Berkshire Hathaway 2017 Annual Meeting Audience Question # 26

Warren and Charlie expresses their disdain for compensation consultants

Warren Buffett:

OK. Andrew?

Andrew Ross Sorkin:

Warren. This comes from a shareholder who I think is here, who asked to remain anonymous.
Writes: “Three years ago, you were asked at the meeting about how you thought we should compensate your successor. You said it was a good question, and you would address it in the next annual letter. We’ve been patiently waiting.”

“Can you tell us now, at least philosophically, how you’ve been thinking about the way the company should compensate your successor, so we don’t have to worry when the pay consultants arrive on the scene?”

Warren Buffett:

Yeah. Well, that… unfortunately, at my age I don’t have to worry about things I say… said three years ago, but this guy, obviously much younger, remembers.

I’m not… well, I’ll accept his word that I said that. But the… there’s a couple possibilities, actually.

I don’t want to get into details on them, but you may have… and I, actually, would hope that we would have somebody, A) who’s already very rich… which they should be if they’ve been working a long time and have got that kind of ability… that’s very rich, and really is not motivated by whether they have 10 times as much money that they and the families can need or a hundred times as much.

And they might even wish to perhaps set an example by engaging for something far lower than actually what you could say their true market value is. And that could or could not happen, but I think it’d be terrific if it did. But I can’t blame anybody for wanting their market value.

And then… if they didn’t elect to go in that direction, I would say that you… would probably pay them a very modest amount and then have an option which increased in value by… or increased in striking price… annually.

Nobody does this, hardly. The Washington… Graham Holdings has done it, The Washington Post Company did a little bit… but would increase because it’s assuming that there were substantial retained earnings every year.

Because why should somebody retain a bunch of earnings and then claim they’ve actually improved the value, simply because they withheld the money from shareholders?

So it’s very easy to design that, and in private companies people do design it in that way. They just don’t want to do it in public companies, because they get more money the other way.

But they might have a very substantial one that could be exercised, but where the shareholder’s… the shares had to be held for a couple years after retirement, so that they really got the result over time that the majority of the stockholders would be able to get, and not be able to pick their spots, as to when they exercised and sold a lot of stock.

It’s… it would… it’s not hard to design. And it really depends who you’re dealing with, in terms of actually how much they care about money and having money beyond what they can possibly use.

And most people do have an interest in that, and I don’t blame them.

But I don’t know. What do you think, Charlie?

Charlie Munger:

Well, I… one thing I think is that I have avoided, all my life, the compensation consultants. To me it’s a… I hardly can find the words to express my contempt.

Warren Buffett:

I will say this. If the board hires a compensation consultant after I go, I will come back.

Charlie Munger:

Mad. Mad.

So I think there’s a lot of mumbo jumbo in this field, and I don’t see it going away.

Warren Buffett:

Oh, it isn’t going to go away. No, it’s going to get worse. It… I mean, the… if you look at, I mean, the way compensation gets handled, I mean, it… you know, everybody
looks at everybody else’s proxy statement and says, “We can’t possibly hire a guy that hasn’t been… “

Charlie Munger:

It’s ridiculous.

Warren Buffett:

…so on. And the human relations department, you know, who work for the CEO, come in and suggest a consultant.

What consultant is ever going to get another assignment if he says, “You should pay your CEO below the… down in the fourth quartile because you’re getting a fourth quartile result?” It…

I mean, it just, you know… it isn’t that the people are evil or anything. It’s just the nature of the situation just… it produces a result that is not consistent with how representatives of the owners should behave.

Charlie Munger:

It’s even worse than that. Capitalism is the golden goose that we all live on. And if people generally get so they have contempt for it because they don’t like the pay arrangements in the system, your capitalism may not last as well. And that’s like killing the golden goose.

So I think the existing system has a lot wrong with it.

Warren Buffett:

I think there is something coming in pretty soon… I may be wrong about this… where companies are going to have to put in their proxy statement the CEO’s pay to the average pay, or something like that. That isn’t going to change anything. I mean…

Charlie Munger:

It won’t change a thing.

Warren Buffett:

It won’t change a thing. And, you know, it’ll cost us virtually…

Charlie Munger:

By the way, it won’t get any headlines, either. It’ll be tucked away.

Warren Buffett:

It’ll cost us a lot of money, with 367,000 people employed around the world. And, I mean, we’ll hope to get something that makes it somewhat simpler so we can use estimates or something of the sort.

But to get the median income or mean income or whatever, however the rules may read, you know, and…

Charlie Munger:

That’s what consultants are for, Warren.

Warren Buffett:

It… it’s, you know, it is human nature that produces this. And, you know, the most…I write in this letter to the managers every two years, I said, “The only excuse I won’t take on something is that everybody else is doing it.”

But of course, “everybody else is doing it,” is exactly the rationale for why people did not want to count the costs of stock options as a cost… I mean, it was ridiculous.

All these CEOs went to Washington and they got the Senate, I think, to vote 88 to 9 to say that stock options aren’t a cost. And then a few years later, you know, it became so obvious that they finally put it in so it was a cost. You know, it reminded me of Galileo or something, I mean, all these guys.

Charlie Munger:

Worse. It was way worse. The pope behaved better to Galileo in the…and he was…

Warren Buffett:

Well, anyway, it’s… it… I would hope, you know, like I say, somebody… well… and it doesn’t even have to be, I’m not talking about the current successor or anybody else.

I mean, successors down the line are probably going to have gotten very wealthy by the time they’re running Berkshire. And the incremental value of wealth gets very close to zero at some point. And there is a chance to use it as a different sort of model.

But I don’t have any problem, if it’s… a system is devised that recognizes retained earnings.

Nobody wanted… I’ve never heard anybody talk about it, you know, in the 20 boards I’ve been on.

You know, if you and I were partners in a business, you know, and we kept retaining earnings in the business and I kept having the value to buy a portion of you out at a constant price, you’d say, “This is idiocy.”

But of course that’s the way all option systems are designed, and it’s better to be… for the CEO and for the consultants. And of course, usually if there’s… there’s some correlation between what CEOs are paid and what boards are paid.

If CEOs were getting paid at the rate that they got paid 50 years ago, adapted to present dollars, director pay would be lower. So it’s… you know, it’s got all these built-in things that, to some extent, sort of kindle the…

Charlie Munger:

No Berkshire director is in it for the money.

Warren Buffett:

Well, they are if they own a lot of stock. And they bought it in the market just like the…

Charlie Munger:

Yeah, it’s…

Warren Buffett:

… shareholder did.

Charlie Munger:

It’s a very old-fashioned system.

Warren Buffett:

I looked at one company the other day, and seven of the directors had never bought a share of stock with their own money. Now they’d been given stock, but not one of them… I mean, I shouldn’t say not one… seven of the directors had never actually bought a share of stock.

And there they are, you know, making decisions on who should be CEO and how they should be paid and all that sort of thing. But, you know, they never felt like shelling out a dollar themselves. Now they’d been given a lot of stock.

And it’s, you know, we’re dealing with human nature here, folks. And that… what you want is to have a system that works well in spite of how human nature’s going to drive it.

And we’ve done awfully well in this country in that respect. I mean, American business has… overall has done very well for the Americans generally. But not every aspect of it is exactly what you want to teach your kids.

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Q&A with Warren Buffett and Charlie Munger: A Compilation of All Shareholder Questions and Answers from The Berkshire Hathaway Annual Shareholder Meetings

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