In a recent Forbes article entitled Warren Buffett, And His Board, May be Too Old to Run Berkshire Hathaway, Francine McKenna makes the case for both greater vigilance by Berkshire investors (including the author) and a different concept of corporate governance.
Ms. McKenna may well be right as to her ultimate conclusion, although Berkshire’s performance over time should give us pause as to whether directors have ‘lost it’. However, her argument that regulators should be involved in this determination illustrates what is wrong with current governance theory. She invokes Prof. Larcker’s treatise on governance as a point of reference as to whether board members are ‘too busy’, discusses the process by which key decisions are made – e.g. the recent $5 billion investment in Bank of America supposedly made by Mr. Buffett while bathing – and discusses at length the ages of board members. Yet none of this has anything to do with the quality of the decision-making or any external exposure which should concern regulators.
One can justifiably argue against (as well as for) the BofA transaction, but the ages of decision-makers and the venue for the decision have nothing to do with its quality. Essentially the same decision-makers were involved in the decision to acquire all of Burlington Northern Railroad, which has thus far been a huge success for Berkshire. Ditto for the 2008 investments in Goldman Sachs preferred stock, which not only paid off handsomely for Berkshire, but also played a role in stabilizing the economy. Are we to believe that 2-3 years have taken a major toll on the competence of the board?
Even assuming that there is some reason for such a belief, is there any reason for regulatory involvement? Why can’t the company’s investors, many of whom are quite sophisticated, not be counted upon to speak up as necessary? Yes, Mr. Buffett controls the company and its board, but has made clear over the years that he listens to responsible investors. More fundamentally, even if one or more decisions prove to be poorly conceived, who, other than shareholders, will be harmed?
Regulatory involvement in private firms is warranted only where missteps can have substantial external implications – e.g. financial firms. However, this is not the case with Berkshire. The company is very broadly diversified – the article refers to its “hundreds of operating companies” – so that even a total loss on the BofA investment or anything comparable to it would not come close to wiping out the shareholders, let alone impact anyone else. At the parent level, there is little debt and tens of billions of cash, which will inherently contain the damage from missteps.
Even for its insurance and reinsurance operations, there is a great diversification of risks and state statutory capital standards and ‘ring fencing’ of exposure so that claim paying ability should not be jeopardized under any circumstances.
With its focus on board member attributes and decisional process and procedures, and muddled rationale for regulatory involvement, the article adheres to mainstream governance concepts, but loses sight of its ultimate objective. That is, governance law exists to protect, or allow the self protection of, shareholders from management depredations and protect the public from spillovers which can impact lending and investing activity and the broader economy. Consider the OECD definition of governance:
Corporate governance involves a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined.
Nowhere does this definition mention ages or other attributes or decisional process. The article correctly identifies horrid governance as a factor in the 2008 demise of Lehman Brothers, an event which clearly had a lot to do with sinking the economy into the Great Recession. However, there is no basis for equating Lehman – with its mountains of traditional and Repo 105 debt – with Berkshire with its pristine balance sheet.
By suggesting that poor or questionable governance is an issue at Berkshire, McKenna makes it harder to correct the many bona fide governance problems which do exist and which jeopardize the economy.