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Buffett on Boards: “Directors are often captive to the management teams they are meant to supervise”

Warren Buffet recently posted his latest “letter to shareholders” within the Berkshire Hathaway Annual Report. What did he have to say about Boards and their relationships with CEOs? He “took time to complain about the poor state of many corporate boards” reports the NY Times. His complaints were numerous.

First, he acknowledged there are too few women in the boardroom saying, “This year, it should be noted, marks the 100th anniversary of the 19th Amendment, which guaranteed American women the right to have their voices heard in a voting booth. Their attaining similar status in a board room remains a work in progress”.

He then addressed the fact, “The bedrock challenge for directors, nevertheless, remains constant: Find and retain a talented CEO — possessing integrity, for sure — who will be devoted to the company for his/her business lifetime. Often, that task is hard. When directors get it right, though, they need to do little else. But when they mess it up,……” Adding, Audit committees now work much harder than they once did and almost always view the job with appropriate seriousness. Nevertheless, these committees remain no match for managers who wish to game numbers, an offense that has been encouraged by the scourge of earnings “guidance” and the desire of CEOs to “hit the number.”

He referred to “one very important improvement in corporate governance has been mandated: a regularly-scheduled “executive session” of directors at which the CEO is barred. Prior to that change, truly frank discussions of a CEO’s skills, acquisition decisions and compensation were rare”. But went on to note that “Acquisition proposals remain a particularly vexing problem for board members”. And observed “I have yet to see a CEO who craves an acquisition bring in an informed and articulate critic to argue against it. And yes, include me among the guilty”.

The problem he says is, “Directors are often captive to the management teams they are meant to supervise, particularly when it comes to acquisitions that chief executives want to make. Overall, the deck is stacked in favour of the deal that’s coveted by the CEO and his/her obliging staff. It would be an interesting exercise for a company to hire two “expert” acquisition advisors, one pro and one con, to deliver his or her views on a proposed deal to the board — with the winning advisor to receive, say, ten times a token sum paid to the loser.”.

Photo by Eugene Chystiakov

On the same topic he cautioned, “Don’t hold your breath awaiting this reform: The current system, whatever its shortcomings for shareholders, works magnificently for CEOs and the many advisors and other professionals who feast on deals. A venerable caution will forever be true when advice from Wall Street is contemplated: Don’t ask the barber whether you need a haircut”.

Buffet also had something to say about the ‘independence’ of independent directors.” Over the years, board “independence” has become a new area of emphasis. One key point relating to this topic, though, is almost invariably overlooked: Director compensation has now soared to a level that inevitably makes pay a subconscious factor affecting the behaviour of many non-wealthy members. Think, for a moment, of the director earning $250,000–300,000 for board meetings consuming a pleasant couple of days six or so times a year. Frequently, the possession of one such directorship bestows on its holder three to four times the annual median income of U.S. households.” And he complained that he himself has “missed much of this gravy train”.

In another shrewd observation he said, “And job security now? It’s fabulous. Board members may get politely ignored, but they seldom get fired. Instead, generous age limits — usually 70 or higher — act as the standard method for the genteel ejection of directors”.

Photo by Cassidy Kelley

The matters already mentioned are serious enough, but he them points to a very serious issue saying, “Is it any wonder that a non-wealthy director (“NWD”) now hopes — or even yearns — to be asked to join a second board, thereby vaulting into the $500,000–600,000 class? To achieve this goal, the NWD will need help. The CEO of a company searching for board members will almost certainly check with the NWD’s current CEO as to whether NWD is a “good” director. “Good,” of course, is a code word. If the NWD has seriously challenged his/her present CEO’s compensation or acquisition dreams, his or her candidacy will silently die. When seeking directors, CEOs don’t look for pit bulls. It’s the cocker spaniel that gets taken home”.

In case you are in any doubt about his criticism of the independence of ‘independent directors’ he added, “Despite the illogic of it all, the director for whom fees are important — indeed, craved — is almost universally classified as “independent” while many directors possessing fortunes very substantially linked to the welfare of the corporation are deemed lacking in independence”.

And to add weight to his argument he provided an example, “Not long ago, I looked at the proxy material of a large American company and found that eight directors had never purchased a share of the company’s stock using their own money. (They, of course, had received grants of stock as a supplement to their generous cash compensation.) This particular company had long been a laggard, but the directors were doing wonderfully.

On this point he concluded, “Paid-with-my-own-money ownership, of course, does not create wisdom or ensure business smarts. Nevertheless, I feel better when directors of our portfolio companies have had the experience of purchasing shares with their savings, rather than simply having been the recipients of grants”.

Following the expression of his concerns he added, “almost all of the directors I have met over the years have been decent, likable and intelligent. They dressed well, made good neighbours and were fine citizens. I’ve enjoyed their company. Among the group are some men and women that I would not have met except for our mutual board service and who have become close friends. Nevertheless, many of these good souls are people whom I would never have chosen to handle money or business matters. It simply was not their game”.

He then advised Berkshire’s shareholders, “we will continue to look for business-savvy directors who are owner-oriented and arrive with a strong specific interest in our company. Thought and principles, not robot-like “process,” will guide their actions. In representing your interests, they will, of course, seek managers whose goals include delighting their customers, cherishing their associates and acting as good citizens of both their communities and our country”.

Perhaps in a reference to the recent announcement by the Business Roundtable which recently restated what it believed the purpose of the corporation to be — not only maximising shareholder value any longer but also having regard for all stakeholders- he added to his own statement saying “Those objectives are not new. They were the goals of able CEOs sixty years ago and remain so. Who would have it otherwise?”

Buffet is as critical of boards as he dare be. If he were more critical holders of Berkshire’s shares might ask how he justifies investing in the companies he does. Arguably they ought to anyway in view of his holding of stock in companies like Kraft Heinz, managed in a way he claims to deplore. But Berkshire’s shareholders are likely to be happy to wilfully ignore some instances so long as their overall returns are so high.

Like Buffet, other institutional investors I have spoken with are also highly critical of boards, especially in off-the-record conversations, but they still invest in the companies whose boards they criticise so much. They have to. There are a limited number of companies in which they can invest. But are they really serving the interests of the people whose money they are playing with?

Recently I have suggested that the failings of boards represent a Global Governance Crisis. Buffet’s public statements provide evidence of this. But the failure of institutional investors to address these problems makes them part of the problem. I believe all the players in the system as it is currently designed are aware of the crisis I speak of and would give it the same label. But the problem is highly complex and systemic, featuring many vested interests. The only people blind to it are the pension owners whose money fuels the system. It can best be described as a wicked problem — A where that is resistant to any resolution, being difficult or impossible to solve because of incomplete, contradictory, and changing requirements that are often difficult to recognize, or where there are no single or obvious solutions to the problem.

By their very nature wicked problems are hard to address, but the Strategic Management Forum aims to address them as part of its “Inquiry into the Nature and Causes of Predictable Surprises and How to Avoid Them”, starting in the spring of this year. Details: paul@thesmfglobal.com



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Paul Barnett

Paul Barnett

Advocating the purpose of all enterprise should be contributions to sustainable widely shared prosperity measured in terms of human flourishing and wellbeing.