Exceptional Compensation, But Only for Exceptional Performance
Eighteen years ago, Buffett wrote the following to Salomon, Inc, shareholders after Salomon's 1990-1991 illegal bond trading scandal:
"Most of you have read articles about the high levels of compensation
at Salomon Brothers. Some of you have also read
discussions of incentive compensation that I have written in
the Berkshire Hathaway annual report. In those, I have said
that I believe a rational incentive compensation plan to be an
excellent way to reward managers, and I have also embraced
the concept of truly extraordinary pay for extraordinary managerial
performance. I continue to subscribe to those views.
But the problem at Salomon Brothers has been a compensation
plan that was irrational in certain crucial respects.
One irrationality has been compensation levels that overall
have been too high in relation to overall results. For example, last
year the securities unit earned about 10% on equity capital — far
under the average earned by American business — yet 106 individuals
who worked for the unit earned $ 1 million or more. Many
of these people performed exceedingly well and clearly deserved
their pay. But the overall result made no sense: Though 1990
operating profits before compensation were flat versus 1989, pay
jumped by more than $ 120 million. And that, of course, meant
earnings for shareholders fell by the same amount.
In Salomon Brothers’ business, which combines leverage with
earnings volatility, it is particularly necessary and appropriate that
the financial equation applying personally to managers be comparable
to that applying to the ordinary shareholder. We wish to see
the unit ’ s managers become wealthy through ownership, not by
simply free - riding on the ownership of others, I think in fact that
ownership can in time bring our best managers substantial wealth,
perhaps in amounts well beyond what they now think possible.
To avoid dilution, the trustee of the EPP purchases stock for
the plan in the market and at some point in the future, the company
may itself elect to make stock repurchases to reduce the
shares outstanding. Within a relatively few years Salomon Inc. ’ s.
key employees could own 25% or more of the business, purchased
with their own compensation. The better job each employee does
for the company, the more stock he or she will own.
Our pay - for - performance philosophy will undoubtedly
cause some managers to leave. But very importantly, this same
philosophy may induce the top performers to stay, since these
people may identify themselves as .350 hitters about to be paid
appropriately instead of seeing their just rewards partially assigned
to lesser performers. Indeed, I am pleased to report that certain
of our very best managers have already asked that the EPP be
modified to allow them to substantially increase the proportion
of their earnings that can be invested through the plan.
Were an abnormal number of people to leave the firm, the
results would not necessarily be bad. Other men and women
who share our thinking and values would then be given added
responsibilities and opportunities. In the end we must have
people to match our principles, not the reverse.
Our goal is going to be that stated many decades ago by
J.P. Morgan, who wished to see his bank transact “ first - class
business — in a first - class way. ” We will judge ourselves in fact not
only by the business we do, but also by the business we decline
to do. As is the case at all large organizations, there will be mistakes
at Salomon and even failures, but to the best of our ability
we will acknowledge our errors quickly and correct them with
equal promptness…"
______________________________________________
Warren Buffett, Third Quarter, 1991 Letter to Salomon Inc. Shareholders
Showing posts with label Executive Compensation. Show all posts
Showing posts with label Executive Compensation. Show all posts
Wednesday, December 16, 2009
Friday, October 23, 2009
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.
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
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.
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
Wednesday, October 21, 2009
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.
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
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