“And Greg will keep the culture.”
— Charlie Munger, 2021 Berkshire Hathaway Annual Meeting
The question of who will succeed Warren Buffett as Chief Executive Officer of Berkshire Hathaway has finally been answered. Although Mr. Buffett has no intention of stepping down anytime soon, Vice Chairman Greg Abel is the current “name in the envelope” who is expected to take the reins of managing the company when the time comes. If Mr. Abel is not available when succession occurs, then Vice Chairman Ajit Jain is expected to be named as CEO.
Prior to the annual meeting on May 1, the question was whether Greg Abel or Ajit Jain would take over the top job. Both men were named Vice Chairmen in January 2018 with Mr. Jain put in charge of insurance operations and Mr. Abel overseeing non-insurance businesses. Mr. Abel, at 58, is a decade younger than Mr. Jain and more likely to be able to serve as CEO for a long period of time. As Berkshire Hathaway Energy’s longtime Chairman, Mr. Abel also has extensive capital allocation experience.
Warren Buffett and Charlie Munger have long taken only a token salary of $100,000 per year. This is due to their large ownership interest in Berkshire as well as their desire to act as exemplars. However, it would be unrealistic and unreasonable to expect that their successors would also elect to only take token pay. After all, Berkshire Hathaway is one of the largest companies in the world with a market capitalization of over $650 billion. The difference between an excellent CEO and a merely average one obviously can add up to billions of dollars of wealth for shareholders. It is logical to expect Mr. Abel’s compensation to be commensurate with his responsibilities.
What can we expect Mr. Abel’s compensation to look like? One clue might be how he has been paid over the past three years since his appointment as Vice Chairman in charge of non-insurance operations. The following table appears in Berkshire’s latest proxy statement:
Readers who are familiar with compensation tables in proxy statements but not familiar with Berkshire might look at this table and wonder if the stock based compensation has been omitted. It hasn’t been omitted — Berkshire pays executives in cash comprised of salary and bonus. Other than retirement account contributions and, in the case of Mr. Buffett, security services, there is no other compensation provided to executives.
Both Mr. Abel and Mr. Jain have been paid identical amounts since taking on their current roles. At $19 million in total cash compensation, both men are compensated well with the vast majority of pay in base salary. How is their pay determined? This is what the proxy has to say:
The [Compensation] Committee has established a policy that neither the profitability of Berkshire nor the market value of its stock are to be considered in the compensation of any executive officer. Under the Committee’s compensation policy, Berkshire does not grant stock options to executive officers. The Committee has delegated to Mr. Buffett the responsibility for setting the compensation of Mr. Abel, Vice Chairman-Non Insurance Operations, Mr. Jain, Vice Chairman-Insurance Operations and Marc Hamburg, Berkshire’s Senior Vice President/Chief Financial Officer and Secretary.
Berkshire Hatahway Proxy
Berkshire’s policy is highly unusual in that Berkshire’s profitability and market value are not considered when setting pay. Instead, Mr. Buffett sets that pay of Mr. Jain, Mr. Abel, and Marc Hamburg who serves as Berkshire’s Chief Financial Officer. How does Mr. Buffett come up with these compensation figures? The proxy does not say and the company has occasionally been criticized for lack of transparency in this area. Presumably, pay for Mr. Abel and Mr. Jain is set based on their respective responsibilities and performance. However, the pay figures are identical, most likely due to a desire that both are perceived as occupying the same level in the organization and not tipping Berkshire’s hand in who will emerge as the next CEO.
Once Mr. Buffett and Mr. Munger are no longer involved with the company and a new CEO is named, the Board of Directors and the Compensation Committee will be in charge of setting the pay of the CEO. Presumably Mr. Buffett has communicated his rationale for pay to the Board and the committee will continue his approach in the future. However, it is possible that the Board may elect to begin using some form of stock based compensation in the future, although I don’t view that as likely.
We cannot consider incentives at Berkshire by just looking at compensation alone. One might think that not incorporating stock in compensation will result in a misalignment of incentives between management and shareholders. Of course, this has not been true in the past since Mr. Munger and Mr. Buffett both have billions of dollars and the majority of their net worths invested in Berkshire. They do not need stock based compensation to feel a profound alignment of incentives with shareholders because they are both major shareholders themselves.
So, we need to look at the amount of stock owned by Greg Abel to fully understand his incentives, both now and in the future. A look at Berkshire’s proxy statement reveals that Mr. Abel controls 5 shares of Class A stock and 2,363 shares of Class B stock, in both cases as a fiduciary for trusts held for family members. Based on quoted stock prices on May 11, 2021, this amounts to slightly more than $2.8 million. Is a $2.8 million ownership interest in Berkshire meaningful for a man who has earned between $18 million and $19 million in each of the past three years? Most people would say that this ownership interest is not a meaningful enough incentive.
But wait, there’s more!
A careful reader of Berkshire’s proxy will notice this statement:
Mr. Abel, a director of and the holder of approximately 1% of the voting stock of BHE, also has an agreement with Berkshire with terms similar to the terms of the agreement with Mr. Scott. The major difference between the agreement with Mr. Scott and the agreement with Mr. Abel is that Mr. Abel can also put his shares to BHE (“BHE Put”) and BHE can call Mr. Abel’s shares (“BHE Call”). The purchase price under either a BHE Put or BHE Call shall be payable in cash and determined in the same manner as the purchase price under Mr. Scott’s agreement.
Mr. Abel came to Berkshire two decades ago when the company acquired MidAmerican Energy. Along with Walter Scott, who serves on Berkshire’s Board of Directors as well, Mr. Abel owns a minority interest in Berkshire Hathaway Energy (BHE). As of the date of the proxy, Mr. Abel owned approximately 1 percent of BHE.
That sounds like a significant ownership interest, and indeed it is. What is it worth?
Fortunately, we can estimate the value of Mr. Abel’s BHE ownership interest based on recent transactions in which BHE purchased part of Mr. Scott’s holdings for cash. These transactions required the agreement of Warren Buffett, Walter Scott, and Greg Abel and, given the incentives and reputations of all parties, we should be confident that the price represents a close approximation of intrinsic value. The proxy gives us the details of the latest purchase:
On March 5, 2020, Berkshire Hathaway Energy repurchased 180,358 shares of its common stock from certain family interests of Mr. Scott for an aggregate cost of $126 million. The per share purchase price was based on a price deemed to represent fair market value and agreed upon by Berkshire, Mr. Abel and Mr. Scott and approved by the Audit Committee. Berkshire is not aware of any other Transaction entered into since January 1, 2020 that is required to be disclosed under Item 404(a) of Regulation S-K.
This implies that BHE had an intrinsic value of $698.61 per share as of March 2020. According the BHE’s latest 10-Q report, there were 76,368,874 shares of BHE outstanding as of April 29, 2021. This implies that BHE’s intrinsic value, as of March 2020, was approximately $53.4 billion. As an aside, there were previous transactions with Mr. Scott in February 2019 at a valuation of $654.44 per share and in 2018 at $603.22 per share.
If BHE had a total intrinsic value of $53.4 billion in March 2020 and Mr. Abel owns approximately 1 percent of BHE, it follows that his personal stake in BHE was worth about $534 million at that date. Since BHE retains all of its earnings and another year has passed, the value of Mr. Abel’s holdings is probably in the high $500 million range.
Is an ownership interest of over half a billion dollars meaningful to a man who is earning $19 million per year? The answer must be an unequivocal yes. Obviously, Mr. Abel has a major amount of skin in the game. His annual “look through earnings” attributable to his BHE stake is certainly far in excess of his $19 million of compensation as Vice Chairman of Berkshire.
However, there is a possible problem.
Mr. Abel’s ownership interest is in BHE, not in Berkshire Hathaway, the parent company. This was entirely appropriate when Mr. Abel was Chairman and CEO of BHE. But as the next CEO of Berkshire Hathaway, he will be responsible for the success of the entire conglomerate, not just BHE. It would seem desirable if Mr. Abel’s ownership interest was in the parent company rather than in a subsidiary.
By all accounts, Mr. Abel is a man of unimpeachable integrity and I believe that if he is charged with overseeing the parent company, he will do so to the best of his ability and allocate capital intelligently across all business units. However, it is still desirable for his direct financial incentives to be aligned with the parent company.
I am not suggesting that Mr. Abel would purposely favor BHE over other business units simply because of his ownership interest in BHE. But in order to put to rest any fears of this taking place and giving more confidence to shareholders at large, perhaps Mr. Buffett and Mr. Abel could come to some agreement to swap Mr. Abel’s interest in BHE for an interest in Berkshire Hathaway Class A or Class B stock. This would give Berkshire an opportunity to increase its interest in BHE by 1 percent and would more directly align Mr. Abel’s financial interests with the parent company. Also, it seems likely that it could be done in a tax efficient manner as a stock swap.
Mr. Buffett isn’t planning to go anywhere and seemed to be in top form at the annual meeting. At the age of ninety, his life expectancy is most likely considerably longer than the actuarial four years that a typical ninety year old male would expect. Nevertheless, life can throw curve balls and succession could be needed at any time. Berkshire’s stock price rose in the days following the annual meeting which might be partly related to the CEO succession choice. Incentives at Berkshire are already well aligned but I hope that they will be enhanced further by Mr. Abel’s ownership in BHE converting to Berkshire Class A or B shares before he takes over as CEO.
Disclosure: Individuals associated with The Rational Walk LLC own shares of Berkshire Hathaway.