Separation of Powers

Separation of powers in the corporate world is a fundamental principle of good Corporate Governance. While the term might make you think of presidents and parliaments, its application in business is just as critical. It refers to the formal division of authority and responsibilities among a company’s key decision-making bodies, primarily its management (led by the CEO), its Board of Directors, and its owners (Shareholders). The goal is to create a system of checks and balances, ensuring no single individual or group can wield unchecked power. A strong separation of powers prevents conflicts of interest, promotes accountability, and protects the long-term interests of the company and its investors. Think of it as the corporate constitution that stops a powerful CEO from becoming an unaccountable monarch.

For an investor, understanding a company's power structure is just as important as understanding its balance sheet. Weak governance can lead to disastrous decisions that destroy shareholder value, while strong governance acts as a powerful safety net. The core issue it addresses is the classic 'agency problem'.

The Agency Problem describes the inherent conflict of interest between a company's management (the “agents”) and its shareholders (the “principals” or owners). Management might be tempted to act in its own self-interest—for example, by awarding themselves excessive pay, using company funds for lavish perks, or pursuing ego-driven acquisitions—rather than maximizing long-term value for the owners. A robust separation of powers is the best defense against this. An independent and engaged Board of Directors, for instance, can challenge the CEO's strategy, set reasonable compensation, and veto value-destroying projects. This oversight forces management to stay accountable to the people whose capital they are managing: the shareholders.

Spotting a weak separation of powers isn't always obvious, but there are some classic warning signs every investor should look for.

This is the number one red flag. The CEO is the top manager responsible for running the company's day-to-day operations. The Chairman is the leader of the Board of Directors, whose primary job is to supervise and hold the CEO accountable. When one person holds both titles, it's like a student grading their own exam. The board's ability to provide independent oversight is severely compromised. While some legendary founders like Warren Buffett at Berkshire Hathaway have successfully held both roles, for the vast majority of companies, it’s a sign of a potential governance weakness.

A board is only as effective as its members. If the board is filled with the CEO's close friends, family members, or long-time business associates, it’s unlikely to provide any meaningful challenge. This is known as a “rubber stamp” board because it simply approves whatever management puts in front of it. Investors should look for a board composed of a majority of independent, outside directors with diverse and relevant experience. You can find this information in the company's annual Proxy Statement.

For followers of Value Investing, good governance isn't just a “nice-to-have”; it's a critical component of a company's intrinsic worth. Value investors seek to buy wonderful businesses at fair prices, and a “wonderful business” is almost always a well-governed one. A company with a poor separation of powers carries a hidden, unquantifiable risk. An all-powerful CEO could misallocate capital on a whim, overpay for a foolish acquisition, or fail to adapt to changing market conditions because no one dares to question them. These actions can permanently impair a company’s earning power and destroy capital. Conversely, a strong separation of powers functions as a kind of “governance moat” that protects the business. It ensures that major decisions are debated, that capital is allocated rationally, and that the company is managed for sustainable, long-term success. This alignment between management and shareholders is precisely what value investors look for.

The best place to investigate a company’s power structure is its annual Proxy Statement (often filed as a 'DEF 14A' with the U.S. Securities and Exchange Commission). This document is sent to shareholders before the annual meeting and contains a wealth of information, including:

• Biographies of all board members and their status as 'independent'.
• Details on whether the CEO and Chairman roles are separate.
• Information on key committees, such as the Audit Committee and Compensation Committee.
• Executive compensation details.

Reading the proxy statement is a crucial due diligence step. It tells you the story of who holds the power and how they are held accountable—a story that is often far more important than a single quarter's earnings report.