Markets are efficient until they aren’t, and nothing renders them less so than poor governance. You can build a beautiful model, interview customers, triangulate channel checks—and still miss the one thing that determines whether those future cash flows reach you: who’s actually in charge and how they behave when the lights dim. Governance is not a box to tick after valuation; it is the operating system that allocates power, information and accountability. The worst blowups rarely announce themselves with a single smoking gun. They whisper through patterns that—if you are listening—sound the same across industries and geographies. Five red flags in particular keep resurfacing.

First: Control without accountability

When governance goes wrong, it often starts with voting power that wildly exceeds economic ownership. Dual-class shares with no sunset, pyramidal holding structures, shareholder agreements that entrench founders or families, and golden shares sitting in the wrong pockets all create the same asymmetry: insiders can win without being right, and outside owners can be right without winning. The tell is not merely the existence of a control structure—many founder-led companies are exemplary stewards—but the refusal to time-limit it, the layering of additional entrenchment devices, and the degradation of basic shareholder rights along the way. Staggered boards, supermajority requirements for bylaw changes, and poison pills that never seem to expire turn a company into a fiefdom. Watch the annual meeting choreography: virtual-only meetings with curated questions, limited time for Q&A, and evasive answers about succession are not costless optics. They indicate a governing philosophy: information flows inward, not outward. When voting control outruns accountability, strategic drift can last years because there is no credible mechanism to course-correct.

Second: Pay that pays for the wrong thing

Compensation is strategy made measurable. If the scoreboard rewards revenue growth “ex-this, ex-that,” margin “adjusted for unusuals” that recur with metronomic regularity, and “strategic” M&A volume irrespective of value creation, the organization will supply exactly that. Red flags here are subtle and cumulative. Targets are changed mid-year “to reflect macro headwinds.” Option grants are repriced after a drawdown. Mega-grants appear when the stock is high and disappear when it is low. Clawback provisions are either absent or drafted so tightly they are ornamental. Pay outcomes decouple from total shareholder return over multi-year periods, yet the compensation discussion reads like a victory lap. Say-on-pay support sinks below the market’s already generous baseline, but the board “respectfully disagrees” and proceeds unchanged. The most telling paragraph in any proxy or annual report is the one that explains why targets moved after the fact. If the narrative is a series of exceptions, you are not reading a compensation plan—you are reading an insurance policy for management.

Third: A board that won’t say no

Independence is not a status; it is a posture. You can populate a board with people who meet every formal definition of independence and still end up with a room that never imposes a real constraint. The giveaways are attendance patterns, committee composition and time allocation. A combined chair/CEO role without a strong, empowered lead independent director, audit and compensation committees chaired by long-tenured allies, and directors who are simultaneously juggling four or five other boards all speak to a capacity problem. Industry knowledge matters, but so does distance from management’s worldview. Interlocking directorships—“you sit on my board, I sit on yours”—make honest disagreement costly. When the minutes are terse, risk oversight is described in boilerplate, and post-mortems on failed deals read like weather reports, you are looking at a rubber stamp. The healthiest boards have a habit of structured dissent: regular executive sessions without management, explicit “pre-mortems” before large capital commitments, and a succession plan that is more than a name on a slide. If you cannot articulate, from public disclosures, how the board monitors cyber risk, capital allocation and culture—and who, specifically, is accountable—assume those duties are ad hoc.

Fourth: Related-party gravity

The cleanest business can be muddied by side doors: leases with entities owned by executives’ families, “strategic” joint ventures where the economics drift into private pockets, consulting arrangements that always seem “immaterial,” and vendor or customer relationships that pivot around personal ties. This is “tunneling” by inches rather than by headlines. You will not usually find it in the press release; you will find it in footnotes, often under the dullest headings. The pattern is recurring amendments to agreements, proliferating special committees that convene and dissolve around transactions, and valuations blessed by advisers with oddly narrow mandates. Accounting can flag the smoke: swelling other receivables tied to affiliates, chronic “timing” differences that never time out, or cash conversion that lags peers despite similar models. The best companies over-disclose here because the easiest way to kill suspicion is to drown it in specifics. The worst hide behind materiality thresholds and legalistic phrasing. When disclosures get shorter as the web of relationships gets denser, assume the economic reality is drifting away from common shareholders.

Fifth: Opacity in the numbers

Non-GAAP metrics are useful until they are weaponized. Watch for ever-expanding lists of add-backs that transform ordinary costs into “one-time” adjustments, revenue recognition practices that migrate as soon as growth slows, and segment reporting that is reorganized so often you cannot track returns over time. Auditor churn is a major warning, as is a ratio of non-audit to audit fees that seems out of line for the complexity of the business. Late filings, material weaknesses in internal control over financial reporting, and restatements rarely arrive alone; they travel with executive turnover in the finance suite, CFO departures “to pursue other opportunities,” and a revolving door in the controller’s office. Equally important is whether people inside the organization feel safe to say hard things. Whistleblower hotlines that route to the legal department but not the audit committee, retaliation cloaked as a reduction in force, and internal investigations conducted by counsel that routinely report to management instead of independent directors all erode the signal you need most: bad news traveling upward quickly. Culture is not soft; it is an information system. If it is broken, your valuation inputs are fiction.

A critic might argue that these red flags are everywhere—that most companies exhibit at least one of them. That is precisely the point. Governance risk is probabilistic, not deterministic. One flag can be mitigated; two can be managed with a margin of safety; three or more compound into something you cannot diversify away. The job is not to demand perfection but to price the residual risk correctly and adjust your activism, engagement or avoidance accordingly. A founder with dual-class stock and a time-bound sunset who discloses metrics conservatively and welcomes tough directors is very different from a controller who entrenches for life, moves targets mid-stream, and keeps the board on a short leash. The labels may be identical; the outcomes are not.

How should an investor operate in this terrain without turning into a full-time forensic accountant? Start by treating governance as forward-looking, not retrospective. Read the proxy or remuneration report before you read the earnings release. Map the flow of authority in the company the way you would map a supply chain: who appoints whom, who pays whom, and who evaluates whom. Track say-on-pay and director election results over time, not in isolation; a trend from 95% to 80% support is a message even if the votes still pass. Note auditor tenure and the reasons given for any change. When the company asks for new authorizations—share issuances, bylaw amendments, acquisitions—ask what constraints they put on themselves in return. And when management tells you the numbers do not capture the real progress, fine: insist on the same alternative metrics, defined the same way, reported quarter after quarter, with clear bridges to GAAP. If those bridges wobble, belief should too.

Ultimately, governance is about the probability that capital entrusted today will be treated with respect tomorrow. The market has a habit of forgiving weak governance in bull runs, only to discover in the downturn that the cost of capital was mispriced. The red flags above are not theoretical; they predict where the bodies are buried because they describe the paths by which things go wrong. You do not need to be a crusader to avoid them. You need to be a skeptic with a memory, willing to connect footnotes to incentives and incentives to behavior. The payoff is not moral satisfaction; it is owning businesses where good news becomes cash and bad news travels quickly—while you still have time to act.