Author: Lawrence Cunningham

1

What Everyone Should Remember about Buffett’s Views on Executive Compensation

Intelligent and well-meaning as they are, critics of Warren Buffett’s decision to have Berkshire Hathaway abstain from voting as a shareholder of Coca-Cola on the latter’s executive pay proposal suffer from two problems.  Some, like Joe Nocera of the New York Timesseem to believe that, since Buffett is powerful and historically a strong vocal critic of executive compensation, he is obliged to cast Berkshire’s vote against it.  When he explained last weekend that directors may not always vote against proposals with which they disagreed others, including Vitaliy Katsenelson at the Institutional Investor, lamented that directors may not always stand up for what they believe.

These positions are a combination of misreading history and naïve. Buffett has always stressed that, as costly to shareholders as executive compensation may be, in raw amounts and in terms of conflicts of interest, they pale in comparison to the vastly larger costs to shareholders of other conflicts between executives and shareholders, especially on acquisitions.  No rational investor should believe that directors are unabashed devotees of the shareholder interest at every turn.  Here is an excerpt from remarks Buffett made as discussant at a Cardozo Law School conference I hosted in 1997, the themes of which he has repeated for two decades:

As a stockholder, I’m really only interested in the board accomplishing two ends. One is to get a first class manager and the second is to intervene in some way when even that first class manager will have interests that are contrary to the interests of the owners.

I think there are great difficulties in achieving both of those ends. I’ve been a director of, counting them up, seventeen publicly owned companies, not counting ones which we control (which probably shows a very dominant, masochistic gene) (laughter). But over that time I’ve wrestled with just these couple of problems and there may be processes that would improve them.

The first one: getting the first class manager. I have never seen in those seventeen cases – and I’m not aware of it in other cases – where a question of mediocrity or worse and the evaluation of change has been made in the presence of a chief executive. It just doesn’t happen. So, I think absolutely to have any chance of having that one solved, you have to have regular meetings of evaluation of chief executives, absent that chief executive. If they are rump meetings or something of the sort – if they’re not regularly scheduled – there is just too much tension created. Because a board may be a legal creation, but it’s a social animal. It is very difficult for a group of people without a very strong leader to all of a sudden, spontaneously decide that they’re going to hold some meetings elsewhere and discuss whether this person who may be a perfectly decent individual, really should be batting clean-up.

So, I think there should be a lot of emphasis on process in terms of evaluation of a CEO. I don’t know how you create a greater willingness on the part of directors to really bounce somebody that they would bounce if they owned 100% of the company or if their family was dependent on the income from the business and so on. I just have not seen it in corporate America.

If you get that first class chief executive – which is a top priority – he doesn’t have to be the best in the world, just a first class one. And I may agree with Jill to some extent – you may be able to turn a five into a five-and-a-half or something by having him consult with lots of other CEOs and get a lot of advice from the board. But my experience is that you don’t turn a five into an eight. I think you’re better off getting rid of the five and having him find something else to do in life and going out and acquiring an eight.

The second problem is: even a first class chief executive has some interests that are in conflict with the shareholders. One is his or her own compensation. The second one gets into the acquisition category. There are psychic benefits to an executive of running a bigger show or just having more action or whatever that can be in conflict with the shareholders, even though that executive may be first class in other respects. The nature of acquisitions is that they get to the board at a point where if you turn them down you are rejecting the chief executive, you are embarrassing him in front of his troops, you’re doing all kinds of things. So, it just doesn’t happen.

I have seen board after board approve deals that afterwards the board members say, “you know, I really didn’t think it was a very good idea but what could we do about it?” And there should be a better mechanism. But I’m not sure what it is. There should be a better mechanism, though, for a board to make those important decisions where a first class chief executive can have an absolutely different equation than the shareholders, weighing all of the personal economic and non-economic considerations. There should be a mechanism that enables the board to bring independent judgment on those in a way that doesn’t put the CEO in a position virtually where he or she has to resign or is embarrassed in front of the troops. And I would welcome any discussion on those matters.

The compensation question where the first class executive could be in conflict with the owners, I think it gets abused some but I don’t think that it amounts to that much when compared with the other two questions – getting the right one and also the question of acquisitions. I think it costs shareholders some money that’s unnecessary, and I think that a lot of the compensation schemes have been quite illogical, but I don’t think that they are overwhelming in terms of evaluation.

On compensation, I can turn purple in meetings. But in the end, the big, dumb acquisitions are going to cost shareholders far, far more money than all of the other stuff.

 

 

0

Berkshire’s 2014 Annual Meeting

Among delightful things I did last week in Omaha was lunch with Bloomberg reporter Noah Buhayar on Thursday ahead of Saturday’s meeting of Berkshire Hathaway shareholders.  Noah wrote several stories in which he kindly quoted me. Here are highlights.

1. Coke Pay.  On Berkshire’s abstention from voting on whether to support or oppose Coca-Cola’s executive pay plan, which other Coca-Cola shareholders challenged and which Buffett considered excessive, Noah correctly quoted what I said Thursday as follows:  “People like to raise tricky issues at the Berkshire meeting, and that’s probably the trickiest one.  You’ve got to decide when you’re going to throw that weight around.” That’s pretty much the answer Buffett and Munger gave on Saturday.  (See Noah’s piece referencing Coke here.)

2. Shareholder Activism.  On Charlie Munger’s remarks about shareholder activism being bad for America–and the responses of two activists–Noah quoted me from a Sunday morning follow-up interview:  “As iconoclastic and unusual as Berkshire Hathaway is, it represents big, corporate America on this issue of activism.  Munger perceives activist investing as making corporations more like commodities than complex, social institutions that over time can contribute value.” (See Noah’s piece on this topic here.)

3. Stock Picking to Business Building. On Buffett’s move from picking stocks to building companies:  “He became famous as a stock picker, and that reputation still dominates in the public image.  He was very good at doing that, but that has not been the definition or content of Berkshire in recent years.”  (See Noah’s piece on this big shift at Berkshire here and my elaboration of it here.)

4. Mood and Continuity.  I predicted on Thursday: “The mood at the meeting will be celebratory, with the stock near an all-time high. Topics at the gathering are often similar from year to year.  From one meeting to the next, the big thing that changes is size. Everything’s bigger.” (See Noah’s piece referencing the celebratory mood here.)

Plus ça change, plus c’est la même chose. And it’s a good thing too.

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Buffett’s Evolution: From Stock-Picking Disciple of Ben Graham to Business-Building Devotee of Tom Murphy

While everyone knows that Warren Buffett modeled himself after Ben Graham for the stock picking that made Buffett famous in the latter 20th century, virtually no one knows a more important point for the 21st century: he has modeled himself after Tom Murphy in assembling a mighty conglomerate.   Murphy, a legendary executive with great skills in the field of acquisitions that resulted in the Capital Cities communications empire, engineered the 1985 $3.5 billion takeover by Capital Cities of ABC before selling it all to to Disney a decade later for $19 billion.  You did not hear that explicitly at Saturday’s Berkshire Hathaway annual meeting, but Warren mentioned it to me at brunch on Sunday and, when you think about it, it’s a point implicit deep in the meeting’s themes and many questions.

In fact, Berkshire mBBB COvereetings are wonderful for their predictability.   Few questions surprise informed participants and most seasoned observers can give the correct outlines of answers before hearing Buffett or vice chairman Charlie Munger speak. While exact issues vary year to year and the company and its leaders evolve, the core principles are few, simple, and unwavering.  The meetings reinforce the venerability and durability of Berkshire’s bedrock principles even as they drive important underlying shifts that accumulate over many years.  Three examples and their upshot illustrate, all of which I expand on in a new book due out later this year (pictured; pre-order here).

Permanence versus Size/Break Up. People since the 1980s have argued that as Berkshire grows, it gets more difficult to outperform. Buffett has always agreed that scale is an anchor. And it’s true that these critics have always been right that it gets harder but always wrong that it is impossible to outperform.   People for at least a decade have wondered whether it might be desirable to divide Berkshire’s 50+ direct subsidiaries into multiple corporations or spin-off some businesses.  The answer has always been and remains no.  Berkshire’s most fundamental principle is permanence, always has been, always will be. Divisions and divestitures are antithetical to that proposition.

Trust and Autonomy versus Internal Control. Every time there is a problem at a given subsidiary or with a given person—spotlighted at 2011’s meeting by subsidiary CEO David Sokol’s buying stock in Lubrizol before pitching it as an acquisition target—people want to know whether Berkshire gives its personnel too much autonomy. The answer is Berkshire is totally decentralized and always will be-another distinctive bedrock principle. The rationale has always been the same: yes, tight leashes and controls might help avoid this or that costly embarrassment but the gains from a trust-based culture of autonomy, while less visible, dwarf those costs.

Capital Allocation: Berkshire has always adopted the doubled-barreled approach to capital allocation, buying minority stakes in common stocks as well as entire subsidiaries (and subs of subs).  The significant change at Berkshire in the past two decades is moving from a mix of 80% stocks with 20% subsidiaries to the opposite, now 80% subsidiaries with 20% stocks.  That underscores the unnoticed change: in addition to Munger, Buffett’s most important model is not only Graham but Murphy, who built Capital Cities/ABC in the way that Buffett has consciously emulated in the recent building of Berkshire.

For me, this year’s meeting was a particularly joy because I’ve just completed the manuscript of my next book, Berkshire Beyond Buffett: The Enduring Value of Values (Columbia University Press, available October 2014). It articulates and consolidates these themes through a close and delightful look at its fifty-plus subsidiaries, based in part on interviews and surveys of many subsidiary CEOs and other Berkshire insiders and shareholders.   The draft jacket copy follows. Read More

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Correction on Faculty Hiring and Buyouts

This post, partly apology, is prompted by a request from a law school dean to retract an assertion I made in a post earlier this week, which requires a little explanation at the outset. In Pikettian Law Schools, I noted how different law schools respond to the problems in legal education that arise from decreased demand and persistent high costs.  A large number of schools are downsizing via faculty buyouts, I said, while some buck the trend by hiring in surprisingly large numbers.

Readers offered various responses to my suggestion that this mimics the idea that the rich get rich and the poor get poorer, including by suggesting it might be about relative sensitivity to market demand or other natural competitive forces.  Some perceived that being listed  among those doing buyouts rather than hiring would hurt a school’s reputation while others thought it would help; some seemed to think that hiring is a sign of strength while others thought it a sign of being irresponsible.

Two readers–a professor at one law school and a dean at another–commented directly on the post that I had incorrectly listed their schools as having taken the buyout approach, noting instead that they had actually been doing serious hiring.   I promptly responded to both comments and made related corrections in the post.

Thereafter, I received a follow-up request from the Dean of Chapman University’s law school to make a new post retracting my erroneous inclusion of Chapman from the list.  I said I would oblige and noted that I would also include his email to me, which is posted below.  I apologize for the error(s) in my previous post.

 

Dear Professor Cunningham,

I am writing to point out an inaccuracy in your April 28 blog entry, Pikettian Law Schools, in which you identify Chapman as a school that has encouraged early faculty retirement without replacing vacancies. With respect to Chapman, this is simply not the case. In fact, this past year, we added four new faculty members, including a significant lateral hire, Lan Cao, who was a Boyd Fellow and Professor of Law at William and Mary Law School before joining our faculty last fall. She is now the Betty Hutton Williams Professor of International Law at the Chapman University Dale E. Fowler School of Law.

We realize that errors like this may sometimes occur; however, this type of information can be harmful to a school’s reputation and to its perception by those in the broader academic community. Because of the impact of such an error, I ask that you do more than simply correct your blog. Instead, would you kindly publish a follow-up retraction, identifying this mistake? I fear that simply posting my response will not do enough to undo initial impressions by the vast majority of your readers who will have already read the blog entry.

Thank you.

Tom Campbell

Dean, Chapman University Dale E. Fowler School of Law

 

 

7

Pikettian Law Schools

Amid a general trend toward far less lateral recruiting by US law schools (see here and here), there are some contrarian schools on the move this year. They are expanding their faculties, while others cut budgets by reducing faculty size.  For example, each of the following schools recruited three lateral tenured law professors this year:  Columbia, Cornell, Harvard, Stanford, and Virginia.  (Source: Brian Leiter, here).

In the academic year just ended, only 28 U.S. law schools (of more than 200) recruited any laterals, the vast majority abandoning a long tradition in legal education.  They moved a total of only 46 professors of many thousands in the profession, down considerably from levels seen in decades past.

Other schools in this minority bucking the trend, with two recruits apiece this year: Alabama, Berkeley, Boston College (where I once was a professor and academic dean), BYU, and Penn.  Among those hiring one tenured  lateral are my own George Washington as well as our archi-rival Georgetown and Northwestern and Texas.

At the other end of the resource spectrum, dozens of schools cut salary expense, the largest line item on academic income statements. They are encouraging early retirement and not replacing the vacancies.  For example, each of the following schools reportedly engaged in significant buyouts in the past couple of years: Albany, Appalachian, Barry, Buffalo, Charleston, Charlotte, Elon, Faulkner, Florida Coastal, Hamline, Liberty, New England,  Phoenix, Seton Hall, Vermont, and Widener.

Others are more curious and harder to classify. Take U. Cal. Irvine, a newcomer climbing the ladder in part through aggressive lateral recruiting, setting the year’s record among schools, reeling in four.  Or Florida International, which hired two laterally this year.

Curiosities aside, in a capitalist society, the rich do get richer and the poor get poorer, as Thomas Piketty has reminded everyone while soaring to academic stardom. Is it surprising that, in such a civilization, the fancier established schools get bigger and stronger faculties while weaker rivals cut faculty deeply through aggressive buyouts?

 

1

Contracts in the Real World Gets CHOICE Award for Outstanding Title

Pop K CoverThe American Library Association last year named my book, Contracts in the Real World: Stories of Popular Contracts and Why They Matter (Cambridge University Press 2012), an “outstanding title” in its annual CHOICE awards.  The following kind entry accompanied the announcement, supplied by A. R. S. Lorenz of Ramapo College.  I’m grateful to the Association–and to the many 1Ls who have bought and used the book profitably in their courses!

 

 

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0

Facebook Playing Spoiler in Apple – Comcast Tie Up

 a comcastWithin hours after Apple Inc. and Comcast Corporation announced their long-anticipated merger agreement late last night, Facebook, Inc. said it would make a hostile bid for Comcast.  The Apple-Comcast deal, a stock-for-stock transaction valuing Comcast at $150 billion, is nominally billed as a “merger of equals” but few doubt that Apple, with a market cap nearing $500 billion, is the true acquirer.

Comcast has two classes of stock, all of the Class A being publicly held while all of the Class B, which has super-voting rights, held by the Roberts family, giving them thirty percent of the company’s total voting power.  A Comcast executive, who said the deal had been in the works for years as part of its strategic plan, called the transaction “a marriage made in heaven that could not be torn asunder.”

a facebookFacebook believes otherwise. The upstart social media business, with a market cap of $170 billion, says the late-night announcement merely put Comcast “up for sale.” Facebook officials said that Comcast’s board must entertain its bid.  Offering a combination of cash and stock that it says values Comcast at $190 billion, Facebook portrays its bid as “clearly superior.”

Comcast officials immediately dismissed Facebook’s overture.  “We are a staid Philadelphia-based, family-oriented company with prime assets such as NBC network television and the Golf Channel,” one Comcast executive explained.  “Facebook is a motley crew of youthful Menlo Park hoodies. We cannot see the two companies coming together under any circumstances. Apple, in contrast, gets our ‘TV culture’.”

For its part, Apple says its valuation of Comcast is generous and that it is not prepared to engage in competitive bidding.  “Facebook cannot be serious in thinking it can win a takeover battle for Comcast against Apple.  We are a far superior company and can assure Comcast and its stockholders of closing the transaction unconditionally.”

a appleAnalysts also noted that the Apple-Comcast merger agreement includes a termination fee requiring Comcast to pay Apple $1 billion if the transaction fails to close for any reason.  In addition, should the transaction note close because the Comcast board determines that its fiduciary duties prevent it from closing, Apple has the option to acquire 19.9 percent of Comcast’s Class A stock at yesterday’s closing market price. The option purchase price may be paid with an Apple promissory note and settled, at Apple’s option, for cash in lieu of shares. There is no cap on its value.

Facebook’s bid is conditional on those two contract terms being withdrawn or declared invalid.  Apple and Comcast have scheduled all-day emergency board meetings for April  1.   

 

0

Job Opportunity: Associate Dean, GW Law’s Econ/Finance Program

The George Washington University Law School seeks an Associate Dean and Program Director for its Center for Law, Economics & Finance (C-LEAF). C-LEAF is a think tank within the Law School, designed as a focal point in Washington, DC, for the study and debate of major issues in economic and financial law confronting the United States and the global community.

Minimum Qualifications: Master’s degree in an appropriate area of specialization and a minimum of 5-7 years of professional or administrative experience. An advanced degree  and experience in legal education is highly preferred.  Extensive knowledge and understanding of business and finance law policy. Previous experience in program administration and fund raising is essential.

To apply, please visit The George Washington University employment site, posting number 003171.

Deadline for applications is March 30, 2014.

The George Washington University is an Equal Employment Opportunity/Affirmative Action Employer.

4

Liquidity and Control at Buffett’s Berkshire Hathaway

Warren Buffett’s ownership of Berkshire Hathaway is skewed heavily towards commanding greater voting power rather than a larger slice of the economic interest. He values control more than liquidity and is delighted to have shareholders who prefer liquidity to control to stake their money accordingly.   It is interesting to see the corporate governance tools used to create this structure and precisely how the voting power and economic interests are determined. 

Berkshire Hathaway, like many other corporations, has multiple classes of stock with different economic and voting rights. Berkshire’s Class A has 10,000 times the voting power as its Class B and 1,500 times the economic interest.  All shares are eligible to vote on most shareholder voting matters and there are no further distinctions as to economic rights, such as dividends or liquidation payments. Market prices generally reflect the economic rather than the voting ratio: the Class A shares recently traded at $170,000 per share while the Class B trade at $113 (very close to 1500-to-1).

Many stockholders, including Buffett, own some Class A and some Class B, in part because they exercised the right to convert A to B to give gifts and otherwise manage estate planning.   It is easy to see what portion Buffett or another shareholder has of each Class, simply his number of shares of a Class divided by all shares of that Class. Buffett, for example, owns about forty percent of Berkshire’s Class A shares and a small number of the Class B.

It is more important to know what percentage of the aggregate voting power and economic interest any given shareholder’s stake represents.  So: what percentage of the aggregate voting power and economic interest does Buffett command?  For Berkshire, the answer can be computed using the following formula that reflects the relative weight of the A compared to the B in votes and payouts:

 

Voting Power    =

Number of A Shares Owned + Number of B Shares Owned / 10,000

Total A Shares Outstanding + Total B Shares Outstanding / 10,000

Economic Interest =

Number of A Shares Owned + Number of B Shares Owned / 1,500

Total A Shares Outstanding + Total B Shares Outstanding / 1,500

 

Applied to Buffett (using the most recent proxy statement figures for share information):

 

          Buffett’s Voting Power =

    350,000 + 3,525,623 / 10,000      

892,657 + 1,126,012,136 / 10,000

= 34.9%

 

Buffett’s Economic Interest =

      350,000 + 3,525,623 / 1,500

892,657 + 1,126,012,136 / 1,500

= 21.4%

 

Conversion charts can be created to show the voting power and economic interest of given levels of A and B share ownership.  The following assume the same figures stated above, which can change from time to time as Class A shares are converted into Class B shares or other capital shuffles occur.

 

Class A Power

Shares % ofClass VotingPower EconomicInterest
  250  – 0.04 0.02
  500 .056 0.05 0.03
1000 .112 0.1 0.06
2000 .224 0.2 0.12
3000 .336 0.3 0.18
4000 .448 0.4 0.24
5000 .550 0.5 0.30
6000 .662 0.6 0.36
7000 .784 0.7 0.42
8000 .892 0.8 0.48
9000 1.00 0.9 0.54
10,000 1.12 1.0 0.60
15,000 1.68 1.5 0.91
30,000 3.36 3.0 1.82

                                                                                                 Class B Power

(shares in millions)

Shares % ofClass VotingPower EconomicInterest
  1 0.1 0.04 0.01
  5 0.4 0.20 0.05
10 0.9 0.42 0.1
20 1.8 0.82 0.2
30 2.7 1.22 0.3
40 3.6 1.62 0.4
50 4.4 2.02 0.5
60 5.3 2.42 0.6
70 6.2 2.84 0.7
80 7.1 3.24 0.8

 

2

The 80/20 Principle

ParetoPareto originated the so-called 80/20 principle in the early 1900s after observing that 80% of the wealth in Italy was owned by 20% of the population.  For a century, innumerable observers have found that the 80/20 pattern, also dubbed the “vital few/trivial many rule,” recurs across many distributions.

Businesses tend to generate 80% of sales from 20% of their products and 80% of their profits from 20% of their customers.  Managers can use the tool to think about operations and allocating resources.  In book publishing, eighty percent of promotional resources are dedicated to twenty percent of the list.

The principle applies among law firms, where twenty percent of clients contribute eighty percent of billings. Firms can use the insight to improve in many ways. For example, it can help partners decide which clients to nurture or fire  or how paralegals should allocate their time.

The concept can be refined for any number of time management tasks, as popularized by Richard Koch’s 1998 book, and in The Four Hour Work Week by Tim Ferris (some notable tips from which Jeff Yates collected a few years ago at The Faculty Lounge).

The concept is not a precise measure nor a universal constant. For example, in America today, 20 percent of the population owns something more like 95% of the wealth. And the insight does not yield to prescriptive policy manuals. It is instead a way of thinking about resource allocation that can improve one’s effectiveness.

I wonder, among law professors, in what ways does the 80/20 rule manifest?  Here are some alluring candidates:

Eighty percent of law professors were trained at twenty percent of the nation’s law schools.

Do eighty percent of a prawf’s citations come from twenty percent of their articles?

Are eighty percent of your downloads on SSRN from twenty percent of your posted pieces?

Are twenty percent of law professors responsible for eighty percent of legal academic blogging, as Eric Goldman once forecast?

Do eighty percent of valuable classroom contributions come from only twenty percent of your students?

What other questions might this apply to for law professors? And what are the implications?

For one, being aware of the phenomenon can help define the activities that matter the most and allocate scarce productive resources on those.  Reflect upon what is special about the twenty percent of your scholarship yielding the vast majority of its influence.   Is it subject matter, methodology, orientation, clarity?  If twenty students in your 100-person classroom pull most of the weight, what should you do about that? Is it necessary to draw the rest in or capitalize on the phenomenon in some other way?