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Monday, February 24, 2020
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Warren Buffett puts a spotlight on conflicted directors
A company’s board of directors is supposed to look out for the interests of shareholders. Or something close to that.
At the very least, non-executive directors should be able to operate and make decisions independently of a company’s executives.
Warren Buffett, however, argues that directors are often conflicted as they have a strong incentive to prioritize the interests of CEOs, and can get paid a fortune if they play along.
“Director compensation has now soared to a level that inevitably makes pay a subconscious factor affecting the behavior of many non-wealthy members,” he writes in his annual letter to Berkshire Hathaway (BRK-A, BRK-B) shareholders. “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.”
But it doesn’t stop there.
“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?” Buffett continues. “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.”
This compensation often includes grants of equity or equity-linked securities, which give these directors some direct exposure to the companies they’re directing. But to Buffett, that’s not the same as buying stock “using their own money.”
“Paid-with-my-own-money ownership, of course, does not create wisdom or ensure business smarts,” Buffett says. “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.”
And so this may explain why CEO pay (which is handled by the board) is so high and bad acquisitions (which must be approved by the board) close regularly. Directors aren’t pushing back against management when they should because they are aligned with management, not shareholders.
As Buffett writes: “When seeking directors, CEOs don’t look for pit bulls. It’s the cocker spaniel that gets taken home.”
Regarding questionable deals that get pushed though by conflicted board members, Buffett proposes a simple alternative: “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.”