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Buffett, Bonuses and Executive Greed

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Warren Buffett decries executive greed yet invested in Goldman Sachs, the symbol of Wall Street bonus excess, and says he has no problem paying people huge amounts of money if they're worth it. Is he being hypocritical with these contradictions, or is there a larger point?

In the past Buffett has been influential on pay, especially with legislators. In the battle over stock option accounting, he played an instrumental role in the decision to recognize employee stock option costs as an accounting expense. His arguments against high executive compensation haven't been well received on Wall Street or in Corporate America, though, in part because he's a multi-billionaire who only pays himself $100,000 a year.

Buffett's opinions on compensation started to form early. When he set up his investing partnership in 1956, he took on the unlimited obligation to earn any investor losses back before he got paid, and decided to forego his cut of profits unless his investors earned more than the risk-free government bond rate.

Given this concept of managers' high duty of stewardship toward their financiers, it's not surprising that Buffett has always opposed bonuses that are paid robotically. He sees reward as being paired with risk, and believes employees should behave like owners.

It was not until Buffett became a board member at Salomon, Inc. that his unconventional views on compensation set off a firestorm within the organization he was overseeing. Buffett voted against bonuses as a member of Salomon's compensation committee; later, as Interim Chairman, he cut bonuses at a crucial time when the firm was recovering from its near-death experience after the Treasury-auction scandal. Employees fled en masse into the welcoming arms of more generous investment banks.

Ironically, Buffett was willing to grant huge paydays to Salomon's traders if they made profits for the firm. He thought of them - but not the investment bankers or other employees -- as taking risk alongside the shareholders in the casino of Wall Street. This attitude flew in the face of Wall Street's bonus culture, in which employees have historically received most of their pay in bonuses that vary but are always significant regardless of how the shareholders fare.

This system's roots lie in the investment banks' origins as partnerships that distributed profits to the partners every year. Originally, the firms' need for working capital and the social dynamic among the partners kept bonus pay in check. Over time, though, as the banks became publicly owned, the pay system evolved into a share-the-spoils mentality in which even poor performers got bonus checks. When an employee gets a $300,000 bonus as a "message" that they are at risk of being fired, something is out of whack.

Buffett's willingness to invest in Goldman Sachs, the emblem of this system of Wall Street greed run amok, doesn't mean he's suddenly had a change of heart. Buffett is a pragmatist when it comes to money. Having rationalized the Goldman investment, he bysteps the pay issue by citing the free market and saying that government interference in setting pay is problematic, which is a separate question.

Wall Street pay is a notable issue for Buffett to duck considering that he has been all over the media lately tackling his role as America's business statesman with unusual vigor. If he wanted to be a leading voice on executive compensation, one of the critical issues of our time, a good place to start is with his own company.

The incentive pay systems for Berkshire Hathaway employees are rigorously thought out, with heavy involvement by Buffett, to reward behavior that will enrich shareholders. The details, though, are not disclosed. I wish Buffett would share some specifics about how he pays his employees because they're an excellent example for other companies to follow.

His views on compensation would also be better accepted in board rooms and trading floors if he paid himself a more realistic salary and incentive than the flat $100,000 a year. Yes, I know, he doesn't need the money, but CEOs are paid for the value of their time, not their financial needs. His choice to pay himself so little has a showy quality that executives in the C-suite find irritating. It undercuts his influence with them.

Along these same lines, Buffett makes most of Berkshire's managers set their own pay, and, shamed by his paltry $100,000, most ask for far less than they could receive elsewhere. Buffett sometimes brags about the fact that these people work for him so cheap, but a CEO who recruits people to work for him for less than they are worth because he's so charismatic is not an example of governance that corporate boards should be emulating.

Much of this is part of Buffett's personal quirkiness, and he's been able to justify it because he's Buffett and his personality is what's made him a success. As part of his legacy, however, Buffett genuinely wants this quirky company he runs called Berkshire Hathaway to become a model for other companies. It could be, if he seized the opportunity that's before him. Berkshire Hathaway could set a powerful example by revising its compensation system. Buffett is such an important voice in the business world that, single-handedly, he could influence the way Corporate America is paid.