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Skin-in-the-game companies outperform

A new report by Macquarie Equities has found that companies with directors that have shares in the company generally outperform by more than 8%.

That’s something that we here at the Motley Fool have known for a long time. Directors tend to be more motivated to look after their shareholders when they have a significant stake in the company, given they will share in the costs and benefits of their decisions.

In a pleasing sign, Suncorp (ASX: SUN) announced last month that its directors would need to own more than $200,000 of the company’s stock. That could see a new trend start where shareholders push for directors to hold more shares in the companies they manage. We would like to see the trend take off, as owning shares in the company they manage makes directors more aligned with their shareholders. Suncorp has given its directors four years to comply with the policy.

The report also found that companies with directors with skin in the game tend to generate higher returns on equity. Higher returns on equity can be an indication of a company outperforming its peers.

Companies with directors with very few shares tend to underperform and that has been proven time and time again. There have been plenty of companies where directors get paid millions and underperform their peers and the market. In some cases companies have paid their directors bonuses despite meagre returns to shareholders and even negative returns. Shareholders have rightly decried directors’ remuneration in those cases, but it’s more a case of shutting the barn door after the horse has bolted.

So far this year a few companies have attracted first strikes from shareholders over their remuneration reports, including David Jones (ASX: DJS), iSelect (ASX: ISU), Aurizon (ASX: AZJ) and SCA Property Trust (ASX: SCP).

Foolish takeaway

Nassim Taleb, author of The Black Swan and Fooled by Randomness, says skin in the game is not just good policy but a moral imperative. Foolish investors may want to consider checking on directors’ shareholdings when looking at companies to invest in.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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