Lessons: Management Over-value Themselves

Per Wikipedia’s definition, “…illusory superiority is a condition of cognitive bias wherein a person overestimates their own qualities and abilities, in relation to the same qualities and abilities of other people.

People tend to think that they are of above-average intelligence while, statistically, at least half are not.

This is an all-too-human cognitive bias that is exhibited in listed companies by management teams that think that they are better, smarter and more valuable than they actually are.

Once again, by definition, half of all listed management teams are below average. Let that sink in.

I am yet to attend a results presentation, have a meeting or conversation with a management team or read a set of results or annual financial statements that do not highlight management as a company’s strength. At best, management does not comment on it and, at worst, management shout from the rooftops about how brilliant they are.

As I said earlier, half of all listed management teams are below average.

What is the harm in what is obviously healthy self-esteem? Well, it can end up being very expensive!

The harm can range, but let me list some of the more common risks of illusory superiority in a listed company’s management team:

Remuneration

The reality is that most listed Boards have “friendly” Remuneration Committees that determine their and management’s remuneration. In environments where the corporate culture either thinks that one or more of the Board/management are amazing, they tend to remunerate accordingly: i.e. generously.

This is merely an anecdotal observation, but arrogant management teams tend to accordingly overpay themselves.

To make matters worse, when shareholders reject rich remuneration schemes or complain, high-paid outside consultants are higher to find ways to justify the numbers. Surprise, surprise…but I am yet to ever see a Board-paid external consultant come to the conclusion that the Board/management that has just paid their fees is itself over-paid!

I’ll say this here and I’ll repeat it ad nauseam below, but the three most expensive letters in the market is: ego.

Risk-taking & Capital Allocation

Management teams that believe they are better than the market can sometimes talk themselves into taking on more risk than the market.

Talk to any professional trader and they will tell you the danger of over-confidence, yet you see this time and time again in the listed space when egotistical Boards take ludicrous risks (with shareholders’ money) with large acquisitions or bringing on major debt or even gigantic share buy-backs (or even rejecting generous take-over offers because they think they are worth more).

This becomes particularly true when management/the Board is not properly aligned with shareholders (Two-edged Blade of an Anchor Shareholder). Not just do they swing for the fences, but they do it with little to no downside to themselves if they are wrong!

Once again, the three most expensive letters in the market is: ego.

Circle of Competence

Finally–and related to the above point of poor capital allocation–over-confident management tends to over-estimate the size of their circle of competence.

In reality, even slightly-below-average management teams are probably quite alright at running their core businesses and, if that was all they stuck to, would do a fine job at delivering beta to shareholders.

It may be the pressures of the growth-hungry listed environment or the dark side of management (bonus/share) incentives, but over-confident management and Boards sometimes make large, dangerous and miscalculated acquisitions into areas that they should not have ventured. More importantly, these acquisitions are made outside of the capital allocators’ circle of competence, in which case they have no real advantage over anybody else here.

Sometimes these acquisitions look to be backward or forward integration, sometimes they are diversifications and–more commonly in South Africa–these look similar to their core businesses but exist in vastly different geographies that the management/Board obviously know little-to-nothing about.

(The moment South African Boards buy a large business abroad, they are probably the buyers of last resort. This is because all the well-connect, in-the-know local investors have already turned that investment down!)

Sometimes these gambles work out, but the odds are stacked against them and most end in tears…

Once again, the three most expensive letters in the market is: ego.

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