It’s hard to have conviction in a company’s direction without thorough knowledge of the people steering the ship. As such, we place a high priority on getting to know management teams before we invest with companies.

While much of what we learn from key executives comes from the hundreds of calls and face-to-face meetings we conduct each year, there’s also a lot of information hidden within proxy statements that gives a good indication of whether an executive is going to “think like an owner.”

This blog reveals some of the things we look at that help us gauge whether a board or management team’s interests are aligned with our own.

First, we strive to understand the nature of the management team’s incentive structures. Specifically, we prefer equity compensation over cash compensation because a high level of stock awards incentivizes the executive to take actions that will drive long-term shareholder value, not boost his or her paycheck in the near term. We also gauge how meaningful that compensation is relative to the executive’s overall wealth.

Peeling the onion back a layer, we like to see that equity compensation is awarded based on specific performance metrics such as earnings per share growth, return on equity, or other measures of efficiency.

Another item we look at is the portion of direct share ownership held by the board and its management team. If the company has a high degree of insider ownership as a percentage of shares outstanding, it is generally a good indicator that they have confidence in the business.

Insider buying and selling of stock, ex-option related activity, is another indicator of the team’s confidence. If management is buying stock, it is generally a bullish sign. If they are selling significant amounts, it could be a potential warning.

Finally, we also evaluate whether there are incentives for management to sell the business. For example, we like to see management receive multiples of their annual salary or bonus in an acquisition event. As part of this analysis, we also look at how many options or restricted stock management holds. Those awards typically vest during an acquisition and provide an incentive to sell.

None of these incentives are viewed in a vacuum. But pieced together and supplemented with conversations with the board or key executives, we can get a good feel for whether a management team is acting as a temporary leader, or a business owner who has the company’s long-term interests at heart.