Compensation Consultants Need Not Apply at Berkshire Hathaway

In his just released, must-read annual letter to shareholders , Warren Buffett, CEO of Bershire Hathaway, talks about a topic related to human resources - compensation. If you have never read a Warren Buffett shareholder letter, I encourage you to visit the above URL and download/read as many as you can. Warren Buffet is without a doubt the most brilliant (and successful) investor ever. He is also has one of the most astute business minds ever and these letters include all sorts of pearls that anyone in business will benefit from reading.

Anyway, back to human resources. In his recent letter, Mr. Buffet strongly criticizes executive compensation, especially the practice of setting executive pay based on how CEOs in similar industries earn, which he refers to as the "All-the-other-kids-have-one" approach (although, as Mr. Buffet writes, "compensation consultants" phrase it more elegantly).

If anyone has the credibility to criticize executive pay, it is Mr. Buffet who runs a 217,000 employee company with revenues near $100 billion. He also has a net worth over $42 billion and is the second wealthiest American behind Bill Gates according to last year's Forbes rankings.

Yet, Mr. Buffet reportedly receives only a $100,000 salary with no stock options as CEO of Bershire Hathaway (the lowest CEO salary of the Fortune 500 companies). His worth comes from the fact that (a) he owns 31% of his company's shares and (b) as CEO, he has run the company exceptionally well since founding it in 1965. In other words, he has earned it - unlike so many CEOs running businesses today. Consider this - $10,000 invested in Berkshire in 1965 was worth over $50 million in 2000.

Mr. Buffet writes that he is "a one-man compensation committee" at Berkshire who determines the salaries and incentives for around 40 CEOs of his operating companies. He says the time it takes him to do this is "virtually none" and that the number of CEOs that have left Bershire for other jobs in the last 42 years is "precisely none". He also said in last year's annual meeting that he has never once hired or relied on compensation consultants and he would not be happy if anyone in his company did so.

According to Mr. Buffet, "if a CEO bats .300 he gets paid for being a .300 hitter even if circumstances outside of his control cause Berkshire to perform poorly. And if he bats .150 he doesn't get a payoff just because the successes of others have enabled Berkshire to prosper mightily."

The solution? Mr. Buffet says "Compensation reform will only occur if the largest institutional shareholders -- it would only take a few -- demand a fresh look at the whole system. The consultants' present drill of deftly selecting 'peer' companies to compare with their clients will only perpetuate present excesses."

Posted by Mark Willaman

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