stanford closer look series		 1
Berkshire Hathaway: The Role of Trust
in Governance
management and Governance Structure
stanford closer look series		 2
Berkshire Hathaway: The Role of Trust in Governance
implications of their decisions but fo...
stanford closer look series		 3
Berkshire Hathaway: The Role of Trust in Governance
“The Management of Berkshire Hathaway,...
stanford closer look series		 4
Berkshire Hathaway: The Role of Trust in Governance
Exhibit 1 — Berkshire Hathaway Operati...
stanford closer look series		 5
Berkshire Hathaway: The Role of Trust in Governance
Exhibit 2 — Berkshire Hathaway: Compen...
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Berkshire Hathaway: The Role of Trust in Governance


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The governance structure of Berkshire Hathaway is remarkably different from that of other corporations, and most of its features do not conform to the “best practices” recommended by experts. Why is this an important exception, and what can it teach us about best practices in governance?

Topics, Issues and Controversies in Corporate Governance

The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important.

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Berkshire Hathaway: The Role of Trust in Governance

  1. 1. stanford closer look series 1 Berkshire Hathaway: The Role of Trust in Governance management and Governance Structure Despite being one of the largest corporations in the world, Berkshire Hathaway receives relatively little public attention for its management and gover- nance structure.1 For the most part, the company is primarily thought of as the investment vehicle of Warren Buffett and his partner Charlie Mung- er. Few realize the size and diversity of its asset base—which includes insurance (GEICO, General Re, Berkshire Hathaway), regulated gas and elec- tric utilities (MidAmerican), railroads (Burling- ton Northern), manufactured housing (Clayton Homes), wholesale distribution (McLane), and many specialty finance, manufacturing, service, and retail companies—and the manner in which the company is governed. Berkshire Hathaway is built on a model that in- volves extreme centralization of capital allocation decisions within corporate headquarters and ex- treme decentralization of operating decisions with- in individual business units. This is underscored by the distribution of the company’s employee base: the corporate office employs 21 individuals, where- as the business units employ over 250,000. It is the lowest ratio of corporate overhead to investor capi- tal among all major corporations (see Exhibit 1). The primary responsibility of headquarters is to allocate capital that the business units generate. For example, if See’s Candies generates pre-tax op- erating cash flow of $70 million during the year, it transfers that amount (less any amount required for capital expenditures) to Omaha for realloca- tion. Decisions on how to reinvest free cash flow are made entirely by Buffett—in some cases in con- sultation with Munger—and are not vetted by any committees or analysts. By David F. Larcker and Brian Tayan May 28, 2010 By contrast, operating decisions are made en- tirely by the managers who oversee each unit. Whereas Buffett has complete discretion about how to reinvest capital at the corporate level, managers have complete discretion about all operating and capital allocation decisions within their businesses. They are not required to meet with Buffett, submit budgets for approval, or develop long-term operat- ing plans. Instead, they make all decisions them- selves, without supervision or corporate control. Munger describes the Berkshire Hathaway system as “delegation just short of abdication.”2 The success of this model is predicated on two conditions: purchasing businesses that are unlike- ly to need significant attention and working with managers who are unlikely to need oversight. The businesses that Berkshire purchases are character- ized by stable economics, high levels of free cash flow, and low requirements for incremental capital.3 They have distinct and durable competitive advan- tages—either in terms of production, distribution, or economic franchise. They are also built on a cul- ture of honesty and integrity. As Munger explains, “We try to buy companies so permeated by a good ethos that they don’t need a lot of direction and checking from headquarters.”4 They are led by ca- pable and honest management, often the same in- dividuals who founded and still run the company. In most cases, Buffett insists that the seller retain a minority interest, so that they remain de facto owners working in partnership with Berkshire Ha- thway. Upon the close of an acquisition, managers are given simple instructions. They should treat the business as though they are its sole owner. They should give no consideration to the accounting Topics, Issues, and Controversies in Corporate Governance and Leadership S T A N F O R D C L O S E R L O O K S E R I E S
  2. 2. stanford closer look series 2 Berkshire Hathaway: The Role of Trust in Governance implications of their decisions but focus entirely on enhancing competitive position and maximizing free cash flow. They should do nothing to tarnish the reputation of their company or Berkshire. Buf- fett believes that this hands-off approach is critical for a successful long-term working relationship: “Our job is not so much to select great manag- ers, because they have this proven record that they come with. Our job is to retain them…. We are de- pendent on them. … We can’t run their businesses. So our job is to make sure that they have the same enthusiasm, excitement, and passion for their job after the stock certificate changes hands as they had before.”5 Managers are paid modest salaries but stand to receive very significant cash bonuses if performance goals are achieved. Buffett tailors the compensation plan to each business, based on its economics and competitive positioning. Managers are compen- sated for elements of the business that are directly under their control (such as growth and profit- ability of insurance contracts). Particular emphasis is placed on the ability to return free cash flow to headquarters. The company does not grant equity- based awards because their value cannot be as close- ly correlated to performance as can cash bonuses.6 Still, cash bonuses can reach extreme levels—tens of millions for superior performance. By contrast, Buffett and Munger receive modest compensation. Their salaries are set at $100,000. They receive no bonuses, options, or restricted grants. Instead, their economic incentive is driven by direct holdings of company stock which they purchased with their own money in the 1960s. As of year-end 2009, the value of those holdings were $40 billion and $1.3 billion, respectively. Similarly, board members receive negligible fees for their ser- vices and are encouraged to purchase substantial sums of company stock with their own money. Eq- uity ownership is intended to align their interests with those of shareholders (see Exhibit 2). Corporate Controls and Oversight The internal controls and oversight mechanisms at Berkshire Hathaway are nominal in compari- son to those employed by other corporations. No due diligence is performed before an acquisition is completed. In general, Buffett asks that the seller of a business to suggest a price. If he thinks it is rea- sonable, he will accept and the deal is closed. Fur- thermore, purchase decisions are not reviewed in advance by the board. Munger explains, “Can you imagine Warren Buffett saying to somebody, ‘Well, I’m sorry, I have to go back and check with my directors’? I mean, of course he has to go back to check with his directors, but he knows what they’re going to say, and everybody knows that what he says is going to govern.”7 Buffett is also primarily responsible for enter- prise risk management. Risk oversight is not dele- gated to a committee or risk management function. According to Buffett, “I regard myself as the chief risk officer at Berkshire.”8 The company’s primary tool to mitigate enterprise risk is the delegation of responsibility to managers with proven skill and in- tegrity. Munger explains, “A lot of people think if you just had more process and more compliance, you could create a better result in the world. Well, Berkshire has had practically no process. We had hardly any internal audit until they forced it on us. We just try to operate in a seamless web of deserved trust and be careful whom we trust.”9 Why This Matters 1. The Berkshire Hathaway model is predicated on responsibility and trust. How do the company’s acquisition criteria, operating principles, and in- centives work together to reinforce those values? 2. The theory of corporate governance is based on an assumption that self-interested managers will take actions that benefit themselves at the cost of shareholders (the “agency problem”), and yet Berkshire Hathaway is built on the opposite as- sumption. How should companies take agency risk into account when designing their gover- nance systems? 3. The operating principles of Berkshire Hathaway are in stark contrast to the “best practices” rec- ommended by governance experts. What does this say about the reliability of those best prac- tices?  1 For more on this topic, see also: David F. Larcker and Brian Tayan,
  3. 3. stanford closer look series 3 Berkshire Hathaway: The Role of Trust in Governance “The Management of Berkshire Hathaway,” GSB Case No. CG-16, Jan. 01, 2009. Available at: 2 The DuBridge Distinguished Lecture Series, “A Conversation with Charlie Munger,” California Institute of Technology, Mar. 11, 2008. 3 MidAmerican Energy and Burlington Northern are two notable ex- ceptions to this last criterion. For a discussion of how they fit into the Berkshire model, see the Berkshire Hathaway Annual Report, 2009, Letter to Shareholders. Available at: http://www.berkshire- 4 Wesco Financial, 2008 Annual Meeting, cited in: Outstanding Inves- tor Digest, Vol. XXI, No. 4&5, Aug. 31, 2008. Edited lightly for clarity. 5 Berkshire Hathaway, 2008 Annual Meeting, cited in: Outstanding Investor Digest, Vol. XXI, No. 4&5, Aug. 31, 2008. 6 In terms of value realized rather than expected value on the grant date. 7 Keynote speech by Charles T. Munger, Stanford University Direc- tor’s College, held at Stanford Law School, Jun. 26, 2006. 8 Hathaway, 2008 Annual Meeting, cited in: Outstanding Investor Di- gest, loc. cit. 9 Wesco Financial, 2007 Annual Meeting, cited in: Outstanding Inves- tor Digest, Vol. XXI, No. 1&2, Feb. 29, 2008. Edited lightly for clarity. David Larcker is the Morgan Stanley Director of the Center for Leadership Development and Research at the Stanford Graduate School of Business and senior faculty member at the Rock Center for Corporate Governance at Stanford University. Brian Tayan is a researcher with Stanford’s Cen- ter for Leadership Development and Research. They are coauthors of the books A Real Look at Real World Cor- porate Governance and Corporate Governance Matters. The authors would like to thank Michelle E. Gutman for research assistance in the preparation of these materials. The Stanford Closer Look Series is a collection of short case studies that explore topics, issues, and controversies in cor- porate governance and leadership. The Closer Look Series is published by the Center for Leadership Development and Research at the Stanford Graduate School of Business and the Rock Center for Corporate Governance at Stan- ford University. For more information, visit: Copyright © 2012 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved.
  4. 4. stanford closer look series 4 Berkshire Hathaway: The Role of Trust in Governance Exhibit 1 — Berkshire Hathaway Operating Companies (2009) Company Employees Company Employees Berkshire Hathaway Homestate Cos. 591 General Re Corporation 2,513 Berkshire Hathaway Reinsurance Group 523 Kansas Bankers Surety Company 18 Boat America Corporation 379 Medical Protective Corporation 414 Central States Indemnity Co. 408 National Indemnity Primary Group 393 GEICO 23,549 United States Liability Insurance Group 546 Insurance total 29,334 insurance businesses Company Employees Company Employees Acme Building Brands 1,947 Kingston (1) 109 Adalet (1) 191 Kirby (1) 549 Altaquip (1) 329 Larson-Juhl 1,594 Applied Underwriters, Inc. 471 The Marmon Group 15,410 Ben Bridge Jeweler 744 McLane Company 15,441 Benjamin Moore 2,380 MidAmerican Energy Company (2) 3,567 Borsheim’s Jewelry 168 MidAmerican Energy Holdings Co. (2) 25 Burlington Northern Santa Fe 35,000 MiTek, Inc. 1,723 The Buffalo News 730 Nebraska Furniture Mart 2,627 Business Wire 498 NetJets 7,226 CalEnergy (2) 360 Northern Natural Gas (2) 878 Campbell Hausfeld (1) 448 Northern and Yorkshire Electric (2) 2,455 Carefree of Colorado (1) 172 Northland 64 Clayton Homes, Inc. 12,133 PacifiCorp (2) 3,158 Cleveland Wood Products (1) 80 Pacific Power (2) 1,164 CORT Business Services 2,248 The Pampered Chef 791 CTB International 1,165 Precision Steel Warehouse 168 Dairy Queen 2,342 Richline Group 2,003 Douglas / Quikut (1) 56 Rocky Mountain Power (2) 2,125 Fechheimer Brothers 677 Russell Corporation 1,744 FlightSafety International 4,140 Other Scott Fetzer Companies (1) 137 Forest River, Inc. 5,355 See’s Candies 3,000 France (1) 80 Shaw Industries 25,492 Fruit of the Loom 26,952 Stahl (1) 99 Garan 4,485 Star Furniture 740 H. H. Brown Shoe Group 1,162 TTI, Inc. 2,603 Halex (1) 96 United Consumer Finance Company (1) 197 Helzberg Diamond Shops 2,147 Vanity Fair Brands, Inc. 2,529 HomeServices of America (2) 2,415 Wayne Water Systems (1) 177 Iscar 9,583 Wesco Financial Corp. 13 Johns Manville 6,411 Western Enterprises (1) 254 Jordan’s Furniture 812 R.C. Willey Home Furnishings 2,250 Justin Brands 793 World Book (1) 191 Kern River Gas Transmission Co. (2) 162 XTRA 523 Non-insurance total 227,758 Corporate office 21 Total Berkshire Hathaway 257,113 non-insurance businesses (1) A Scott Fetzer Company (2) A MidAmerican Energy Holdings Company
  5. 5. stanford closer look series 5 Berkshire Hathaway: The Role of Trust in Governance Exhibit 2 — Berkshire Hathaway: Compensation and Equity Ownership (2009) summary Compensation Note: “All other compensation” includes the value of director fees received by Buffett for serving on the board of The Washington Post Company in which Berkshire Hathaway has a significant ownership position. Named Executive Officers Year Annual Salary Annual Bonus All Other Compensation Total Compensation Warren E. Buffett, Chairman and CEO 2009 $ 100,000 - $ 75,000 $ 175,000 Charles T. Munger, Vice Chairman 2009 100,000 - - 100,000 Marc D. Hamburg, CFO 2009 862,500 - 12,250 874,750 Non-Executive Directors 2009 Non-Executive Directors 2009 Howard G. Buffett $ 3,000 Charlotte Guyman $ 7,000 Stephen B. Burke - Donald R. Keough 6,700 Susan L. Decker 3,000 Thomas S. Murphy 7,000 William H. Gates, III 2,700 Ronald L. Olson 3,000 David S. Gottesman 3,000 Walter Scott, Jr. 3,000 equity ownership Director Class A Class B Total Value Economic Interest Warren E. Buffett 350,000 75,013,134 39,667,367,000 24.3 % Howard G. Buffett 1,406 841,050 194,970,000 0.1 % Stephen B. Burke 5 - 496,000 - Susan L. Decker - 6,250 413,000 - William H. Gates, III 4,350 77,313,900 5,534,194,000 3.4 % David S. Gottesman 19,044 2,604,439 2,060,867,000 1.3 % Charlotte Guyman 100 600 9,959,000 - Donald R. Keough 70 - 9,943,000 - Charles T. Munger 13,057 - 1,295,124,000 0.8 % Thomas S. Murphy 1,310 11,600 130,705,000 0.1 % Ronald L. Olson 284 15,000 29,160,000 - Walter Scott, Jr. 100 - 9,919,000 - Notes: Based on year-end closing prices: BRK.A: $99,190; BRK.B: $66. Shares beneficially owned by William H. Gates, III includes 77,313,900 Class B shares owned by the Bill & Melinda Gates Foundation Trust. Source: Berkshire Hathaway, form DEF 14A, filed with the Securities and Exchange Commission, Mar. 11, 2010.