Why a great company can be a bad investment

INVESTORS deciding where to deploy their money ask questions that are familiar: How fast is the company growing? What are its margins? How strong is its balance sheet? What is the valuation?

But before looking at the price-to-earnings ratio, perhaps we should ask: Who is really in control?

A good business is not necessarily a good investment. Investors should consider the quality of a company’s governance as part of the risk-return equation, rather than treat it as a footnote to financial analysis.

A claim on the business

Imagine two companies with similar businesses, growth rates and profits.

Company A has one class of shares, a genuinely independent board, meaningful voting rights for minority shareholders and clear accountability between management, the board and shareholders. 

Company B is controlled by a founder with a relatively small economic stake, but significantly greater voting rights and considerable influence over the board.

Should the two companies necessarily trade at the same valuation? I would argue that they should not. 

The second company may have an excellent business, exceptional growth and a brilliant founder, but investors are not simply buying the business; they are buying a claim on it. 

The value of that claim depends on not only the company’s ability to generate profits, but also how well shareholders’ interests are protected.

Founder control is not always bad

There is nothing inherently wrong with founder control. 

Some of the world’s most successful companies have been built by strong founders with a clear vision, and larger voting control can sometimes protect a company’s long-term strategy from short-term market pressures.

Dual-class shares can therefore have a legitimate purpose.

The problem, in my view, is not control itself, but unaccountable control. If shareholders provide the capital but have limited ability to challenge management or the controlling shareholder, who protects them when the founder gets it wrong?

The recent debate over SpaceX has brought this tension into sharper focus, with Elon Musk retaining substantial voting control over the company. 

The question is not whether a founder is a great entrepreneur; it is whether visionary entrepreneurship should automatically justify more shareholder control. Those are two different things.

Go to the AGM

There is something investors can do that requires no sophisticated financial model: attend the annual general meeting (AGM). 

I often remind participants in my investment and governance lectures that if they really want to understand a company, they should attend its shareholders’ meeting.

An annual report can tell us a great deal about a company’s financial performance and formal governance structure, but it cannot always tell us how people actually behave in the boardroom. 

At an AGM, an investor can observe the dynamics: How does the controlling shareholder behave? How does the chairman handle difficult questions?

Does the management answer questions directly or become defensive? Do the non-executive directors participate, and do independent directors seem engaged?

These observations may not appear in the annual report, yet they can tell an investor a great deal about the company’s culture. 

A company may have all the right boxes ticked on paper – independent directors, audit committees, governance policies and detailed disclosures – but governance is ultimately about what happens when people disagree. 

An investor can sometimes see that at an AGM.

Governance is a risk

Having spent many years in investment banking and on company boards, I have come to appreciate that the quality of a business and its governance are two different things. 

This is why I believe governance should be part of an investor’s risk assessment. Perhaps, investors should even think about a “governance discount”, much as they think about a liquidity discount or country-risk premium. 

I do not mean this as a mechanical formula, but as a simple question: If I have less control, less information and fewer avenues of recourse, am I being adequately compensated for the additional risk?

Investors who dislike a company’s governance structure can simply walk away.

They are free to decide that the potential returns are not sufficient compensation for the governance risk, and different investors may reasonably reach different conclusions.

Ultimately, governance comes down to the board. 

Can independent directors constructively challenge the chief executive when necessary? Can the board question the controlling shareholder, when the company’s interests and minority shareholders’ interests diverge? 

Is the board prepared to act, if the person who created the company’s success eventually becomes a source of risk?

A good board is not one in which everyone agrees. It is one in which directors are prepared to disagree constructively when it matters, and those disagreements can be resolved for the long-term interests of the company and all its shareholders.

That can be difficult to assess from a distance, which is another reason an AGM can be so revealing.

Good governance protects value

Hence, when we assess whether a company is a good investment, perhaps we should look beyond its earnings, growth and valuation.

Financial statements tell us what happened, but they do not always tell us how decisions are made or who has the greatest influence over how profits are used.

A great entrepreneur can build a great business, but investors are not buying the entrepreneur; they are buying a stake in the company. 

So the next time we consider an investment, perhaps it is worth doing something that requires neither a Bloomberg terminal nor a complicated valuation model: Go to the AGM, watch the boardroom, listen to the questions and observe how people respond.

Then ask: Who is really in control, and what happens if they get it wrong?

A good business can create value, but good governance helps determine whether that value can be protected and shared.

The writer is a CFA charter holder and a retired investment banker.

The commentary is based on the writer’s experience, observations and argument. AI tools were used as part of the research and writing process. The writer remains fully accountable for the commentary’s accuracy, originality and final form.