You will be able to judge whether management is paid to grow value per share or just size.
Larkspur bought its coatings business four years ago. The chairman's letter called it a step towards diversification. Marcus, reading the remuneration section for the first time, found a simpler explanation: the chief executive's bonus was tied to revenue growth, and the acquisition added about S$60 million of revenue overnight. It also added S$30 million of goodwill and a segment that, as lesson 6.4 showed, earns almost nothing, and the bonus paid out in full that year.
People do what they're paid to do. Before you trust management to grow the value of your shares, check what they're actually paid for, how much of the company they own, and whether anyone controlling the company does business with it on the side.
SGX annual reports include a remuneration section in the corporate governance report, which discloses directors' and top executives' pay, often in bands, and describes the performance measures behind bonuses and share awards. For US companies, the detail sits in the proxy statement under a section usually headed compensation discussion and analysis.
The totals are what newspapers report. For an analyst the measures matter more, because a pay figure tells you what management earned last year while the measures tell you what behaviour the board is paying for in future.
Larkspur's made-up plan had two parts. A yearly cash bonus paid on revenue growth and EBITDA against budget. And a performance share plan granting shares that vest after three years if revenue grows by a set compound rate. Neither measure mentions profit per share, cash flow or return on capital.
Measures based on size, such as revenue, EBITDA, assets under management or store count, can be grown by spending shareholders' money. An acquisition adds revenue at once, whatever price was paid. Issuing new shares to fund growth adds EBITDA while each existing share owns less. Borrowing heavily adds both, and the risk lands on shareholders.
Measures based on value per share are harder to game. Earnings per share, free cash flow per share and return on invested capital all fall if management overpays for growth. Total shareholder return against a peer group ties pay to what holders actually received. A plan that uses one of these, measured over three years or more, rewards the behaviour you want.
The best plans combine a value measure with a long vesting period and a requirement for executives to hold shares after they vest. The worst pay large bonuses on one-year revenue or EBITDA targets, set each year by a board that can lower the bar after a bad year.
Larkspur's plan sat near the bad end. That didn't mean the coatings deal was made for the bonus. It meant nothing in the pay plan would have stopped it.
The other side of incentives is ownership. A chief executive who holds shares worth several times their salary feels a fall in the share price the way you do, while one who holds almost none can treat it as somebody else's problem.
The annual report's shareholding statistics list substantial shareholders and directors' interests. Larkspur's founding family held 55% of the shares, and the chief executive, the founder's son, held a further 2% directly. That's strong alignment on the share price, though, as the next section shows, a controlling family can have interests beyond it.
Directors and substantial shareholders of SGX companies must disclose when they buy or sell shares, and those notices appear on SGXNet. US insiders file a Form 4 with the SEC, searchable on EDGAR. Selling is weak evidence on its own, because executives sell for tax, diversification and school fees. Buying with their own money in the open market is more telling, because there's usually only one reason to do it. Several insiders buying in the same month is worth a note in your log.
Many SGX companies are controlled by a founding family, a parent company or a government-linked holder. Control can be a strength, with a long view and no pressure from quarterly targets. It also creates a risk that the controller does business with the company on terms that favour the controller.
SGX's listing rules call these interested person transactions and set out when they must be announced, when they need independent shareholders' approval, and how they must be disclosed in the annual report. Many companies obtain a general mandate from shareholders for routine dealings and then list the totals each year.
Larkspur's made-up annual report, on page 170, showed one: it rented a warehouse in Malaysia from a company owned by the founding family, for about S$1.2 million a year. That's small against its revenue of S$400 million. The questions to ask are whether the rent is at market rates, whether the amount is growing faster than the business, and whether new dealings keep appearing. One small lease is ordinary in a family-controlled company, whereas a list that grows every year, or a large asset bought from the controller at a price set by the controller, is the pattern that has hurt minority holders.
Marcus's summary for his log read: "Management owns a lot of shares, which helps. Pay is tied to revenue and EBITDA, which rewards size. One small related-party lease. Watch for acquisitions." Now write down the performance measures in your chosen company's pay plan, and mark whether each one rewards value per share or just size.
Write down the performance measures in your chosen company's pay plan and whether each rewards value per share.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).