Home > Corporate Governance Theory > What do Buffet and Munger say (and do) about corporate governance?

What do Buffet and Munger say (and do) about corporate governance?

Every year before Spring arrives, we use to find some interesting readings about Berkshire Hathaway`s shareholders meeting, the company investment decisions or views, and some other topics. In this post I will choose one of the more relevant themes Mr. Buffet and Mr. Munger refer to when they describe their management style and investment decisions: Corporate Governance Buffett and Munger`s preferences.

In June Rhee`s post in Harvard`s blog, (1), Mr Buffet`s choice when addressing corporate governance is described; it should be noted though that we are talking about firms where there is a controlling shareholder, (BH), so that the main conflicts are the choice of a Ceo, compensation, minority shareholders and others.

The first Buffet`s concern is communication between managers and shareholders; messages must be sent in simple language and relate to facts, with no predictions. Secondly, he is not interested in complex organizational structures, but in recruiting honest, capable, and hard working managers, and particularly in the case of Ceos, (their performance is difficult to isolate and there is no one senior to them). Third, directors need to be chosen for their savvy and owner orientation, as their main function is to select the best Ceo and to oust him in case expectations are not met. According to Buffet, other assets, such as independence or diversity, are not valuable by themselves.

There are outstanding differences between companies with a controlling shareholder who is also a manager, (where disagreements between directors and managers lead to the director substitution), and those where the controllling shareholder is not a manager, (where directors can take disagreements to the major shareholder). Things are more complicated without controlling shareholders: in order for the board`s oversight and discipline to be effective, directors need to be outsiders whose strongest weapon is his resignation threat.

Mr Buffet enthusiastically recommends that the Ceo evaluation is done in specific meetings without the Ceo`s presence.

Long-term concerns are addressed as follows by BH: first, Ceos are ordered to manage as if the company was never going to be sold, as if they were the owners of that only asset; second, he does not trust in stock options, (for their assimetry, their irrevocability, and because of the fact that BH`s companies retain all net profits). Managers can buy stock or options with their money and receive the owner`s benefit that way.

As for Pay, Buffett emphasizes the need for it to be linked to a simple performance measure, (such as net profits minus the cost of capital),

Munger`s views are very similar to those, but perhaps more intellectually elaborated, (I will follow David Larcker and Brian Tayan`s article, “Corporate Governance According to Charles T. Munger”), (2). In order to discourage the self interest of managers, companies use monetary or cultural incentives, and controls, (carrots and sticks). Mr Munger prefers culture as a mechanism, what he calls a “seamless web of deserved trust”. That allows to reduce controls and make everything simpler. Agency costs are reduced if the choice of a Ceo includes character requirements, so that he is “unlikely to engage in actions detrimental to shareholders”. A second requirement for this web is a responsible culture in the firm, (accountability, basic controls, and conservative accounting and modest executive and directos compensation).

He doesn`t trust complex governance structures or so called “best practices”,  he favors simple procedures and structures. David Larcker questions whether this ways are sustainable once companies are out ot the founders` influence and sway. One thing I particularly wonder about is the reason why managers would accept so much lower compensation packages in BH`s firms than in other firms, as it is apparently the case. What is the not monetary compensation part of the formula?

(1) “Governance Buffett Style” by June Rhee, (extracted from The Essays of Warren Buffett: Lessons for Corporate America (3d ed. 2013) by Professor

Cunningham., at https://blogs.law.harvard.edu/corpgov/2013/03/29/governance-buffett-style/

 

(2) “Corporate Governance According to Charles T. Munger” by David Larcker and Brian Tayan, (Stanford Closer Look Series), at http://public-prod-acquia.gsb.stanford.edu/sites/default/files/38_Munger_0.pdf

(3) One of the many books about Buffett investment approach: “Warren Buffett”, by Robert G. Hagstrom.

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