Wednesday, March 18, 2009

Revisiting Warren Buffett's Criteria for Selecting Corporate Directors

Given the recent outrage about the high compensation for executives who did poor jobs running their companies, and given the role corporate boards of directors play in setting executive compensation, it's worth revisiting Warren Buffett's comments on selecting corporate directors. Buffett wrote this in his 2006 Berkshire Hathaway Shareholder Letter (p.19 in the PDF):

In selecting a new director [Yahoo! CFO Susan Decker], we were guided by our long-standing criteria, which are that board members be owner-oriented, business-savvy, interested and truly independent. I say “truly” because many directors who are now deemed independent by various authorities and observers are far from that, relying heavily as they do on directors’ fees to maintain their standard of living. These payments, which come in many forms, often range between $150,000 and $250,000 annually, compensation that may approach or even exceed all other income of the “independent” director. And – surprise, surprise – director compensation has soared in recent years, pushed up by recommendations from corporate America’s favorite consultant, Ratchet, Ratchet and Bingo. (The name may be phony, but the action it conveys is not.)

Charlie [Munger, Berkshire's Vice Chairman] and I believe our four criteria are essential if directors are to do their job – which, by law, is to faithfully represent owners. Yet these criteria are usually ignored. Instead, consultants and CEOs seeking board candidates will often say, “We’re looking for a woman,” or “a Hispanic,” or “someone from abroad,” or what have you. It sometimes sounds as if the mission is to stock Noah’s ark. Over the years I’ve been queried many times about potential directors and have yet to hear anyone ask, “Does he think like an intelligent owner?”

The problem of corporate executives or directors not acting in the interests of shareholders is a prime example of an agency conflict. We touched on this in a post last summer ("Agency Conflicts").

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