Legions of people have learned valuable lessons from Warren Buffett about investing; his $375 billion Berkshire Hathaway last month celebrated its 50th anniversary under his leadership. But Buffett’s and Berkshire’s lessons about corporate administration have been ignored, although they are more socially and economically significant. For fifty years, while other American companies evolved into bureaucracies, Berkshire maintained a distinctive anti-bureaucratic culture, despite now employing 350,000 people across sixty different subsidiaries.
As explored in my book, Berkshire beyond Buffett: The Enduring Value of Values (Columbia University Press 2014), Berkshire’s practices are based on old-fashioned values such as self-reliance, autonomy and thrift. They yield financing with few banks, decentralized governance, and a philosophy of partnership among shareholders—all one-million of them. While Buffett is personally responsible for forging this venerable institution, all managers and professionals across corporate America would do well to study Berkshire’s practices, highlighted below and in a forthcoming article, Berkshire’s Disintermediation.
American companies borrow heavily, thanks to tax incentives and the seductive appeal of leverage to goose returns. But Berkshire shuns debt as costly and constraining, preferring to rely on itself and to use its own money. It generates abundant earnings and retains 100% of these—not having paid a dividend in nearly fifty years. In 2014, Berkshire earned $20 billion—all available for reinvestment. In addition, thanks to its long-time horizon, Berkshire holds many assets acquired decades ago, resulting in deferred taxes now totaling $60 billion. These amount to interest-free government loans without covenants.
The principal leverage at Berkshire is its insurance float. This refers to funds that arise because Berkshire receives premiums up front but need not pay claims until later, if it all. Provided insurance is underwritten with discipline, float is akin to borrowed money but cheaper, and without due dates or covenants. At Berkshire, float now totals $72 billion, most of which is available to buy businesses that multiply Berkshire’s value.
All these sources of funds can be transferred between Berkshire subsidiaries, so those with excess cash support those with capital needs—all tax free and without the frictional costs of debt. Berkshire and its subsidiaries have become self-reliant, self-disciplining, financing machines. (Two of Berkshire’s capital intensive subsidiaries, a railroad and a public utility, borrow significant sums, but none is guaranteed by Berkshire.)
Today, corporate America’s boards are bureaucracies appointed to serve as intermediaries between shareholders and management. Directors are monitors involved in specific strategic decision making. They meet monthly, using many committees, which in turn hire consultants, accountants and lawyers. American directors, heralded for being “disinterested,” are well paid—averaging $250,000 annually—including considerable stock compensation plus company-purchased liability insurance.
Berkshire’s board, in contrast, follows the old-fashioned advisory model that fell into disuse beginning in the 1980s. Comprised of friends and family, Berkshire directors serve because they are interested in Berkshire. They do not oversee management but provide support and advice. There are few committees, no hired advisors, and two or three meetings a year. Berkshire pays its directors essentially nothing and provides no insurance. But Berkshire’s directors are significant shareholders and bought the stock with their own cash—the main reason they are there.
American corporations are hierarchies, with shareholders seen to own a residual claim on firm assets, an equity stake after liabilities are covered by assets. Boards and managers treat shareholders accordingly, as inputs into a production function.
Buffett defines Berkshire as a partnership, declaring from the outset: “while our form is corporate, out attitude is partnership.” This is a radical and profound disintermediation: it views the corporation as a conduit through which shareholders own its assets, not merely an equity stake.
The attitude is a legacy from Buffett’s start: he was running a partnership in 1965 when it acquired Berkshire, which then began acquiring other companies en route to becoming the galactic conglomerate of today.
Among Berkshire shareholders, the partnership attitude is mutual. In contrast to Berkshire, most American corporate equity is owned by large financial institutions—mutual funds, hedge funds, pensions, money managers and other intermediaries. Stock trading is frequent and portfolios rebalanced regularly to maintain diversification. All this action generates significant fees for intermediaries and frictional costs for investors.
Berkshire’s shareholders are mostly direct owners of the stock—individuals, families, family offices—or hold it through a family-oriented firm that concentrates in Berkshire stock. Berkshire’s share turnover at very low and for many shareholders Berkshire is their largest holding. All this inaction minimizes the role and costs of numerous intermediaries, from stockbrokers to stock exchanges.
Most corporate boards set dividend policy to follow a regular periodic amount invariant to business conditions; they split the stock when price exceeds an affordable trading range to keep shareholders interested in trading it. Berkshire’s dividend policy varies with corporate ability to reinvest earnings profitably—which has meant no dividends since 1969; and it has polled shareholders on whether they approve this policy (they do).
Far from splitting the stock to keep the price low, Berkshire battles to avoid associated behavior. A spectacular example occurred in 1996, when Berkshire’s stock traded at $36,000. Two money managers designed a trust that would buy the stock and then issue fractional units designed to trade at a low price. They would charge fees for this service that would draw new traders to Berkshire, increasing transaction costs. To knock out these meddlers, Berkshire amended its charter to rename its existing common stock Class A and add a Class B, with fractional economic and voting rights. It offered as many shares as necessary to fill demand, killing the unit trust.
Mergers & Acquisitions
American corporations tend to design acquisition programs using strategic plans administrated by an acquisitions department, a practice lauded by governance gurus. This approach relies heavily on intermediaries such as business brokers and investment bankers, who charge fees and have incentives to get deals done; firms also use consultants, accountants and lawyers to conduct due diligence before closing.
Berkshire has never had any such plans or departments, rarely uses bankers or brokers, and does limited due diligence. In the early days, Berkshire ran a newspaper ad announcing its interest in acquisitions and stating its criteria—reprinted in every annual report. Berkshire now relies on a network of relationships, including previous sellers of businesses. Berkshire executives are self-reliant, thanks to extensive reading that gives them broad business knowledge. And they develop self-discipline about the limits of that knowledge, so readily pass on things they don’t understand.
Most sizable American corporations use centralized procedures and departments, middle managers meeting regularly, along with consultants, directives, supervision, and second-guessing. They are thick with internal controls, thanks to incentives provided by a combination of regulatory zeal and a cottage industry of compliance consultants. Corporate America has embraced a culture of command and control.
Berkshire has fallen for none of that—no centralized human resources, technology or legal departments; no hierarchies for reporting or budgeting; no middle managers or consultants. All such functions are handled in the individual units. In fact, Berkshire headquarters employ just 24 people. Berkshire subsidiaries tend to mirror the parent in favoring a trust-based culture rather than command and control.
Berkshire gives the CEOs of its subsidiaries unbridled discretion over operations and strategy. Buffett sends them the same one-page letter every two years with six broad mandates on it, such as protect Berkshire’s reputation and report bad news early. Many speak to Buffett only once a year—others less often.
Rationale and Implications
Berkshire’s savings from anti-bureaucratic practices include direct costs of fees and interest plus vastly larger indirect costs of relying on advisors whose incentives are for more action—more debt, more deals, more trading, more services, more fees—whether or not in Berkshire’s interest. The principles of self-reliance, autonomy and thrift go hand in hand. The costs include occasional errors in acquisitions and employee violations of trust. Although such costs are not trivial, the net benefits have been tremendous.
Skeptics say Berkshire and its culture are due solely to the singular personality of Warren Buffett, and that without him, Berkshire could not have been built and will cease to exist. So they say that the example offers no broader systemic lessons for other American corporations. But such beliefs seem facile. After all, Berkshire is comprised of sixty different substantial subsidiaries in scores of distinct business led by hundreds of different people. Yet despite such diversity, those businesses and people embrace a core set of common values, including thrift, self-reliance and autonomy.
Far from a one-man show, Berkshire is likely to endure long after Buffett leaves the scene. What’s more, Berkshire teems with lessons for American corporate culture. Corporate America is bureaucratic, thanks to a regulatory environment that promotes rigid board structures and internal control, along with professional classes who advise on every aspect of corporate life, not only raising money or finding acquisitions but recruiting directors, paying executives, and, yes, designing board structures and internal control systems. A self-reinforcing feedback loop ensues, with few checks or brakes.
Yet if you were to design a system of business administration from scratch, would it look more like that prevailing in corporate America today or that practiced at Berkshire for fifty years? I agree that Buffett is exceptional. But that doesn’t warrant ignoring the institution he built or its values and practices. Rather, just as millions of investors have incorporated Buffett’s investing wisdom in the past two generations, the next two generations of entrepreneurs and policymakers should heed Berkshire’s lessons for corporate administration.
The preceding post comes to us from Lawrence A. Cunningham, professor at George Washington University and author, most recently, of Berkshire Beyond Buffett: The Enduring Value of Values. The post is based on his recent article, entitled “Berkshire’s Disintermediation: Buffett’s New Managerial Model” and available here.