written by reader Berkshire Hathaway’s Biggest Question

By mazorsedge, June 22, 2015

[ed note: I’m traveling and not writing much this week or next, so thought I would introduce you to an investor who I met in Omaha — David Mazor writes Mazor’s Edge, which he describes as offering “clear, concise news and analysis of Berkshire Hathaway and its companies.” He’s an interesting guy, and he’s a lot more clear and concise than I am. Since Berkshire comes up in these pages with some frequency, and I own shares myself, I asked him to share a guest article with Gumshoe readers — these are his words and thoughts, any ideas are his and any typos are mine… and the underlying point about compensation and incentives is worth considering whether you invest with Buffett or not]

Who will succeed Warren Buffett, who turns 85 in August, as the head of Berkshire Hathaway (BRK-A, BRK-B)? This would seem to be the biggest question hanging over the shareholders of the massive conglomerate. Will it be Greg Abel, the head of Berkshire Hathaway Energy, or Ajit Jain, who heads up Berkshire’s reinsurance business? Both are frontrunners, especially since Vice-chairman Charlie Munger, who is himself 91 this year, specifically dropped their names in his shareholder letter included in the 2014 Berkshire Hathaway annual report. Yet while people speculate on Buffett’s successor, I would suggest there’s a far more important question. After all, CEOs come and go, and whoever follows Buffett and Munger will eventually be succeeded by others.

So, the biggest question is not who will succeed Buffett; it’s how will they be compensated. In other words, how will they participate in the growth of the company as compared to how Buffett has participated?

Can a unique situation be replicated?

Berkshire Hathaway may be unique in the sheer number of companies that operate under its umbrella. It’s not only a conglomerate; it’s a conglomerate of conglomerates. For example, Berkshire’s Marmon Group has 160 independent manufacturing and service businesses, and Berkshire’s Scott Fetzer Group oversees 21 diverse companies. But even this is not what is most unique about Berkshire. What’s most unique is that Warren Buffett is participating first and foremost just as you do, as a shareholder.

The most underpaid CEO in the Fortune 500

For a man overseeing a conglomerate with a market value of roughly $347 billion, you would think that Buffett receives sky high compensation, especially since that conglomerate’s share value has risen 1,826,163% (yes, that’s not a misprint) from 1966 to 2014. However, Buffett (and Charlie Munger) have annual salaries of only $100,000. What’s more, there are no stock options and no bonuses. Buffett and Munger’s rock bottom salaries mean that they are participating in Berkshire just like you are, as long-term shareholders that care more about increasing the underlying intrinsic value of the company than any short-term trick to boost the stock price.

Think that doesn’t matter?

“The more CEOs are paid, the worse the firm does over the next three years, as far as stock performance and even accounting performance,” notes Michael Cooper of the University of Utah’s David Eccles School of Business. Prof. Cooper co-authored a paper that proved just that.

Just look at David Zaslav, CEO of pay-TV channel Discovery Communications (DISCA, DISCB, DISCK). Zaslav had a total compensation package of $156.1 million in 2014, yet the same year the stock lost a quarter of its value, even as the broader market boomed. The shareholders felt the pain, while Zaslav got the gain. That’s not exactly participating on the same basis.

A Hedge without the 2 and 20

Hedge fund managers built their fortunes on the 2% annual management fee and a 20% of the profits, but that’s not necessarily the same for the hedge fund’s investors, who don’t get that management fee to cushion any tumble in profits. Remember in 2008 when Buffett bet hedge fund manager Ted Seides that a low-priced index fund tracking the S&P 500 would beat the average of any 5 hedge funds over a 10-year period that Seides picked? Well, the “Million-Dollar Bet” is looking more and more like a sure bet for Buffett, because he knew the high friction costs would hurt the hedge funds’ returns.

In fact, Berkshire’s a conglomerate that operates as hedge fund without the management fee structure. Like a hedge fund, it can buy 100% of a company (unlike a mutual fund), it uses derivatives to increase its leverage and hedge its risk, and because its leadership is in lock step with its investors, all that benefit goes right to each shareholder.

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Whose side will they be on?

In 2011, David Sokol, who once looked like the heir apparent to Buffett, abruptly resigned after it turned out that he had accumulated over 96,000 shares of Lubrizol before bringing the company to Buffett’s attention as a potential acquisition. Buffett later called Sokol’s actions “inexplicable” and “inexcusable,” and while the SEC dropped its probe, the Sokol fiasco showed that’s it’s not automatic that Berkshire’s leadership will align with its shareholders interests

Berkshire’s Future Leadership

Berkshire’s future generations of leadership may be great stock pickers, able to build portfolios that equal the $100 billion portfolio that Buffett built. They may be great capital allocators like Buffett, able to use the profits from one company to by other companies with even greater growth potential. They might even be as savvy opportunists, unleashing Berkshire’s mountains of cash just when others credit has dried up. However, the big question is whether they do it on the same basis as Buffett and Munger, on behalf of all the shareholders.

© 2015 David Mazor
David Mazor writes exclusively about Berkshire Hathaway on his blog www.mazorsedge.com.

This is a discussion topic or guest posting submitted by a Stock Gumshoe reader. The content has not been edited or reviewed by Stock Gumshoe, and any opinions expressed are those of the author alone.



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June 22, 2015 10:03 am

Super article. Clear, concise, and easily understandable. Hope to see more of this guest submitter when appropriate.

👍 22
June 22, 2015 1:28 pm

What’s the odds that any CEO candidate would work for such a low salary? Guys like Munger & Warren don’t come along that often, if ever. They have set an example, who’s next?

June 22, 2015 4:06 pm

I believe Charlie Munger is as creditable for BHA’s success as the Oracle of Omaha and deserves to be so recognized. I just learned he is 91, same as I, and I hope he keeps doing his thing just as I am trying to do despite my arthritic hips.

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👍 237
June 22, 2015 6:38 pm
Reply to  1paglee

Robert Paglee, I am much younger than you as I am just approaching my 84th birthday. So I decided to comment briefly in relation to ;your arthritic hips.
Doctor Mark Wiley has produced the second edition of his book titled “Arthritis Reversed, groundbreaking 30 day arthritis relief action plan”. You can probably find it online, maybe at Amazon book section or other places, HOWEVER, I have an extra copy that I would gladly send you. All it takes is an address. No payment necessary. Absolutely no commercials will be sent along. I will not share your address with anyone or any company. So send me a message to pelham.solutions@gmail.com.

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👍 82
June 22, 2015 6:18 pm

Great article. Thanks Travis and David.

June 22, 2015 9:08 pm

I wish they would announce their successors now as opposed to waiting for a “breaking news—Warren Buffet dies at XX”. It surely would be easier on the sticker price once the inevitable happens. I am long BRKB and not looking forward to the day…

👍 742
Dave in Sunny FL
Dave in Sunny FL
June 22, 2015 10:07 pm
Reply to  Frenchy

Frenchy, I used to think that; but Buffett has laid out a very convincing case in the latest annual report for how the job will be sliced up, with familiar names in the key roles. The company is poised for growth in the (very) long term, so If some fool wants to part with his shares for that reason, buy on the dip! “The graveyards are full of indispensable men.”

Dave in Sunny FL
Dave in Sunny FL
June 22, 2015 9:58 pm

I don’t think this is quite as big an issue as the author seems to make it out to be. Buffett has set the tone, and his character permeates the organization. The members of the Board of Directors receive what Buffett describes as “token fees.” At the same time, the lieutenants who captain the various components of the conglomerate are well-compensated: “$17.4 million in 2011 compensation to Thomas P. Nerney, CEO of its United States Liability Insurance Group; $12.4 million to Geico Corp. CEO Tony Nicely, and the National Indemnity Co. unit gave $9.26 million to Ajit Jain,” according to an old Bloomberg article. Since it’s been decided that future CEOs will come from internal candidates, the chances of finding and installing an options monster or spin-off maven seem low. And, in the unlikely event that were to happen, that’s the reason Buffett wants his son to serve as an Executive Chairman: to assist the Board to act to remove a CEO, if necessary. My wife has given me instructions that her future retirement account investments be limited to more Brk.B shares; and her returns to date have put my nimble investing to shame. Reading the annual report from this company (and not just Buffett’s letter) is a genuine pleasure each year. Comparing it to the dreck I see from companies that are in the midst of “reinventing” themselves for future growth, I sleep very well holding Berkshire shares. To all those stock newsletter pundits looking for the “next Buffett,” be advised: the original is still here, still working, and doing great!

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