Regular GuruFocus readers will no doubt be aware that Warren Buffett (Trades, Portfolio) published his latest annual letter to shareholders of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) over the weekend. It contained the usual - highly illuminating - insights regarding his investment philosophy, the importance of insurance float to Berkshire’s continued success and a rundown of the performance of its subsidiaries for the past year.
What is the problem?
What stood out to me, however, was a different section, focusing on a topic somewhat off the well-trodden path: executive compensation. This issue is one that I find myself pondering increasingly often. Why is it that the average pay of CEOs of the top 350 American companies has risen 940% since 1978, while the pay of the average American worker has increased only 12% over that same period? Why has the CEO-to-worker pay ratio increased from 20:1 in 1965 to 278:1 in 2018. Have CEOs become that much more productive? Or were executives grossly underpaid in the mid-60s?
The real explosion in CEO pay happened during the mid-90s, when the Clinton administration implemented changes to the tax code, creating a loophole which incentivised boards to allocate far more stock options to CEO pay packages. Ironically, these changes were actually implemented to curtail CEO pay by capping the tax-deductibility of executive salaries to $1 million. So CEOs could still be paid as much as their boards deemed necessary, but only the first $1 million of that pay could be claimed as a business expense. Like so many government policies, this change had a huge and unforeseen second-order consequence that exacerbated the problem that it set out to solve.
This is why Jamie Dimon today owns more than $1 billion worth of JPMorgan (JPM, Financial) shares, most of which were granted to him by the bank's board of directors. Of course, you may say that if the board decided to grant him those shares, then all is fair. Except, of course, for the fact that Dimon also happens to be the chairman of JPMorgan's board of directors. Ben Hunt, an asset manager and editor of Epsilon Theory, estimates that from 2016 to 2018, shares owned by senior executives at JPMorgan accounted for 18% to 27% of all shares bought back by the bank. In other words, the share buyback policy instituted by Dimon benefits himself more than probably any other individual.
You may think that 18% to 27% of all buybacks is an appropriate percentage to pay managers. I don’t. I don’t think Buffett does. And if you are a JPMorgan shareholder, you shouldn't either. As the chairman of one of the largest companies in the history of mankind, and as someone who has served on the board of directors of more than 20 companies, Buffett is pretty well-informed when it comes to determining executive pay. In my next piece on this topic, we will look at the problems that the Oracle of Omaha has identified in the current way boards determine compensation, and what might be done to rectify the issue.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Seth Klarman: Lessons From the Dotcom Bubble
- Joel Greenblatt: 3 Mistakes That Investors Make
- Do Successful Investors Need to Be Great Forecasters?
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