Warren Buffett has always been concerned about management, its roles and how it performs.
.There is a supreme irony in terms of business management: It is much easier for an inadequate CEO to keep his job than for an inadequate subordinate. A CEO who does not perform well is carried for countless years.
Why is it that possible? Simply because there are no performance standards for his job.
The CEO has no immediate superior who can measure his performance.
Although the CEO´s boss is the board of directors, the latter seldom measures his performance.
The board of directors does not get into any trouble. If they hire an inadequate CEO and he makes a mistake, they don´t worry. If the mistake is a serious one and results in a takeover, directors will probably profit from it.
An important issue for Buffett in terms of management is the relation between the Board of Directors and the CEO. They should be congenial. However, that is not always the case. It is very frequently seen how directors criticize CEO´s performance at board meetings. That is not well seen at all.
What happens in Berkshire Hathaway (BRK.A, Financial)(BRK.B)? How is it managed?
Buffett has a very clear idea. He knows that his and the vice chairman´s job is to attract and keep outstanding managers.
Indeed, they have never had such difficulty in Berkshire. Usually managers came with companies Buffett and Munger (the vice chairman) bought. This is because they demonstrated talent throughout their careers.
Managers chosen by Buffett become managerial stars long before Warren gets to know them.
He does not like managers who pursue acquisitions or perform any activity for reasons other than the good of the company.
Another important issue is that the managers chosen by Buffett tend to be independently wealthy. This generates no threat to their permanent interest because they love what they do and work accordingly. They are not thinking how much money they will make and can achieve outstanding performance.
Furthermore choosing the right players will always make a team manager look good.
A by-product in managerial style is the ability it gives Buffett to expand Berkshire´s activities.
For a long time, Buffett has always tried to work with people he likes and admires.
At Berkshire annual meetings, Warren Buffett sometimes mentions that he would forgo a profitable opportunity if pursuing it meant forging a partnership with someone whom he did not trust. In other words, if you are suspicious of the CEO, you should not invest in that companyâs stock.
When investing for the long run, the quality of management â including integrity â is more important than current profitability, because profitability canât be sustained if management quality is poor. Here are a few signs of a good CEO, based on Buffettâs thoughts.
First and foremost, track record matters a lot. To the best of my knowledge, all Berkshire subsidiary CEOs have a proven track record in their respective companies or in the same industry. Buffett is unlikely to hire a person from one industry to run a company in another industry. This coincides with his principle of staying in your circle of competence.
Maybe this was one reason why Robert Nardelli was not successful at Home Depot. In 2000, he became CEO of Home Depot after successfully running General Electricâs mines and locomotive businesses, but Nardelli lacked retail experience. In 2007, he was asked to resign from Home Depot â only to be appointed as the Chrysler CEO several months later! In 2009, when Chrysler filed for bankruptcy, he agreed to resign from his position by the end of the bankruptcy case.
Second, CEO compensation should be examined for abuse. Nothing is wrong with paying CEOs well, but to pay them exorbitantly may indicate a lax corporate governance culture. At Home Depot, Nardelliâs problems probably started with the fact that he was from a different industry but that he had also negotiated a generous compensation contract.
He had access to several corporate jets and other expensive benefits, for which he was criticized. Nardelliâs compensation was so well designed that when he left Home Depot, he received a $210 million severance package, despite presiding over a 40 percent decline in the companyâs stock price. Highly paid CEOs also create a money-minded culture in the organization. Such CEOs do not command respect from employees, and when companies fall on hard times, they cannot possibly lead effectively. Such organizations are not likely to do well for shareholders in the long run.
Third, a CEO should have a conceptual framework that he or she can articulate well. You should listen carefully to a CEOâs answers at public meetings or conference calls (all analyst conference calls are now open to the public). For example, if a CEO expands the company into a new business in which he or she lacks expertise, how does he or she explain
this decision? You should examine the explanation carefully. Buffett also pays attention when CEOs forecast earnings: âWe are suspicious of those CEOs who regularly claim they do know the future â and we become downright incredulous if they consistently reach their declared targets.
Managers that always promise to âmake the numbersâ will at some point be tempted to make up the numbers.âIt may not be possible to avoid all companies that make forecasts, because most do. But avoid investing in companies for which CEOs claim to regularly accomplish seemingly impossible targets.
Fourth, you should read the company chairmanâs annual letters (frequently co-signed by the CEO) to the shareholders from several years. If letters generally offer excuses for weak results, you should certainly be suspicious of the quality of the management. In many of these letters, success is often attributed to management efforts, but failures are attributed to exogenous reasons, such as the weather or Chinaâs product dumping. Do you want to partner with company managers who have a habit of making excuses and avoiding responsibility?
Fifth, you should attend annual shareholder meetings. It gives you a unique opportunity to evaluate the companyâs managers by examining their responses to shareholder questions. You may not learn more about company financials as they are already reflected in company financials.
However, your objective should be to learn more about management attitude toward shareholders, which you certainly do in these meetings. You can develop a sense of whether you trust the management or not.
Buffett and Munger have often emphasized the importance of trust and have mentioned that they would not invest in a company if they did not trust its management. To show his trust in various company managements, Buffett transferred his voting rights at different points in time in American Express, Washington Post, and Salomon Inc. to their respective
management.
Last and probably overarching, a very high level of integrity among company employees and the CEO is important. When Bill Gates was asked what he admired most about Warren Buffett, he replied, âWith Warren, there are a lot of things you could pick, . . . his integrity is an example for the world.âAt various Berkshire annual shareholder meetings, a video clip of Buffettâs 1991 testimony to Congress is shown to the shareholders to explain the company philosophy. At the time, Buffett was chairman of the investment banking firm Salomon, Inc. He told Congress that a letter was sent to all Salomon employees to obey
all laws and to behave as if they were never ashamed of their actions.
Buffett wrote to the employees, âLose money for the firm and I will be understanding; Lose a shred of reputation for the firm and I will be ruthless.âClearly, money is important but money alone must not be the main driving force for a CEO. Integrity is more important for the long-term survival of a company.
With some thought, you should be able to judge the quality and integrity of a companyâs CEO. These six points do not by any means constitute an exhaustive list to study company management. For example, I would rather invest with CEOs who do not lead an extravagant
lifestyle. I am not claiming that identifying shareowner-oriented CEOs, like Warren Buffett, is easy. However, an investor should make sincere efforts in that direction. After all, you only need to find a few outstanding CEOs to be successful investor. It is indeed worth the trouble.
.There is a supreme irony in terms of business management: It is much easier for an inadequate CEO to keep his job than for an inadequate subordinate. A CEO who does not perform well is carried for countless years.
Why is it that possible? Simply because there are no performance standards for his job.
The CEO has no immediate superior who can measure his performance.
Although the CEO´s boss is the board of directors, the latter seldom measures his performance.
The board of directors does not get into any trouble. If they hire an inadequate CEO and he makes a mistake, they don´t worry. If the mistake is a serious one and results in a takeover, directors will probably profit from it.
An important issue for Buffett in terms of management is the relation between the Board of Directors and the CEO. They should be congenial. However, that is not always the case. It is very frequently seen how directors criticize CEO´s performance at board meetings. That is not well seen at all.
What happens in Berkshire Hathaway (BRK.A, Financial)(BRK.B)? How is it managed?
Buffett has a very clear idea. He knows that his and the vice chairman´s job is to attract and keep outstanding managers.
Indeed, they have never had such difficulty in Berkshire. Usually managers came with companies Buffett and Munger (the vice chairman) bought. This is because they demonstrated talent throughout their careers.
Managers chosen by Buffett become managerial stars long before Warren gets to know them.
He does not like managers who pursue acquisitions or perform any activity for reasons other than the good of the company.
Another important issue is that the managers chosen by Buffett tend to be independently wealthy. This generates no threat to their permanent interest because they love what they do and work accordingly. They are not thinking how much money they will make and can achieve outstanding performance.
Furthermore choosing the right players will always make a team manager look good.
A by-product in managerial style is the ability it gives Buffett to expand Berkshire´s activities.
For a long time, Buffett has always tried to work with people he likes and admires.
At Berkshire annual meetings, Warren Buffett sometimes mentions that he would forgo a profitable opportunity if pursuing it meant forging a partnership with someone whom he did not trust. In other words, if you are suspicious of the CEO, you should not invest in that companyâs stock.
When investing for the long run, the quality of management â including integrity â is more important than current profitability, because profitability canât be sustained if management quality is poor. Here are a few signs of a good CEO, based on Buffettâs thoughts.
First and foremost, track record matters a lot. To the best of my knowledge, all Berkshire subsidiary CEOs have a proven track record in their respective companies or in the same industry. Buffett is unlikely to hire a person from one industry to run a company in another industry. This coincides with his principle of staying in your circle of competence.
Maybe this was one reason why Robert Nardelli was not successful at Home Depot. In 2000, he became CEO of Home Depot after successfully running General Electricâs mines and locomotive businesses, but Nardelli lacked retail experience. In 2007, he was asked to resign from Home Depot â only to be appointed as the Chrysler CEO several months later! In 2009, when Chrysler filed for bankruptcy, he agreed to resign from his position by the end of the bankruptcy case.
Second, CEO compensation should be examined for abuse. Nothing is wrong with paying CEOs well, but to pay them exorbitantly may indicate a lax corporate governance culture. At Home Depot, Nardelliâs problems probably started with the fact that he was from a different industry but that he had also negotiated a generous compensation contract.
He had access to several corporate jets and other expensive benefits, for which he was criticized. Nardelliâs compensation was so well designed that when he left Home Depot, he received a $210 million severance package, despite presiding over a 40 percent decline in the companyâs stock price. Highly paid CEOs also create a money-minded culture in the organization. Such CEOs do not command respect from employees, and when companies fall on hard times, they cannot possibly lead effectively. Such organizations are not likely to do well for shareholders in the long run.
Third, a CEO should have a conceptual framework that he or she can articulate well. You should listen carefully to a CEOâs answers at public meetings or conference calls (all analyst conference calls are now open to the public). For example, if a CEO expands the company into a new business in which he or she lacks expertise, how does he or she explain
this decision? You should examine the explanation carefully. Buffett also pays attention when CEOs forecast earnings: âWe are suspicious of those CEOs who regularly claim they do know the future â and we become downright incredulous if they consistently reach their declared targets.
Managers that always promise to âmake the numbersâ will at some point be tempted to make up the numbers.âIt may not be possible to avoid all companies that make forecasts, because most do. But avoid investing in companies for which CEOs claim to regularly accomplish seemingly impossible targets.
Fourth, you should read the company chairmanâs annual letters (frequently co-signed by the CEO) to the shareholders from several years. If letters generally offer excuses for weak results, you should certainly be suspicious of the quality of the management. In many of these letters, success is often attributed to management efforts, but failures are attributed to exogenous reasons, such as the weather or Chinaâs product dumping. Do you want to partner with company managers who have a habit of making excuses and avoiding responsibility?
Fifth, you should attend annual shareholder meetings. It gives you a unique opportunity to evaluate the companyâs managers by examining their responses to shareholder questions. You may not learn more about company financials as they are already reflected in company financials.
However, your objective should be to learn more about management attitude toward shareholders, which you certainly do in these meetings. You can develop a sense of whether you trust the management or not.
Buffett and Munger have often emphasized the importance of trust and have mentioned that they would not invest in a company if they did not trust its management. To show his trust in various company managements, Buffett transferred his voting rights at different points in time in American Express, Washington Post, and Salomon Inc. to their respective
management.
Last and probably overarching, a very high level of integrity among company employees and the CEO is important. When Bill Gates was asked what he admired most about Warren Buffett, he replied, âWith Warren, there are a lot of things you could pick, . . . his integrity is an example for the world.âAt various Berkshire annual shareholder meetings, a video clip of Buffettâs 1991 testimony to Congress is shown to the shareholders to explain the company philosophy. At the time, Buffett was chairman of the investment banking firm Salomon, Inc. He told Congress that a letter was sent to all Salomon employees to obey
all laws and to behave as if they were never ashamed of their actions.
Buffett wrote to the employees, âLose money for the firm and I will be understanding; Lose a shred of reputation for the firm and I will be ruthless.âClearly, money is important but money alone must not be the main driving force for a CEO. Integrity is more important for the long-term survival of a company.
With some thought, you should be able to judge the quality and integrity of a companyâs CEO. These six points do not by any means constitute an exhaustive list to study company management. For example, I would rather invest with CEOs who do not lead an extravagant
lifestyle. I am not claiming that identifying shareowner-oriented CEOs, like Warren Buffett, is easy. However, an investor should make sincere efforts in that direction. After all, you only need to find a few outstanding CEOs to be successful investor. It is indeed worth the trouble.
