THE NUMBER-ONE QUESTION Warren Buffett wants to know about any director candidates is whether they are shareholder oriented. When building trust with shareholders, there are few better ways than appointing many such people to a corporate board.
Trust is essential in the boardroom and, according to Buffett, this trust underlies the board’s most important duty: selecting an outstanding CEO. All other tasks are secondary because, if the board secures an outstanding CEO, it will face few other major problems.
Not many boards can live life so simply, however, so Buffett offers additional guidance for public company directors. And he should know. He once joked that his service on a score of public company boards revealed a “very dominant, masochistic gene.”1 In his board service, Buffett has interacted with more than three hundred directors and scores of CEOs.
Among CEOs Buffett considers best are Thomas S. Murphy, who led Capital Cities Communications before and after it acquired ABC in 1985; Robert Iger, a Murphy protégée who has been running Walt Disney Company since 2005; and Katharine Graham, who skillfully ran Washington Post Company from 1973 to 1991.
Such CEOs all meet Buffett’s practical bottom line test: they are people anyone would trust and be happy to have their child marry.
All CEOs must be measured according to a set of performance standards, Buffett notes. A board’s outside directors must formulate these standards and regularly evaluate the CEO in light of them—without the CEO being present. Standards should be tailored to the particular business and corporate culture but should stress fundamental baselines, such as returns on shareholder capital and progress in market value per share.
Performance should not be based on quarterly earnings or the achievement of related guidance targets. In fact, Buffett argues that companies are usually better off not providing analysts with earnings guidance. Directors might remind CEOs that such guidance is not required and may not serve shareholder interests.
To promote an environment of trust, Buffett advises, all directors should act as if there is a single absentee owner and do everything reasonably possible to advance that owner’s long-term interest. They need to think independently to tighten the wiggle room that “long-term” gives to CEOs: although corporate leaders should think in terms of years, not quarters, they must not rationalize sustained subpar performance by perpetual pleas to shareholder patience. To that end, it is desirable for directors to buy and hold sizable personal stakes in companies they serve, so that they truly walk in the shoes of owners.
Buffett embodies this commandment. He is a shareholder advocate par excellence, whose board service has almost always involved companies where Berkshire owns a significant stake. Prominent examples include Capital Cities/ABC (1986–1996); Coca-Cola Company (1989–2006); Gillette (1989–2003); Kraft Heinz (2013–2016); Salomon (1987–1997); US Airways Group (1993–1995); and Washington Post Company (1974–1986 and 1996–2011).
Buffett’s board tenure is also a long-term commitment. In all but two of the foregoing instances where his board service ended, it did so only because the company ceased to exist: Capital Cities/ABC merged into Disney; Gillette into Procter & Gamble; Salomon into Travelers Insurance; and US Airways into America West Airlines; Washington Post Company’s assets were divided up for sale. One exception was at Kraft Heinz, where Buffett was succeeded by Berkshire vice chairman, Greg Abel.
The other exception was at Coca-Cola. In 2005, despite Berkshire having long owned a substantial stake in the company—worth $8 billion then and nearly $20 billion now—the California Public Employees’ Retirement System (CalPERs) as well as Institutional Shareholder Services (ISS) challenged Buffett’s independence as a director. They cited their checklist rules against specified business relationships, pinpointing how various Berkshire subsidiaries, including Dairy Queen Corporation, were customers of Coca-Cola.
In the ensuing board election, 16 percent of Coca-Cola’s shares were cast as withhold votes on Buffett, so he was reelected, but he nevertheless opted to stand down. While we disagreed with those doubting Buffett’s independence, he responded to the shareholder ballot and set an example: any director receiving a nontrivial level of withhold votes should withdraw from the board. But the argument was perverse: neither CalPERS nor ISS asked whether Buffett was a trustworthy steward of shareholder capital at Coca-Cola, a question that would have required looking at context rather than referring to a checklist.
If the CEO’s performance persistently falls short of the standards set by the outside directors, then the board must replace the CEO. The same goes for all other senior managers they oversee, just as an intelligent owner would if present. In addition, the directors must be the stewards of owner capital to contain any managerial overreach that dips into shareholders’ pockets. Such pickpocketing can range from imperious acquisition sprees to managerial enrichment through interested transactions or even myopia amid internal scandal and related crisis.
All these problems undermine trust. In addressing these problems, the director’s actions must be fair, swift, and decisive. In crisis, the Berkshire mantra is “get it right, get it out, and get it over.”2 The classic case concerned Salomon’s 1991 bond-trading imbroglio referred to earlier. Amid knowledge of illegality, CEO John Gutfreund allowed problems to fester, refraining from firing the guilty and failing to inform the board or regulators. On becoming aware of these dire events, the board promptly requested Gutfreund’s resignation. They then appointed a reluctant Buffett to lead the investment bank out of its dark days and reshape its culture.
Directors who perceive a managerial or governance problem, including eroding trust, should immediately alert other directors to the issue. If enough are persuaded, concerted action can be readily coordinated to resolve the problem.
In the American boardroom in recent years, trust has been demoted in favor of mechanistic approaches to corporate governance. Examples include the movement to split the roles of chair and CEO, expanding board size, adding independent directors, adopting a new code of ethics, updating firm compliance programs, and appointing multiple committees to administer it all.
Although such steps can improve an organization’s health, the informal norms that define a corporate culture are more powerful. Directors do best by promoting, earning, and sustaining a culture of trust—appointing a trustworthy CEO and winning shareholder trust in the judgment.
Companies should make their directors available to their largest long-term investors, Buffett says. These representatives should discuss issues put to shareholder votes that affect enduring value. In fact, companies should seek reciprocal access, getting their directors out to receive the shareholder perspective.
Even high-quality directors can fail because of what Buffett calls “boardroom atmosphere.” Populated by well-mannered individuals, boards see broaching certain topics as akin to belching at dinner—from questioning the wisdom of an acquisition to CEO succession.
Adjust the social atmosphere of the room, Buffett urges. How to do so depends on the corporate culture and personalities involved. Aside from formal meetings, boards can convene for meals, training sessions, and retreats. All these opportunities offer the chance for diplomatic engagement, to build trust, and to promote better deliberations and outcomes.
Here, too, shareholders can play a role. A few large institutions, acting together, can effectively reform a given company’s corporate governance simply by withholding their votes for directors who were tolerating odious behavior, Buffett observes. In some cases, he laments, “this kind of concerted action is the only way that corporate stewardship can be meaningfully improved.”3
Finally, what qualities should be sought in directors when boards undertake their own succession planning? The answer is people who are capable of honoring these commandments, meaning those who are skilled managerial recruiters and overseers given the company’s particular business and culture; people who are owner-oriented, engaged, articulate, communicative, and astute. Basic habits such as diligence, preparation, and attendance are essential. Above all, however, companies do best by having trustworthy directors, and boards do best by appointing outstanding CEOs then leaving them alone.