Buffett’s Letter to Break Months of Silence Amid Tumult in U.S.
February 25, 2021
October 13, 2021
At a symposium hosted two decades ago featuring Warren Buffett and his annual shareholder letters, the legendary investor joked that his service on 17 public company boards revealed a “dominant masochistic gene.” Buffett has since served on several more boards, interacting with some 300 members during his illustrious half-century career.
The Berkshire Hathaway chairman and CEO has devoted parts of his letters to describing what the best directors do. A condensed version of these points follows. Living by these “10 commandments,” as I call them, has made him excel in the boardroom.
Outstanding CEOs Bob Iger at Disney; Katharine Graham, who skillfully ran The Washington Post; and Jeff Bezos, the current owner of that company’s legacy newspaper and founder and CEO of Amazon all meet Buffett’s practical bottom-line test: They are people any director would like, trust and admire and be happy to have their child marry.
All CEOs must be measured according to a set of performance standards, Buffett notes. A board’s outside directors must formulate these and regularly evaluate the CEO in light of them — without the CEO being present. Standards should be tailored to the particular business and corporate culture but stress fundamental baselines such as returns on shareholder capital and steady progress in market value per share. Performance should not be based on quarterly earnings and emphatically not in terms of whether the manager achieves guidance targets. In fact, Buffett argues that companies are usually better off not providing analysts with earnings guidance.
All directors should act as if there is a single absentee owner and do everything reasonably possible to advance that owner’s long-term interest, Buffett advises.
They need to think independently to tighten the wiggle room that “long term” gives to CEOs — while corporate leaders should think in terms of years, not quarters, they must not rationalize sustained subpar performance by perpetual pleas to shareholder patience. To that end, it is desirable for directors to buy and hold sizable personal stakes in the companies they serve so that they truly walk in the shoes of owners. Buffett’s board service has almost always involved companies where Berkshire owns a significant stake. Prominent examples: Cap Cities/ABC (1986–1996); The Coca-Cola Co. (1989–2006); Gillette (1989–2003); Kraft Heinz (2013–present); Salomon Brothers (1987–1997); US Airways (1993–1995); and The Washington Post (1974–1986 and 1996–2011).
There is a sub-commandment in this lesson — call it Commandment 3.5: Directors can and should sometimes replace themselves.
In 2005, despite Berkshire’s longtime substantial stake in Coca-Cola — worth $8 billion then and $18 billion now — CalPERS as well as Institutional Shareholder Services challenged Buffett’s independence as a director. They cited business relationships between various Berkshire subsidiaries and Coca-Cola, including Dairy Queen, a customer. Buffett objected, stressing how Berkshire’s large and lengthy stock ownership dwarfed the modest and routine business transactions of its subsidiaries.
In the ensuing board election, 16 percent of Coca-Cola’s shares were cast as withhold votes on Buffett, so he was reelected, but he nevertheless opted to stand down. While I disagreed with those doubting Buffett’s independence, he responded to the shareholder ballot and set an example: Any director receiving a non-trivial level of withhold votes should withdraw from the board.
If the CEO’s performance consistently falls short of the standards set by the outside directors, then the board must replace the CEO. The same goes for all other senior managers they oversee, just as an intelligent owner would if present. In addition, the directors must be the stewards of owner capital to contain any managerial overreach that dips into shareholders’ pockets. Such pickpocketing may range from imperious acquisition sprees to managerial enrichment through interested transactions or even myopia amid internal scandal and related crises.
In addressing these problems, the director’s actions must be fair, swift and decisive; in crisis response the Berkshire mantra is “Get it right, get it out, and get it over.” The classic case concerned Salomon Brothers’ 1991 bond-trading imbroglio, four years after Berkshire acquired a block of preferred stock and Buffett joined its board. Amid knowledge of illegality, CEO John Gutfreund allowed problems to fester, refraining from firing the guilty and failing to inform the board or regulators. On becoming aware of the dire events, the board promptly requested Gutfreund’s resignation — and appointed a reluctant Buffett to lead the investment bank out of its dark days and reshape its culture.
Directors who perceive a managerial or governance problem should alert other directors to the issue. If enough are persuaded, concerted action can be readily coordinated to resolve the problem. Aside from basics like whether the CEO is meeting performance standards or to curtail managerial excess, take the perennial topic of whether the roles of chairman and CEO should be separate or combined.
As stated in principles Buffett endorsed last year with a dozen other boardroom denizens (called “commonsense principles”), outside directors are best positioned to evaluate this question and then present it to the full board. Those with strong views either way need to make their case to fellow outside directors based on general research and the company’s specific circumstances and culture.
When a director remains in the minority and the problem is sufficiently grave, reaching out to absentee owners is warranted, Buffett believes. Colleagues may resist or complain, which imposes a useful restraint against going public for trivial or nonrational causes. But consistent with confidentiality and other fiduciary duties, informing shareholders is sometimes appropriate, Buffett says.
In 1996, when Buffett served on the board of Gillette — of which Berkshire owned 11 percent — Gillette agreed to acquire KKR’s share of Duracell International for $7.82 billion in stock. For its related services in the transaction, KKR’s bill was double that of Gillette’s advisors (though in line with market pricing), and Buffett strongly protested the fee. While outvoted by the rest of the board, Buffett made a public record of his disagreement for fellow shareholders to see.
As stated in the “commonsense principles” endorsed last year, companies should make their officers and directors available to their largest long-term investors.
Even high-quality directors can fail because of what Buffett calls “boardroom atmosphere.” Populated by the well-mannered, boards see broaching certain topics as akin to belching at dinner — from questioning the wisdom of an acquisition to CEO succession. Adjust the social atmosphere of the room, Buffett urges. How to do so depends on the corporate culture and personalities involved. Aside from formal meetings, boards can convene for meals, training sessions and retreats, all offering the chance for diplomatic engagement.
Any director unable to persuade enough fellow directors or shareholders that vital change is needed ultimately has one vital lever: threaten to resign.
Buffett admonishes boards as to compensation committees: “Directors should not serve on compensation committees unless they are themselves capable of negotiating on behalf of owners.” In other words, this task should not be delegated to consultants, though it too often is.
At this year’s annual meeting of Berkshire shareholders, he warned, “If the board hires a compensation consultant after I’m gone, I will come back.” He quipped that CEOs who otherwise welcome him on a board do not want him on the compensation committee.
In the negotiations, directors must make one point non-negotiable: all forms of compensation, especially equity-based, must be treated as an expense for accounting purposes. No CEO can have his cake and eat it too.
The audit committee occupies a central role in today’s financial reporting ecosystem, yet directors cannot conduct the audit and sometimes feel overwhelmed. Buffett’s advice is to focus on what is possible, which is simply getting the auditors to candidly divulge what they know. Buffett prescribes getting answers to these four issues:
What qualities should be sought in directors when boards undertake their own succession planning? The answer: People capable of honoring these commandments, meaning those who are skilled managerial recruiters and overseers, given the company’s particular business and culture, and are owner-oriented, engaged, articulate, communicative and astute. Basic habits such as diligence, preparation and attendance are also essential.
Buffett adds these qualifications that make for high-quality directors: business savvy, a strong interest in the specific company and an owner-orientation. Companies boasting such directors gain an advantage. If those directors then follow Buffett’s 10 commandments, the shareholders are doubly blessed.
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