Billionaire Warren Buffett Gives Tips on Corporate Governance

WHAT makes good corporate governance? Fundamentally, stakeholders must realise that good corporate governance is not the sole responsibility of the regulators.

“Every market participant has a role to play, particularly the companies themselves in exercising self-discipline. The board of directors must act fairly and demonstrate high standards of ethics and integrity in their decision-making,” Securities Commission chairman Tan Sri Zarinah Anwar told StarBizWeek in February 2009.

US PLC Berkshire Hathaway is a prime example of how top management’s personal values combined with corporate and board discipline has delivered stunning returns on investment and immense accolades. Not only was Berk-shire’s billionaire chairman Warren Buffett voted the most admired director in Directorship magazine’s annual survey of exceptional directors in April 2008. But under Buffett’s stewardship, Berkshire stock appreciated 362,319% from 1964 to 2008 (measured in after-tax dollars), compared with 4,276% for the S&P over the same period (measured in pre-tax dollars).

During a recent seminar in Kuala Lumpur entitled Warren Buffett Corporate Governance: Building a World Class Board of Directors organised by the Malaysian Alliance of Corporate Directors, Buffett expert and author Robert P. Miles explained some of the hallmarks of the Buffett model of ethical management:

Minimal Board Compensation: The board is the lowest paid of all Berkshire employees, earning US$2,700 annually. According to a 2008 Steven Hall and Partners Director Compensation Study, compensation for directors averaged US$245,000 for approximately 228 hours, equivalent to US$1,074 per hour. Buffett himself earns an annual salary of US$100,000, and earned more as an ex-director of Coca-Cola – US$144,000 per year.

No Stock Options: Buffett believes stock options should not be part of executive compensation and resigned from Coca-Cola’s board when the beverage giant insisted on paying stock options. Berkshire directors get no stock options and instead must buy stock on the open market, or “pay to play.” Executives too receive no stock options since exceptional managers who earn generous cash bonuses can buy stock if they wish.

No Indemnity: Although Berkshire is an insurance company, it doesn’t provide professional indemnity insurance for directors and officers, unlike 93% of US companies. This forces management to better identify, assess and manage risks. Not understanding their risks and taking excessive risk for higher returns was the downfall of US financial institutions in the recent sub-prime crisis.

No Retirement: Directors and officers are asked to serve for a lifetime, with no term limits, enabling the company to seamlessly tap accumulated experience and knowledge, especially of the owners-turned-managers running the family businesses acquired by Berkshire. There are no management contracts, and managers are free to leave at any time. This unorthodox arrangement has paid off. “On average the managers are worth US$100mil and some are billionaires. They’re working for passion, not for the money,” reasoned Miles.

Transparency: Buffett explains his principles on values and investing in the Berkshire Hath-away Owner’s Manual. These include treating shareholders like partners, not taking on debt, preferring to buy family-owned businesses, and being free to talk about anything except the stocks that Berkshire is buying or selling, which would create investing competition.

A highlight of Berkshire’s annual general meeting, which welcomed about 36,000 investors and their guests last year, is the gruelling six-hour Q&A session with Warren Buffett. Imagine local PLCs opening themselves up to such scrutiny!

On the downside, the question of Berkshire succession remains murky even though Buffett is 79. Berkshire lifetime director Bill Gates told Bloomberg that the Berkshire board spends 50% of their time discussing succession planning. His son Howard Buffett has been appointed as the non-executive chairman, empowered to ensure that the Buffett values system endures. But a successor with executive powers has not been formally designated, whether for operations or for investment.

Furthermore, the issue of dominant board members who are also substantial shareholders is of concern everywhere, and is equally relevant at Berkshire. Berkshire did change its board composition to include a larger number of independent directors post-2002 when the Sarbanes-Oxley Act took effect. Previously, the board was “very family-oriented and rubber-stamped everything Warren said,” noted Miles. However, the change may be more in form than substance since Gates has implied in a Bloomberg television interview that the directors must back up Buffett, or be shown the exit. The lack of an arms-length relationship between Buffett and directors like Gates who is Buffett’s bridge partner and heavily influenced by him in philanthropy affects board independence too.

Despite these concerns, investors continue to trust implicitly in Berkshire and Buffett. Buffett’s personal reputation for good ethics and behaviour and Berkshire’s unique corporate culture and discipline have delivered phenomenal results. The Berkshire model demonstrates that good corporate governance is good for the bottomline and the share price. Likewise, if Malaysian PLCs and other public enterprises should define what good ethics mean to them and behave accordingly, we could see a correspondingly better performance among our markets and companies as we gain further trust from international investors.

 The writer TAY KAY LUAN is the Regional Director of Asean & Australasia of ACCA.

Source: The Star Online