Buffett's approach to designing a compensation package for directors

Share On Facebook

An important reason for the exceptional high returns on capital at Berkshire Hathaway’s subsidiary Scott Fetzer is that Ralph Schey, CEO, was incentivised through his compensation deal to focus on returns on capital rather than total profits. As always, Buffett drew up a simple contract, but it hit the nail on the head when aligning the interests of the manager with those of Berkshire’s shareholders.

  • The first logical step, is to ensure that compensation is based on the results at Scott Fetzer rather than those at Berkshire. He wrote in his 1994 letter to BH shareholders:

“What could make more sense, since he’s responsible for one operation but not the other?  A cash bonus or a stock option tied to the fortunes of Berkshire would provide totally capricious rewards to Ralph.  He could, for example, be hitting home runs at Scott Fetzer while Charlie and I rang up mistakes at Berkshire, thereby negating his efforts many times over.  Conversely, why should option profits or bonuses be heaped upon Ralph if good things are occurring in other parts of Berkshire but Scott Fetzer is lagging?”

  • Secondmake sure the rewards are great for great performance, “In setting compensation, we like to hold out the promise of large carrots, and make sure their delivery is tied directly to results in the area that a manager controls.”
  • Thirdpenalise low rates of return on capital through a charge on use of capital, reward high rates of return and pay a bonus to managers handing over capital to head office:

“When capital invested in an operation is significant, we also both charge managers a high rate for incremental capital they employ and credit them at an equally high rate for capital they release. The product of this money’s-not-free approach is definitely visible at Scott Fetzer.  If Ralph can employ incremental funds at good returns, it pays him to do so:  His bonus increases when earnings on additional capital exceed a meaningful hurdle charge. But our bonus calculation is symmetrical:  If incremental investment yields sub-standard returns, the shortfall is costly to Ralph as well as to Berkshire.  The consequence o

……………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1

CLICK HERE TO REGISTER FOR FREE ON ADVFN, the world's leading stocks and shares information website, provides the private investor with all the latest high-tech trading tools and includes live price data streaming, stock quotes and the option to access 'Level 2' data on all of the world's key exchanges (LSE, NYSE, NASDAQ, Euronext etc).

This area of the ADVFN.com site is for independent financial commentary. These blogs are provided by independent authors via a common carrier platform and do not represent the opinions of ADVFN Plc. ADVFN Plc does not monitor, approve, endorse or exert editorial control over these articles and does not therefore accept responsibility for or make any warranties in connection with or recommend that you or any third party rely on such information. The information available at ADVFN.com is for your general information and use and is not intended to address your particular requirements. In particular, the information does not constitute any form of advice or recommendation by ADVFN.COM and is not intended to be relied upon by users in making (or refraining from making) any investment decisions. Authors may or may not have positions in stocks that they are discussing but it should be considered very likely that their opinions are aligned with their trading and that they hold positions in companies, forex, commodities and other instruments they discuss.

Leave A Reply

Do you want to write for our Newspaper? Get in touch: newspaper@advfn.com

By accessing the services available at ADVFN you are agreeing to be bound by ADVFN's Terms & Conditions

P: V: D:20190124 03:15:24