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The big investment sin I’m guilty of

As much as I want to worship myself as an exceptionally thorough and diligent investor the fact is I’m still guilty of one basic investing sin:

I haven’t adequately evaluated the CEOs and board of directors of some of the companies I own.

I can understand if it sounds like a weak confession, but the recent high-profile blow-ups of insurer CBL CORP FPO NZX (ASX: CBL) and digital media company Big Un Ltd (ASX: BIG) should convince you otherwise.

If we are going to risk our hard earned money investing in specific companies it is essential to understand who is controlling the company.

In the cases of both CBL and Big Un serious questions have been raised about the backgrounds of those in charge of the companies and the directors charged with their oversight.

In the case of insurer CBL it has been pointed out in New Zealand media that the company’s IPO document stated that one of the company’s directors had been involved in directorships of seven companies “which became subject to insolvency events”, while another was previously bankrupt.

In the case of Big Un the AFR’s Jonathan Shapiro noted that co-founder and CEO Richard Evertz was once convicted of impersonating a police officer and blackmailing people, as well as separately being found to have made “false and deceptive claims to individuals” by the Federal Court.

Although past failure isn’t always destined to be repeated, bad behaviour likely is. The problem is it can be difficult and time consuming to track down.

How to quickly evaluate a company’s governance

Going forward I’m resolving to be more thorough in my due diligence of management and directors.

A great starting point for identifying potential corporate governance issues is looking at the mix of independent non-executive directors on the board.

The role of directors is to represent investor interests and manage the conflict that occurs between company managers and investors so we want to ensure a strong representation of experienced, competent, independent directors. The CFA Institute advocates for an independent majority on the Board.

An independent director does not have a material relationship with the company or those running it allowing them to be more objective. This is especially important for small businesses where family and friends can sometimes end up in key board positions.

Doing the work won’t guarantee the company performs to expectations, but it is a crucial final layer of defence I think many people probably neglect.

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Motley Fool contributor Regan Pearson has no position in any of the stocks mentioned.

You can follow him on Twitter @Regan_Invests.

The Motley Fool Australia owns shares of CBL Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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