Walking on Water For the Rest of Us Mortals

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Expert Perspective by Grahall’s OmniMedia Editorial Board

The March 12, 2010 article “Closer Look at Berkshire’s Executive Compensation Policy” author Ravi Nagarajan says:  “Berkshire Hathaway’s 2010 Proxy Statement was released yesterday and… Mr. Buffett’s total compensation remained at $175,000 which included $100,000 of salary and $75,000 in director’s fees from the Washington Post… The $100,000 salary for Mr. Buffett and Mr. Munger has remained constant for 29 years, during which time inflation has eroded over 60 percent of the purchasing power of a dollar… Mr. Buffett has over 98 percent of his net worth in Berkshire while Mr. Munger’s family has over 80 percent invested in the company. Both men wish to set an example by ensuring that their fortunes move in lockstep with the results for investors…”

Although this stance is very admirable on the part of Messrs: Buffett and Munger, it is  a formula that would be neither commendable nor wise in most other companies.  Berkshire Hathaway is a conglomerate more than 50 separate companies from diamonds to shoes to furniture to energy to insurance. It spans a large number of the various industries and its stock is more akin to a broad based mutual fund or index fund than to an individual security.  There is no comparing Berkshire Hathaway to other large cap companies such as Freeport McMoran, Coach or Superior Energy who are single industry stocks. 

For CEOs of these more typical companies it would be foolish to have 98% of their personal net worth in the stock of their own company as the risk of unanticipated market or industry downturn could ruin the executive.  When Buffet and Munger tout the benefits of being aligned with shareholders they are also taking advantage of what few other company CEO’s can do which is to have significant diversification and therefore a thoughtful investment portfolio.  It is not just that the over concentration of personal wealth in a typical company is bad for the CEO, it is also our belief that a high concentration of CEO wealth in his own company stock can be unhealthy for the company and therefore shareholders as well.

As we shared on our blog “Too Much of a Good Thing”: “To some, diversification might seem contrary to the goal of having a CEO’s wealth tied closely to that of the company’s performance.  But we believe that CEOs can sometimes play it too safe.  This is a radical comment, we know, in today’s environment where excess risk on the part of some executives resulted in far-reaching economic problems.  But hear this out:  If a CEO has too much stake in his own company’s stock and is nearing his retirement, might it not be in his best interest to avoid risk — even appropriate risk — if he might not be around to benefit from the longer term outcomes?  And wouldn’t that be counterproductive to the shareholders and the company as a whole?”

And it is not just the CEO where excessive concentrations of stock can be an issue for the company.  In our blog “Bucking the Trend” we said:  “…the practice of concentrating a CEO’s and other executives’ personal wealth in the form of his own company’s stock is poor compensation strategy and worse business strategy. It can force the executives to change their approach from “offense” to “defense” and that might put the shareholders’ total capital at risk.” 

And although the “risk of risk aversion” might not be a problem for Berkshire Hathaway, we don’t think this is a good strategy for the vast majority of companies. 

A second consideration is the frequency with which companies should revisit their rewards strategies.  In new forthcoming research, Grahall found that the most successful companies revise their compensation programs as the company advances through the stages of development.  The structure appropriate for a start-up or emerging company would be far different from that of a mature organization.  Essentially, the rewards program needs to flex to the circumstances of the company and the economy. 

This is the 29th straight year that Warren Buffett has taken a salary of $100,000 from Berkshire Hathaway.  Based on the consumer price index, in 1980 $100,000 was worth 2 ½ times what it is today.  On March 19th, 2010 Berkshire Hathaway stock traded at $122,930 per share; in 1980 the stock price was around $340 a share.  On the whole, Mr. Buffett has done quite well even as inflation erodes the purchasing power of his salary.  A 36,000% increase in the Berkshire Hathaway stock price can buy a lot of groceries.  Even if Berkshire’s Board hasn’t modified its executive compensation policy, the market has essentially done that for them.  Mr. Buffett is making a far different pay now than 30 years ago.

But again we need to point out that Berkshire Hathaway is not a typical publicly traded company. We might all aspire to be Buffett and our companies to be Berkshire Hathaway, but since we aren’t and most won’t soon be, we would all be wiser to take a boat across a lake than believe we could walk on water.

Contact Grahall’s  OmniMedia Editorial Board at edie.kingston@grahall.com

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