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By Mel Duvall  |  Posted 2003-08-01 Print this article Print

Shareholders nearly deify Warren Buffett for the way he manages his diverse holding company, Berkshire Hathaway of Omaha.

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Buffett's Principles

While other investors have been capsized by the financial storm, Berkshire Hathaway stockholders were largely unscathed. Chris Stavrou, a Connecticut shareholder, has attended the annual meetings in Omaha for 18 years. He's heard all of Buffett's axioms and corny jokes. Still, he wouldn't think of missing a meeting. "It's a little bit the same as why you keep going to church every Sunday," he says. "To be reminded of the principles of smart investing."

Buffett has been a critic of executive paychecks and expensed stock options and has served as an all-around industry watchdog. What goes largely unacknowledged in this love-in is that Buffett often contradicts himself. His somewhat blind trust in his managers and his willingness to do without due diligence on acquisitions run counter to what's considered good operating procedure. And Buffett can simply be wrong, like any human. Berkshire's $21.7 billion purchase of General Reinsurance in 1998 has resulted in $8.3 billion in underwriting losses to date.

Where Buffett really stands apart, however, is not just in his unwillingness to invest in technology companies, but his unwillingness to invest in technology for his own company as well. While many firms are turning to information systems to meet new accounting regulations, clean up financial reporting and monitor ongoing business changes, Buffett is not. He relies on fax, phone and mail to receive the financial results of his companies.

Berkshire will do whatever is necessary to comply with new regulations, he says. But more technology and more laws aren't needed, he says. Stronger ethics are.

That's noble and desirable but ignores the spectrum of human nature, says Tim Leech, a former director of risk-management services at Coopers & Lybrand, and now president of risk-management software company CARDdecisions. Leech says Buffett could possibly be a mind reader, with Godlike skills to hire only the most capable, honest people, but his own experience as a forensic accountant points to the contrary.

"Most of the people I have investigated and sent to jail for defrauding large amounts of money, their bosses all thought they were the salt of the earth, incapable of doing something like that," he says. "You've got corrupt accountants, corrupt management, corrupt lawyers, corrupt investment dealers that are hyping stocks that they know to be dogs ... the system has gone all to hell."

Institutional Shareholder Services (ISS), a governance advisory service, recently gave Berkshire a score of just 1.5 out of 100 for the quality of its own corporate governance.

The firm considers 61 variables, such as the independence of the board of directors, executive compensation, how frequently outside auditors are rotated, and whether and how much stock officers and directors own. Some factors are scored together with others. For example, ISS says that a board with both a majority of independent directors and all-independent key committees, such as compensation and audit, will get a higher score than if the company had only one of these.

At Berkshire, there is no compensation committee. Buffett himself sets the compensation for Berkshire's officers. Then he proposes his own salary and bonus and the board votes on it.

Of course, Buffett's $100,000 salary wins praise. But that's not enough to negate at Berkshire what would raise eyebrows at other companies: relatives such as wife, Susan, and son, Howard, on the Berkshire board; directors who own large chunks of Berkshire Hathaway stock; and a lack of sophisticated technology relaying financial data to the CEO.

Buffett fans counter that these issues don't matter. The man took an initial kitty of $500,000 and turned it into a holding company worth $110 billion today. Since 1965, the book value of Berkshire's shares has grown 22% annually, more than doubling the 10% a year growth of the S&P 500.

As a persistently profitable collection of companies that sell paint, carpet, aviation services, energy, underwear, cooking gadgets, bricks and insurance, Berkshire is a unique entity, they say. It can't be judged by the rules that govern the rest of the corporate realm.

"The board may not be independent on paper, but it works well," says Nell Minow, editor at the Corporate Library. This governance research group gives Berkshire an A on a school-style A to F scale. Minow says Berkshire's board works effectively, despite its seeming lack of independence, and she cites Buffett's low salary as responsible. "You have to look at the big picture," Minow says. "[Berkshire is] in a class by themselves."

Contributing Editor
Mel Duvall is a veteran business and technology journalist, having written for a variety of daily newspapers and magazines for 17 years. Most recently he was the Business Commerce Editor for Interactive Week, and previously served as a senior business writer for The Financial Post.

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