Why ethical management teams are the best kind

Most successful investors will testify to the fact that selecting outperforming stocks is as much about identifying high quality management teams as it is about analysing the numbers, arguably more so. With outperformance in mind, one of the leading indicators of a high quality management team is their ethics. It’s an area worthy of investor attention.

Integrity is the basis of ethics

Integrity is the basis of ethics in the business world and all other spheres. In the words of C.S. Lewis, “Integrity is doing the right thing, even when no one is watching.”

Doing the right thing when no one else is watching is self-explanatory to those who have integrity, but what many successful investors are aware of is that ethics imply so much more about a person than the single decision which reveals their ethics to the world.

When business ethics are showcased in all their glory, investors are simply catching a glimpse of the tip of the iceberg of management’s worth. In the words of Henry Kravis, “If you don’t have integrity, you have nothing. You can’t buy it. You can have all the money in the world, but if you are not a moral and ethical person, you really have nothing.”

What ethics look like in the corporate world

With the boom in ESG-focused assets in recent years, some investors may look to ESG scores, or rather G (governance) scores for a measure of a management team’s business ethics. Whilst that’s a useful backdrop to cross-reference, the more useful measure of ethics is management action and behaviour at the coal face.

Let’s be honest about the process through which ethics are revealed… Ethics are usually showcased during times of challenge which require difficult decisions to be made. So the number of useful ethics-revealing data points can be disparate and varied in the corporate world.

Here’s a great example of what to look for.

Years ago, Costco was struggling to fund its employee healthcare plan in the face of rapidly rising healthcare costs. Management had committed to funding 95% of employees’ healthcare costs through the company’s healthcare plan, but they feared they wouldn’t be able to afford to do so because of those rising costs. So Costco’s management told employees at the time that they’d only be able to fund 90% of their healthcare costs in order to make the numbers work. But then, come the end of the year, they discovered they could have indeed funded the full 95% of their employees’ healthcare costs after all. So they faced a tough choice. They could either keep all those extra millions of dollars they’d saved, or they could be honest with their employees and distribute the excess funds to them as initially promised.

Costco management revealed their integrity by doing the ethical thing. They made the decision to pay out the excess funds to employees. As Jim Sinegal, the co-founder and former CEO of Costco explained at the time, “We felt that our word to our employees was much more important than the money that was involved in this. And it was significant to them relative to their life.”

There’s no arguing with that. And there’s no arguing with the fact that Costco management showcased their quality to the investment world in a way most investors will never forget.

Ethics are the basis of good business

It won’t surprise most investors who followed the Costco healthcare fund story that the stock has been one of the strongest performers in the S&P 500 since then. That success didn’t come about because of the decision management made to do the right thing with the healthcare pay-outs. It happened because Costco’s management are high quality.

That one ethical decision was merely a glimpse of their thinking which was focused upon supporting their customers, employees, and investors on their journeys to the best of their ability. That’s value creation in all its glory, and it’s at the very heart of all successful businesses.

So ethics aren’t just a nice-to-have, a box-ticking exercise aimed at achieving a higher ESG score, or a fluffy concept debated by MBAs from the comfort of university. Ethics are core to business success in the real world.

Ethical management teams are the best kind

Whilst the equivalent of the Costco example doesn’t always present itself to investors hoping to learn more about management teams prior to investing, it’s worth being aware of the importance of ethics when assessing management quality.

Ethics are of vital importance to great management teams, and are often a leading indicator of businesses which are positioned to create significant value for their stakeholders and thus outperform over the long term. Remember, actions speak louder than words.

Disclaimer: This article is prepared by Simon Turner. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.