[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.
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.
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