the game, you treat the asset like your family, like you’re committed to it essentially. What that does is it brings you in the right brain. And so, it brings you into that whole brain management, because most boards are very left brain, KPI oriented. And so, that skin in the game does bring you over, I think, to the right and then you end up with a much more balanced view essentially. The best boards, unfortunately, it’s less than 20% of boards actually have active debates according to Harvard. But the best boards are–

Jake: The rest is just eating bagels or what’s the–

Steven: I have the stats. There’s an awesome HBR study. So, 46%–

Tobias: In those little sandwiches really sticks to the roof of your mouth?

Jake: Yes.

Steven: [laughs] So, 46% of boards are passive, 19% of boards are controlled by the CEO and only 14% of boards have mentorship relationships and only 12 of them have this relationship of a partnership. It took a few years at CTT for us to get there, but our boards are truly– They’re not tense, but it’s a– We are truly disagreeing and going in a massive debate. We have actually U-turned company policy within single meetings based on these debates.

That’s what companies should have. Unfortunately, only 25 of boards have that happening. That was with HBR. So, I’m guessing they’re probably even looking at best in class boards. So, I think there’s a significant unmet need to have ownership represented on boards.

Jake: Were you able to control for related party transactions? Sometimes there’s accusations where there’s economics being sucked out by a control shareholder by somebody who’s got a lot more power there?

Steven: So, in the academic universe, they’re like, “Hey, what are you bringing new to the table?” There have been studies, Jake, that talked about that– I think it was like more 1980s, 1990s. From that perspective, there’s a perfect weirdly U-shaped correlation to the ownership. So, the ideal sweet spot was I think around between 5% and 30% ownership where the controlling CEO, board member whoever it is, as an active check on them. So, when you get really low on ownership, the performance suffers. And then, when you get really high, also the performance suffers.

Jake: Corporate– [crosstalk]

Steven: I think that goes back to, speaking of the French company that we were talking about earlier Bolloré, it goes back to– You absolutely know on that board, no one is disagreeing with the found. And so, having that healthy ability to disagree is crucial.

I know this from Wally World from nano-cap land. There’s a lot of companies that are run by 30%, 50% holders that are really being mismanaged and are terrible. And so, you do need a healthy tension between stakeholders. Jake, there was also another study that looked at multiple stakeholders on board versus one. I think the sweet spot was three individual large stakeholders on the board led to that healthy tension and debate, actually. But I didn’t look at the related party thing necessarily for this one only because it had already been examined.

Tobias: Along the same vein, I’ve got a question here from one of the listeners. “Are there places where Owner operators are a clear disadvantage?? E.G. large family ownership in Korea?” He’s given us the example.

Steven: So, Korea hits into the study. Obviously, Asia-Pacific was the largest geography with obviously someone that’s 20% plus. When I looked at the last 30 years of data– Now, I cut the data in 2022. But when I looked at it, there was no relationship between higher levels and lower levels in performance. It was basically zero correlation between higher levels.

The Korean example is exactly the negative example that we were just talking about which is it’s almost always a full control situation where minority voices are totally irrelevant. I mean, not even considered. And so, you obviously enter into many of these where you’re trapped with someone that might not necessarily be “whole brain or best in class.”

It’s one of the major downsides. It’s why I think owner operators really deserve an active manager looking at at them as opposed to just buy them all, because there’s not– I would say, it’s not all great. It’s not all gumdrops and lollipops. Korea is a great example.

I’m an ex-US investor and so I’ve been watching Korea with great enthusiasm. I think the market is trying to take the steps that Japan took years ago. So, I think it should be on everyone’s watchlist that I don’t know if this closed behavior of the tribal are necessarily going to be there forever, because who knows with the political, how the political environment unfolds. But everyone is looking at the Japanese example with great interest. Because if your capital markets are constantly trading at a single digit earnings multiple by definition, your economy is playing with two feet handcuffed behind its back essentially.

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