Corporate Expense Accounts-"A New Normal?"

In yesterday's New York Times, Joe Sharkey reports on Vince Vitti's book, Travelogy: Managing Travel Thru the Great Recession, "intended, Mr. Vitti says, for senior executives, chief financial officers who need to exercise far greater control and get more personally involved in expense account monitoring.....All the C.F.O. has to do is hang one or two people for expense account padding. Then everybody will straighten out, at least for a couple of years." ________________________________________

Joe Sharkey, Paying Closer Attention to Expense Accounts, New York Times, October 27, 2009

Warren Buffett's frugality and strict corporate cost controls are legendary, beginning 31 years ago.

"....our after-tax overhead costs are under 1% of our reported operating earnings and less than 1/2 of 1% of our look-through earnings. We have no legal, personnel, public relations, investor relations, or strategic planning departments. In turn this means we don't need support personnel such as guards, drivers, messengers, etc. Finally, except for Verne, we employ no consultants. Professor Parkinson would like our operation - though Charlie, I must say, still finds it outrageously fat.

At some companies, corporate expense runs 10% or more of operating earnings. The tithing that operations thus makes to headquarters not only hurts earnings, but more importantly slashes capital values. If the business that spends 10% on headquarters' costs achieves earnings at its operating levels identical to those achieved by the business that incurs costs of only 1%, shareholders of the first enterprise suffer a 9% loss in the value of their holdings simply because of corporate overhead. Charlie and I have observed no correlation between high corporate costs and good corporate performance. In fact, we see the simpler, low-cost operation as more likely to operate effectively than its bureaucratic brethren. We're admirers of the Wal-Mart, Nucor, Dover, GEICO, Golden West Financial and Price Co. models.
________________________________________________
Warren Buffett, 1992 Letter to Berkshire Hathaway Shareholders

"We cherish cost-consciousness at Berkshire. Our model is the widow who went to the local newspaper to place an obituary notice. Told there was a 25-cents-a-word charge, she requested "Fred Brown Died" She was then informed there was a seven-word minimum. "Okay" the bereaved woman replied, "make it "Fred Brown died, golf clubs for sale.'"
________________________________________________
Warren Buffett, 2002 Letter to Berkshire Hathaway Shareholders

"I can't resist one more Chandler quote: "Beginning this year about March 1st...we employed ten traveling salesmen by means of which, with systematic correspondence from the office, we covered almost the territory of the Union." "That's my kind of sales force."
_________________________________________________
Warren Buffett, 1996 Letter to Berkshire Hathaway Shareholders

"Our experience has been that the manager of an already high-cost operation frequently is uncommoningly resourceful in finding new ways to add to overhead, while the manager of a tightly-run operation usually continues to find additional methods to curtail costs, even when his costs are already well below those of his competitors."
_________________________________________________
Warren Buffett, 1978 Letter to Berkshire Hathaway Shareholders

Executive Compensation-Part II

Check out Joe Nocera's excellent article on the aftermath of Kenneth Feinberg's, the pay czar, rulings on the compensation of the "25 most highly paid executives at the seven big companies that still hold billions of dollars in government assistance." According to Feinberg, "the strategic construct is that that their compensation should be tied to the performance of the company."

Nocera minimizes this "strategic construct" as differing only in degree from pay policies that already exist and not addressing "in what matters most." He writes:

"But there was always a loftier goal for Mr. Feinberg. When he first took this thankless assignment from the Treasury Department in June, the hope was that when he made his rulings, he would help change the etos of executive pay, not just the seven companies that came under his perview, but all across Wall Street and, for that matter, across corporate America. When asked by a CNBC reporter on Thursday whether he believed the pay structure he established would lead to changes across Wall Street, he replied, "I hope so."

But the truth is. It won't. No pay czar can do that. That's something only shareholders can do.

Nell Minow, the co-founder of the Corporate Library and a fierce proponent of executive compensation reform, didn’t even think that was particularly likely. “The only way you’re going to change things is to throw the bums out,” she said caustically.

The “bums” she had in mind, of course, were corporate directors, especially the ones who sat on the compensation committees. Right now, it seems likely that Congress will pass a “say on pay” bill, giving shareholders the right to vote thumbs-up or thumbs-down on executive pay. (It has already passed in the House of Representatives.) But that is just a starting point, since, after all, say-on-pay would be only an advisory vote, and wouldn’t be binding on the board.

Instead, Ms. Minow believes that shareholders need the ability to vote directors off the board if they feel they are doing a bad job — on executive pay or anything else. Right now, the deck is so stacked that it is nearly impossible, especially since many companies don’t allow simple, majority votes to elect (or reject) directors. But the most straightforward way to shrink the oversize pay of Wall Street executives — and, more generally, curb the excesses of executive pay — would be to make directors more accountable to the company’s shareholders.

As well-meaning as Mr. Feinberg is, and as diligently as he worked through his assigned task, he shouldn’t be the pay czar. No one person should be. That’s a job more properly reserved for shareholders. You know, the ones who own the company."
_______________________________________________
Joe Nocera, Pay Cuts, but Little Headway in What Matters Most, New York Times, October 23, 2009


Buffett has been saying this for years

"When the manager cares deeply and the directors don’t, what’s needed is a powerful countervailing force – and that’s the missing element in today’s corporate governance. Getting rid of mediocre CEOs and eliminating overreaching by the able ones requires action by owners – big owners. The logistics aren’t that tough: The ownership of stock has grown increasingly concentrated in recent decades, and today it would be easy for institutional managers to exert their will on problem situations. Twenty, or even fewer, of the largest institutions, acting together, could effectively reform corporate governance at a given company, simply by withholding their votes for directors who were tolerating odious behavior. In my view, this kind of concerted action is the only way that corporate stewardship can be meaningfully improved.

Unfortunately, certain major investing institutions have “glass house” problems in arguing for better governance elsewhere; they would shudder, for example, at the thought of their own performance and fees being closely inspected by their own boards. But Jack Bogle of Vanguard fame, Chris Davis of Davis Advisors, and Bill Miller of Legg Mason are now offering leadership in getting CEOs to treat their owners properly. Pension funds, as well as other fiduciaries, will reap better investment returns in the future if they support these men.

The acid test for reform will be CEO compensation. Managers will cheerfully agree to board
“diversity,” attest to SEC filings and adopt meaningless proposals relating to process. What many will fight, however, is a hard look at their own pay and perks.

In recent years compensation committees too often have been tail-wagging puppy dogs meekly following recommendations by consultants, a breed not known for allegiance to the faceless shareholders who pay their fees. (If you can’t tell whose side someone is on, they are not on yours.) True, each committee is required by the SEC to state its reasoning about pay in the proxy. But the words are usually boilerplate written by the company’s lawyers or its human-relations department.

This costly charade should cease. Directors should not serve on compensation committees unless they are themselves capable of negotiating on behalf of owners. They should explain both how they think about pay and how they measure performance. Dealing with shareholders’ money, moreover, they should behave as they would were it their own.

In the 1890s, Samuel Gompers described the goal of organized labor as “More!” In the 1990s,
America’s CEOs adopted his battle cry. The upshot is that CEOs have often amassed riches while their shareholders have experienced financial disasters. Directors should stop such piracy. There’s nothing wrong with paying well for truly exceptional business performance. But, for anything short of that, it’s time for directors to shout “Less!” It would be atravesty if the bloated pay of recent years became a baseline for future compensation. Compensation committees should go back to the drawing boards."
__________________________________________________
Warren Buffett, 2002 Letter to Berkshire Hathaway Shareholders

"Irrational and excessive comp practices will not be materially changed by disclosure or by
“independent” comp committee members. Indeed, I think it’s likely that the reason I was rejected for service on so many comp committees was that I was regarded as too independent. 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."
_______________________________________________
Warren Buffett, 2006 Letter to Berkshire Hathaway Shareholders

Executive Compensation

In today's New York Times, it was reported that Credit Suisse will "radically change the way it paid its employees."

"The Credit Suisse plan will cover roughly 2,000 employees in the United States. Top executives will receive a greater portion of their total compensation in the form of their monthly cash salaries, while bonuses will be split evenly between cash and stock.

The stock will vest over four years, and the cash portion will pay out in three. But both components will be adjusted based on the bank's performance over that period, with a particular emphasis on its return on equity, a closely-watched financial measure. The performance of an executive's business will also be taken into account."
________________________________________________
Graham Bowley, Credit Suisse Overhauls Compensation, New York Times, October 21, 2009


Contrast this plan with that of Warren Buffett's long-time incentive compensation system for Berkshire Hathaway executives. No compensation plan consultants need apply.

"At Berkshire....I am a one man compensation committee who determines the salaries for the CEOs of around 40 significant operating businesses. How much time does this aspect of my job take? Virtually none. How many CEO's have voluntarily left us for other jobs in our 42-year history? Precisely none."
___________________________________________
Warren Buffett, 2006 Letter to Berkshire Hathaway Shareholders

"At Berkshire, we want to have compensation policies that are both easy to understand and in sync with what we wish our associates to accomplish."
_____________________________________________
Warren Buffett, 1999 Letter to Berkshire Hathaway Shareholders

"At Berkshire, however, we use an incentive compensation system that rewards key managers for meeting targets in their own baliwicks. If See's does well, that does not produce incentive compensation at the News-nor visa versa. Neither do we look at the price of Berkshire stock when we write bonus checks. We believe good unit performance should be rewarded whether Berkshire stock rises, falls, or stays even. Similarly, we think average performance should earn no special rewards even if our stock should soar.

The rewards that go with this system can be large.....We do not put a cap on bonuses, and the potential for rewards is not hierarchical. The manager of a relatively small unit can earn far more than the manager of a larger unit if results indicate he should. We believe, further, that such factors as seniority and age should not effect incentive compensation (though they sometimes influence basic compensation). A 20-year old who can hit .300 is as valuable as a 40- year old performing as well."

_______________________________________________
Warren Buffett, 1985 Letter to Berkshire Hathaway Shareholders

When we use incentives-and these can be very large-they are always tied to the operating results for which a given CEO has authority. We have no lottery tickets that carry payoffs unrelated to business performance. 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. An example: We now own $61 billion of equities at Berkshire, whose value can easily rise or fall by 10% in a given year. Why in the world should the pay of our operating executives be affected by such $6 billion swings, however important the gain or loss may be for shareholders?

________________________________________________

Warren Buffett, 2006 Letter to Berkshire Hathaway Sharehoders

Talented Managers And The Right Environment-Part II

In today's New York Times, Carol Bartz, CEO of Yahoo, answers the question, "What about leading others?"

"A lot of it is just picking the right team and picking people so much better than you are, and involving them in a decision."
___________________________________________________
Adam Bryant, Imagining a World of No Annual Reviews, Corner Office, October 18, 2009

Talented Managers And The Right Environment

In today's New York Times, Ruth Reichl, former Editor-In-Chief of Gourmet magazine and producer of "Gourmet's Adventures With Ruth," offers her advice for running an enterprise:

"How you be a good boss is you find really talented people and you give them the means to work."
__________________________________________________
Mike Hale, Gourmet Brand Survives, On a New Platter for PBS, New York Times, October 17, 2009

Warren would agree.

"Charlie and I know that the right players will make almost any team manager look good. We subscribe to the philosophy of Ogilvy & Mather's founding genius, David Ogilvy: "If each of us hires people who are smaller than we are, we shall become a company of dwarfs. But, if each of us hires people who are bigger than we are, we shall become a company of giants."
_______________________________________________
Warren Buffett, 2002 Letter to Berkshire Hathaway Shareholders

"Usually the manager came with the companies we bought, having demonstrated their talents throughout careers that spanned a wide variety of circumstances. They were managerial stars long before they knew us, and our main contribution has been to not get in their way. This approach seems elementary: if my job were to manage a golf team--and if Jack Nicklaus or Arnold Palmer were to play for me--neither would get a lot of directives from me about how to swing."
_______________________________________________
Warren Buffett, 1987 Letter to Berkshire Hathaway Shareholders

"I believe the GEICO story demonstrates the benefits of Berkshire's approach. Charlie and I haven't taught Tony a thing--and never will--but we have created an environment that allows him to apply all of his talents to what's important. He does not have to devote his time or energy to board meetings, press interviews, presentations by investment bankers or talks with financial analysts. Furthermore, he need never spend a moment thinking about financing, credit ratings or "Street" expectations for earnings per share. Because of our ownership structure, he also knows that this operational framework will endure for decades to come. In this environment of freedom, both Tony and his company can convert their almost limitless potential into matching achievements.
_____________________________________________
Warren Buffett, 1998 Letter to Berkshire Hathaway Shareholders

"CEO's Must Embrace Stewardship As a Way of Life and Treat Owners As Partners Not Patsies. It's Now Time for CEO's to Walk the Walk."

So said Warren Buffett seven years ago. Not written by a PR department, he has embraced and practiced this challenge to CEO's for his entire career.

"Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholders as partners, and ourselves as managing partners.....We do not view the company itself as the owner of our business assets but instead view the company as a conduit through which our shareholders own the assets."
____________________________________________________
Warren Buffett, 1996 Letter to Berkshire Hathaway Shareholders

"Charlie and I cannot promise you results. But we can guarantee that your financial fortunes will move in lockstep with ours for whatever period of time you elect to be our partners. We have no interest in large salaries or options or other means of getting an "edge" over you. We want to make money only when our partners do and in exactly the same proportion. Moreover, when I do something dumb, I want you to be able to derive some solace from the fact that my financial suffering is proportional to yours."
_________________________________________________________
Warren Buffett, 1996 Letter to Berkshire Hathaway Shareholders

"At Berkshire , we believe that the company's money is the owners' money just as it would be in a closely-held corporation, partnership, or sole proprietorhip."
_________________________________________________________

Warren Buffett, 1993 Letter to Berkshire Hathaway Shareholders

"Active" versus "Passive" Investing

Today, the Wall Street Journal reports on a recent study by Morningstar. Selected excerpts follow:

"While it has been established that most actively managed mutual funds lag behind their indexes over time, a new study further twists the knife: Active management suffers even more by comparison on a risk-adjusted basis.

The study found that in many cases where an actively managed fund beats its index on an absolute basis, the additional risk it took didn't justify the returns earned. Not only should that be a warning sign for investors -- because greater risk means greater volatility -- but it also suggests that fund managers aren't living up to what is expected of them.

The study by Morningstar Inc. found that, over the past three years, while about half of actively managed funds outperformed their respective Morningstar indexes -- which cover the nine different Morningstar investment styles -- only 37% did on a risk-, size- and style-adjusted basis. The numbers are similar for five and 10-year returns.

"It's not enough to beat an index in a way (that assumes more risk)," said Travis Pascavis, director of equity indexes at Morningstar. A riskier fund should provide greater returns, he added.....

The key to thinking of risk in terms of returns versus an index, he said, is that, in theory, if investors wanted to take on more risk for greater returns, they could simply buy an index fund and lever up their exposure. That would also increase returns while adding risk -- and do so at a cheaper cost than most actively managed funds. It is against this standard that actively managed funds should be judged, he said....

Mr. Pascavis said it is important for investors to be comfortable with the risk they are taking on when they buy a mutual fund. What is more, his study found that if a fund has higher risk, it is often a sign of an underperformer: Funds performing in the top 25% over the past three years had much lower risk and volatility than their peers.

"There is generally a positive relationship between risk and return, where better-performing funds are riskier; however, this has not been the case over the last three years," noted the study, which added that poor returns of the recent market likely helped less-risky funds.

Even in absolute terms, the results highlighted the shortcomings of many actively managed funds. Over the past five years across the nine Morningstar-style boxes -- value, core and growth in the small-cap, midcap and large-cap sectors -- only large-cap growth and midcap value saw more than half of active managers beat their indexes..... "
_____________________________________________
Sam Mamudi, Active Management Loses in Risk Study, New York Times, September 8, 2009

Buffett would agree with the findings of this study

"Let me add a few thoughts about your own investments. Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.

Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected": You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.

To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices.

Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value. Though it's seldom recognized, this is the exact approach that has produced gains for Berkshire shareholders......."

Warren Buffett, 1996 Letter to Berkshire Hathaway Shareholders

In January 2008, to prove his point, Buffett entered into a bet (each side put up $320,000, with the final proceeds going to the winner's favorite charity) with Protege partners, a fund-of-funds hedge fund, that their handpicked funds will not beat the S&P 500 index over the next 10 years. A principal of Protege said, "Fortunately, for us, we're betting against the S&P's performance. not Buffett's"