2010: How does Berkshire set performance based-compensation?

BECKY QUICK: This question comes from Mark Wares (PH) and it has to do with Berkshire’s compensation.

He says, “How does Berkshire structure the performance based-compensation of the CEOs of its subsidiaries? Please because as specific as you can regarding the metrics on which you focus the most, and how the degree to which those are attained translates into compensation.”

WARREN BUFFETT: Yeah, well, the first thing we do is we never engage a compensation consultant. (Applause)

And we have, whatever it may be, 70-plus or whatever number businesses we have.

They have very different economic characteristics. To try to set some Berkshire standard to apply to businesses such as insurance, which has capital as a bulwark but which we get to invest in other things we’d invest in anyway, so there’s minus capital involved, to a BNSF or our utility business where there’s tons of capital involved, or in between See’s where there is very little capital involved.

We have other businesses that are basically just so damn good that a, you know, a chimpanzee could run them, and we have other business that are so tough at times that, you know, if we had Alfred P. Sloan back, you know, we wouldn’t be able to do very well with them.

So there’s enormous differences in the economic characteristics of our business.

I try to figure out what — if I owned the whole business — what is a sensible way to employ somebody and compensate them, considering the economic characteristics of the business. So we have all kinds of different plans.

It doesn’t take a couple of hours of my time a year to do it. We have managers who stay with us, so they must be reasonably happy with the plans.

And, you know, it is not rocket science, but it does require — it requires the ability to differentiate.

If we had a human relations department, it would be a disaster. They would be attending conferences and people would be telling them all these different things to put in equations and so on. It just requires a certain amount of common sense.

And it requires, incidentally, an interaction with the managers where, you know, I listen to them, they listen to me, and we sort of agree on what really is the measure of what they’re actually adding to the company.

And — what do you — what do you say to that, Charlie?

CHARLIE MUNGER: Well, I think the U.S. Army and General Electric have centralized personnel policies that probably work best for them, and we have just the opposite system, and I think it clearly works best for us.

And practically nobody else is entirely like us, which makes us very peculiar. And I like it that way, don’t you?

WARREN BUFFETT: Yeah, we really like it that way. We get worried when people agree with us. (Laughter)

We pay people — we pay some very big money. We have managers that have made and will make in the tens of millions annually, and we have managers that, you know, when we suffer, they suffer.

But you’ve got to treat people fairly. Even though they don’t need the money, everybody wants to be treated fairly.

And so the rationale for how you’re doing it should be understood, but there is no cross-Berkshire rationale at all. I mean, if you run See’s Candy, to put a cost of capital factor in or something like that, what the consultant would tell you, it’s nonsense.

It isn’t going to make any difference whether there’s 40 million or 43 million or 37 million of capital in the business.

The main thing to do is, in terms of market position and all that sort of thing, the real thing I really want to pay managers for is widening the moat that separates our business from our competitors’ businesses over time. Now, that gets very subjective, so I don’t have any perfect way of doing that. But that is always going through my mind in trying to design compensation systems.

So far, like I say, I don’t think — I can’t — can you recall any manager that’s ever left us over compensation, Charlie?

CHARLIE MUNGER: I think it’s amazing how simple it’s been and how little time it has taken and how well it has worked.

There’s this idea that headquarters can do these wonderful things. Headquarters, in a conglomerate kind of a company, is frequently hated in the field. We don’t want to be hated in the field. We don’t want an imperial headquarters with big costs that’s imposed everywhere.

And averaged out, it’s worked wonderfully well for us.

WARREN BUFFETT: Yeah, we make no headquarters charges. We charge for our credit with a couple of companies, but — most companies are allocating a couple percent of sales, maybe, or whatever it might be, to all their different operations. And usually it’s resented out in the field. And —

CHARLIE MUNGER: Is it ever.

WARREN BUFFETT: Yeah. So we don’t do it.