Quality of Management — 3 — The BS Filter

In Part 1, I ended with Phil Fisher’s line — “Getting to know management is like getting married — you never really know the girl until you live with her.” In Part 2, I argued that capital allocation is the one dimension of management quality that is genuinely knowable from the numbers. But that still leaves the harder question unanswered: what about everything that isn’t in the numbers?

Most of us will never ‘live with’ the management of the companies we invest in. We will never sit across the table from them in an unscripted moment. We will never watch how they behave when the auditor pushes back, or when a key customer walks away. We get the conference call, the annual report, and the carefully curated investor presentation. In other words, we get the performance — not the person.

So how do you fine tune your BS Filter?

#The Context Problem

Before we even get to filtering what management says, we need to confront a deeper issue — are we even measuring the right thing?

Christopher Mayer, in 100 Baggers, nudges us toward an uncomfortable truth. The CEO who delivered spectacular results in a turnaround is not the same CEO in a growth phase. The context changed. The person didn’t. And yet, we as investors carry forward a mental model of ‘good management’ that was forged in an entirely different environment.

Pulak Prasad puts it more directly in What I Learned About Investing From Darwin — “An exceptional CEO was impressive in a certain context with a certain business — this context and this business are different. How are we to know that the new CEO, faced with a set of challenges they have almost certainly never met before, will do what they are promising to do? We don’t.”

This is the context problem. Don’t elementalize — don’t separate the CEO’s performance from the company and market context in which that performance occurred. The same person can look like a genius in one setting and a mediocrity in another. Date your assessment regularly. The management you evaluated two years ago may no longer be the management you own today — not because the people changed, but because the landscape did.

#The Six Filters for Truth

If we accept that management quality is partly unknowable, then the next best thing is a good filter for sorting signal from noise. Scott Adams, of all people, offers something useful here. In How to Fail at Almost Everything and Still Win Big, he lays out what he calls the Six Filters for Truth:

Personal experience (human perceptions are iffy)
Experience of people you know (even more unreliable)
Experts (they work for money, not truth)
Scientific studies (correlation is not causation)
Common sense (a good way to be mistaken with confidence)
Pattern recognition (the most useful, but the hardest to master)

Adams’s punchline is devastating — each one of these is a complete train wreck. And yet, we mortals need to navigate the world as if we understood it.

Now apply this to corporate India. When management tells you on a conference call that ‘the demand environment remains robust’ or that ‘we are cautiously optimistic about the next quarter’ — which filter are you using? Personal experience? You haven’t run their business. Experts? The sell-side analyst asking the question is working for a fee. Common sense? That’s how most investors end up mistaken with confidence.

The only filter that has a fighting chance is pattern recognition — and it only works if you’ve built the pattern library over years of watching what management does after they finish saying things. That is the BS Filter from Part 2 in practice. The conference call is the input. The capital allocation decisions that follow are the output. The gap between the two is where your filter earns its keep.

#Reciprocity as a Proxy for Integrity

But what about integrity — the thing Buffett called the first quality you look for in someone you hire? Capital allocation tells you about competence. The BS Filter helps you track consistency. Neither directly measures integrity. And integrity, by its nature, reveals itself only under pressure — which means you usually discover its absence too late.

Is there any proxy that gets us close?

Richard Thaler’s Misbehaving offers one. In his work on fairness and cooperation, Thaler (drawing on Matthew Rabin’s reciprocity theory) shows that humans are conditional cooperators. People are willing to cooperate if enough others do. But if they sense that they’re playing with free riders, cooperation collapses.

The insight for investors is this: companies with strong reciprocity cultures produce observable markers. Voluntary turnover tells you whether people choose to stay when they could leave. Employee satisfaction scores — the genuine ones, not the curated Glassdoor posts — tell you whether the internal contract feels fair. Institutional knowledge retention tells you whether the organisation is a place where people build careers or merely collect paycheques.

These are the closest we get to measuring the unmeasurable. A management that treats its employees fairly, shares the gains of success, and doesn’t gouge during hard times — that is a management exhibiting reciprocity. And reciprocity, as Thaler’s experiments show repeatedly, is the foundation of sustained cooperation.

A company where talented people voluntarily stay, even when headhunters call, is telling you something that no conference call ever will.

#The Horse, The Jockey, and the Final Admission

After three posts, we arrive where Buffett did — “When management with a reputation for brilliance meets a company with bad economics, it’s the reputation of the company that remains intact.”

The horse usually matters more than the jockey. But knowing that doesn’t mean the jockey is irrelevant — it means you need to know which questions are worth asking. And the answer, after all of this, is fewer questions than you’d think. Can you track what they do with capital? Yes — that’s knowable. Can you filter what they say from what they do? Yes — but only with a pattern library built over years. Can you measure their integrity directly? No — but you can watch for the markers of reciprocity that reveal it indirectly. This is another test of Management Quality that you can use as a ‘hack’.

Everything else — the charisma, the vision statements, the confident projections about the next five years — is noise. Expensive, seductive noise.

#The Wealth Creation Inversion

Jeff Bezos, in an interview at The Economic Club Of Washington (9/13/18), said something that has stayed with me — “Somebody needs to make a list where they rank people by how much wealth they’ve created for other people. Instead of the Forbes list, which ranks you by your own wealth.”

That is the ultimate test of management quality. Not how much the promoter is worth, but how much wealth the promoter has created for everyone else — employees, shareholders, customers, the ecosystem. And here’s the catch: this metric is only knowable in hindsight. You cannot rank management by wealth created for others while they are still creating it. You can only see it when the story is done.