Buffet On Boards — Thoughts & Analysis

On February 22, Warren Buffet released his annual letter to Berkshire Hathaway’s shareholders (note that the letter is to shareholders and not to stakeholders). In this letter there is a section entitled “Boards of Directors” in which Mr. Buffet offered some of his thoughts on the world of corporate governance. Because most of these comments are in alignment with my thoughts on governance and that were articulated in one form or another in my book Governance Arbitrage: Blowing Up the Pubic Company Governance Model to Maximize Long-Term Shareholder Value, I am addressing same in this article.

“Over the years, many new rules and guidelines pertaining to board composition and duties have come into being. The bedrock challenge for directors, nevertheless, remains constant: Find and retain a talented CEO — possessing integrity for sure — who will be devoted to the company for his/her business lifetime. Often that task is hard. When they get it right, they need to do little else. But when they mess it up…………”

Unfortunately, boards mess this up far too often and it costs shareholders huge sums of money. The leadership advisory firm ghSMART conducted the CEO Genome project over ten years, building a database of over 17,000 in-depth assessments and logging over 13,000 hours of interviews. They determined that there is clearly a costly misalignment between what it takes to get hired into the CEO role and what it takes to perform well. These same researchers went on to say that, even if the CEO is selected based on the right criteria, boards end up making decisions not objectively but through a distorted lens of power plays, group think and bias. The upshot? Research from PricewaterhouseCoopers shows that forced CEO turnover costs shareholders $112 billion annually on a global basis.

“During the first 30 or so years of my service, it was rare to find a woman in the room unless she represented a family controlling the enterprise. This year, it should be noted, marks the 100th anniversary of the 19th amendment which guaranteed American women the right to have their voices heard in voting booths. Their attaining a similar status in a board room remains a work in progress.”

I am all for women on boards. But, I am adamantly opposed to diversity for the sake of diversity. One of the more recent boards I was involved in restructuring ended up with 60% women and 40% men. However, and this is the critical point, we did not develop this board with the intent to have gender balance. Instead, we clearly defined the criteria needed for directors based on the industry and the specific value creation drivers of the company. We did not care who served on the board as long as they were the most competent individuals we could find. Further, the women who were selected had total clarity that they were selected based on their experience AND track records, i.e. on merit instead of as a part of the current overbearing push for diversity and inclusion. Analyze any public company board. With some exceptions, if the majority of the board does not have directors that fall into one of three competencies (industry, specific to the company’s value creation drivers and general value creation track record) then the selection process has been poor.

“Compensation committees now rely much more heavily on consultants than they used to. Consequently, compensation arrangements have become more complicated — what committee member wants to explain paying larger fees year after year for a simple plan? — and the reading of proxy material has become a mind-numbing experience.”

I address the same issue in Governance Arbitrage. Compare this to the simple yet high accountability inducing compensation plans for CEOs at the portfolio companies of the top private equity firms. Typically, CEOs and other management can earn a substantial amount but only if aggressive investment return hurdles are exceeded over a longer term basis. And, note that these companies, in every study I have seen, outperform their publicly traded peers over 5 year periods in the basic underling operating performance measures by wide margins. And there is wonder at why there have been massive flows of capital to the private markets and the material reduction in the number of public companies over the last 20 or so years.

In discussing the level of fees paid to “independent” directors Mr. Buffet addresses the desire on the part of many of these directors to seek another lucrative board role: “To achieve this goal, the NWD (non-wealthy director) will need help. The CEO of a company searching for board members will almost certainly check with the NWD’s current CEO as to whether NWD is a “good” director. “Good,” of course, is a code word. If the NWD has seriously challenged his/her CEO’s compensation or acquisition dreams, his or her candidacy will silently die. When seeking directors, CEOs don’t look for pit bulls. It’s the cocker spaniel that gets taken home.”

So true. I have experienced this personally on multiple occasions. In one situation a company was engaged in a road show for a secondary equity offering. The management team was bungling the road show and it looked like it might be a failure. The lead investment bank asked me if I could assist with the road show (even though I was not management) as I had a long track record of creating value in this industry as an owner/investor. I did and a number of the institutional investors to whom presentations were made agreed to invest with the condition that I be named to the board of the company. The CEO and other board members did a song and dance re adding me to the board. However, once the funds had been invested, they reneged on the board seat. The board felt that I would be a “disruptive presence’ in the boardroom. Translation: I would disrupt their low accountability, “when will this meeting be over so we can go to dinner” priority approach to “governing.”

“At Berkshire, we will continue to look for business-savvy directors, who are owner-oriented and arrive with a strong specific interest in our company. Thought and principles, not robot-like “process” will guide their actions. In representing your [shareholders] interests, they will, of course, seek managers whose goals include delighting their customers, cherishing their associates and acting as good citizens of both their communities and our country.”

There are three strong messages in the above paragraph. First, is that Berkshire always has and will continue to select directors not based on political correctness but on competence, track record and commitment.

Second, what will drive the Berkshire board is noted: “Thoughts and principles.” How refreshing. Regulators and perhaps even more so, the governance community, has inundated public company boards with an overwhelming “color by the numbers” approach to governance, little of which has anything to do with developing the full potential of the company.

The third message appears to be a veiled slap to the Business Roundtable’s new promotion of the “Stakeholder” model of governance. As I have pointed out in past articles and comments, one, of many, of the fallacies of the argument for a “stakeholder” model is that companies focused on maximizing shareholder value somehow ignore or treat their “stakeholders” poorly. If that is the case, then it is not due to a shareholder value model, it is due to incompetent directors and management. It is common sense that if a business genuinely is governed and managed to develop its full potential, i.e. maximize its value over time, this cannot be accomplished by dealing improperly with customers, suppliers, employees, the community and the environment. In short, this is exactly what Mr. Buffet is saying above when addressing the representation of the shareholders’ interests. Common sense business versus the BRT’s unworkable, “make everyone equal stakeholder model.”

The public company governance model may be one of the worst organizational entities in the history of business. That the world’s greatest capital allocator addresses some of its shortcomings should not be surprising and should be (but don’t wager real money on it) a wakeup call for disruption of this model.




Takeover entrepreneur, activist investor and author of Governance Arbitrage

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Henry D. Wolfe

Henry D. Wolfe

Takeover entrepreneur, activist investor and author of Governance Arbitrage

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