2000: How does excessive executive compensation affect a business's investment prospects?

AUDIENCE MEMBER: Yes, good afternoon. My name is Tom Gayner from Richmond, Virginia.

And in the current environment, it seems that the attacks on the moats of wonderful businesses are coming from inside the castle, in the form of option-based compensation, just as much as from outside competitors.

One of your role models, Ben Franklin, said, “Even a small hole can sink a great ship.” It seems like the holes are getting bigger.

Can you discuss what, if any, forces may cause this to change? Is it a problem that will get worse or get better?

My second is specifically, in your role as directors of companies like Coke and Gillette, are you seeking to change these practices? And what kinds of success do you expect there? Do they let you on the comp committee?

And three, if these compensation practices are irrational, does Berkshire benefit from this irrationality? Thank you.

WARREN BUFFETT: Well, to carry the castle analogy further, we not only look for a great economic castle, but we look for a great knight in charge of that castle. Because that’s important. He’s the one that throws the crocodiles into the moat and widens the moat over time.

And of course, the question is, you know, how much does the knight get of the castle for doing that? And I think, generally speaking, at Berkshire, you get a very fair deal in terms of the amount that —

We’ve got a lot of castles around. And we try to pay people fairly. But I don’t think that the division of — is unfair between the owners of the castle and the knights that are around there, protecting the moat.

The — it’s hard for me to imagine how the compensation practices — the question of how much the knight gets of the castle — how that changes in favor of the owners of the castle over time. The ratcheting effect is just unbelievable.

No one, no compensation committee in America, will be listening to a consultant who walks in and says, “I think your management should have an arrangement that ends up in them being in the lower half.”

And if no one wants to be in the lower half, believe me, the median is going to move up.

I mean, there is no way around that. I mean, these people meet yearly or more often. And they sit there with a proxy statement of every other company in their business. You know, and they pick out the ones that have the biggest numbers in them.

And they say, “Well, gee, we need a management at least as good as this. And how are we going to attract people?” and all this other stuff.

And it’ll only ratchet upward. And I think that’s a fact of life. And I think that it’s important for shareholders to understand that.

I’ve been on the board of 19 companies, not counting any Berkshire subsidiaries or anything like that. The last comp committee I was on was at Salomon. And I was chairman of the comp committee, I think. I may be wrong on that. There were three of us. And the other two guys were terrific guys.

And the earnings came in one year, $100 million or so — I think it was 1990 — below the previous year. And comp was up a fair amount.

And I’d found that there had been some earlier issues involved and so on. I just said, I couldn’t swallow it anymore. And I voted against it.

I can’t remember whether I was chairman or not. But in any event, it was two to one against me. And I think it would’ve been two to one against me if I’d been chairman.

And the other two fellows were perfectly rational. They said, “How do we keep these people? And, you know, how can we repudiate our management?” All the sort of things you get.

So as a practical — I’ve got one friend, terribly well-regarded businessman — and he’s been — they don’t throw you off the comp committee. They just don’t re-nominate you.

And he’s been bounced from two of them simply by raising some questions that — about things you would find outrageous.

I’m not on the comp committee. I’ve been on only one comp committee. And they saw what I did. So that was the end of it.

People say, “We love your ideas,” And, you know, “You think creatively. We don’t want to hear about your thoughts on compensation.” And that, you know, it’s understandable.

You know, and every — and you run into some terrific cases of people. I mean, the fellow who runs Fastenal, for example, they are just outstanding. And there are a number of cases where people behave very well.

But most of them, I think some — I don’t think it’s money so much, sometimes. I just think it’s ego. They just can’t stand to see some guy that they think is batting .280, and they’re batting .300, and he’s getting paid more money. And, you know, and that process is endless.

And that, I, you know, that’s understandable. It’s like who gets top billing in a movie or something of the sort. People care about, you know, where their name is compared to somebody else’s. And their name, in this case, is compensation. And it — I doubt if it reverses itself.

Charlie?

CHARLIE MUNGER: No, I think we can confidently expect that the situation will get worse. And I think we can confidently expect that that is bad for Berkshire Hathaway to the extent that it’s a passive shareholder in big corporations.

There is one place where we get an advantage: our own culture and attitude being so different, it does attract some of these people that own wonderful businesses.

I mean, we literally, on occasion, find people for whom we’re the only acceptable buyer. They don’t like this culture of other big corporations any better than you do. And that does give us an advantage.

WARREN BUFFETT: Yeah. You asked us a question, also, about the — how active we might be in saying this. We’re not going to ever sit here and tell you what we say in other boardrooms, because it would reduce any effectiveness we might have. And we probably don’t have that much effectiveness anyway. But —

You can only belch so many times at the dinner table and get invited back. And — (laughter) — we’ve probably done enough of our share of that. And you — we try to run Berkshire in a way that we find admirable. And we try to spell out our reasoning on it and everything else. And we hope that maybe somebody latches onto that as a model someplace.

But going around condemning people by name does not work. And so we, you know, we hate the sin and love the sinner and all that sort of thing. And it doesn’t have much effect.