What are the characteristics of good business leaders? Honesty, financial responsibility and a focus on rewarding shareholders are surely key attributes.

In my mind, management acumen and integrity is probably the most overlooked  aspect that underpins a company’s success. Here’s a closer look at how bad management can sour your investment.   

Freeport-McMoRan, Inc. (NYSE: FCX) is a $24 billion (in market value) diversified commodities producer. It owns copper and gold mines along with oil and gas properties.

#-ad_banner-#The slump in both metals and oil prices has been a double whammy for this company, but commodity prices will fluctuate through cycles. The key is how Freeport-McMoRan handled the slump, which has negatively impacted investors’ returns.

In the first quarter of 2015, the company announced a huge write-down in the value of its oil and gas assets and announced it was considering selling or spinning parts of that division off to “unlock shareholder value.”

The truth: the company’s foray into oil and gas was a disaster from the start. A decision to acquire McMoRan Exploration, a former subsidiary, was an unwise move.

Even though crude oil prices were high in 2012, McMoRan Exploration was in trouble and running out of cash. Luckily a knight in shining armor appeared. Freeport-McMoRan announced it would acquire McMoran Exploration for close to $15 dollars per share, an generous premium to the $7-to-$8 a share that McMoRan Exploration was trading at a week earlier. Investors disliked the deal so much that shares of Freeport-McMoRan fell more than 16% on the day the deal was announced.

Worse still, there were major conflicts of interest in the deal. Many people in senior leadership positions at Freeport-McMoRan, like James Moffett who was chairman of both companies, had significant stakes in McMoRan Exploration. The high cost of the deal was in essence a generous gift from the shareholders of FCX to him and other top executives of McMoRan Exploration.

So why is Freeport-McMoRan getting out of oil and gas now? It looks like the company may not have any choice but to sell. But the timing undermines the first rule of investing: buy low and sell high. Freeport-McMoRan is taking the opposite approach here, selling when crude oil is near its bottom.

Freeport-McMoRan has been selling other mining assets and recently slashed the dividend 84% to conserve its fast-dwindling cash pile. The company has almost $20 billion in net debt and most of its cash is overseas, meaning it would get hit with a large repatriation tax bill should it need to bring that cash home.

Freeport-McMoRan’s management is expected to deftly navigate the commodity price swings, but have proven to be ill-suited to the task, at least thus far. The balance sheet is in rough shape and engaged in ethically questionable deals. What’s not to like?

Another company with problems in the C-Suite is Prospect Capital Corp. (Nasdaq: PSEC). Prospect Capital is a business development company, or BDC, whose primary business is to make loans to mid-size companies. Such loans are generally higher-risk and most banks prefer to avoid them.  

Like Freeport-McMoRan, the management of Prospect Capital has made rewarding themselves a priority over rewarding shareholders. Unlike Freeport, the management team of Prospect Capital aren’t actually employees of Prospect Capital.

A common management structure for BDCs is to have an “external manager” to control the assets and make investment decisions on behalf of the company. For its services, Prospect’s external asset manager charges a hefty 2% fee based on assets under management.

As you can imagine, a manager paid based on assets under management is incentivized to increase assets under management, regardless of whether their actions make economic sense for shareholders.

Prospect Capital’s is notorious for issuing shares when the stock is trading below net asset value. A BDC is a lot like real estate investment trusts in that it is required by law to pay out nearly all of its investment income as a dividend. This means BDCs have to issue shares to grow.

BDCs that are well managed and create value for shareholders usually trade at a level equal to or greater than net asset value. When the BDC issues shares at face value and use the cash to make additional profitable investments, both the new and old shareholders win.

However, when a BDC has assets worth $12 per share and issues new shares at $11, current shareholders are essentially subsidizing the new shareholders.

Such action could be justified in rare circumstances. For instance, if there was a tremendous investing opportunity that the potential returns would justify the dilution. However, Prospect Capital’s management has not delivered much in the way of gains for investors: net asset value and net investment income have languished since 2010.

So despite diluting the stake held by existing shareholders several times over the last few years (including three separate instances in 2014), Prospect’s investing performance hasn’t justified the dilution and has simply created a larger asset base on which to collect its hefty fee.  

Prospect Capital’s most recent misstep was to completely mislead shareholders about the safety of its dividend. After announcing Q3 2014 results, many investors spotted a payout ratio in excess of 100% for five straight quarters and realized that a dividend cut was inevitable.

That cut was finally announced in December 2014, just a month after declaring on the Q3 conference call that a cut wouldn’t be needed. The announcement was also just days after the annual shareholder meeting in which management obviously knew that it would soon be cutting the dividend. The deception by management around this event is just the latest in a long line of moves that have little regard for the owners of the company.

Just as high quality managers like Warren Buffett and Tom Malone make their shareholders rich over time, it also works the other way. Low quality managements will lose money for investors as Freeport-McMoRan and Prospect Capital have done.

Risks to Consider: Both Freeport-McMoRan and Prospect Capital have been beaten down, and a convincing case can be made that these are value plays with upside. Prospect Capital is selling below its net asset value and Freeport-McMoRan could rebound if commodity prices rise. But ask yourself, “Why would I trust these managers to deliver market beating returns over the long term?”

Action To Take –> Fill your portfolio with quality companies with management teams that have shown they can deliver for shareholders.

If oil, natural resources or commodities are what interests you, look no further than StreetAuthority’s Scarcity & Real Wealth. Our resident natural resources expert Dave Forest has more than a decade’s experience as a trained geologist and analyst. His industry insight allows him to read the markets and provide the most timely, potentially lucrative advice for everything from oil and gold to molybdenum. Most recently, Dave has been talking about a rally in gold prices. To gain access to Dave’s latest research, click here.