Signs of a Good CEO, Based on Buffett’s Thoughts
It is widely known that in the long term, management quality has a leg up on profitability because profitability cannot be sustained with a poor management.
Based on Buffett´s thoughts, here are some signs of a good CEO. First and foremost, track record matters a lot. In the case of Buffett, all Berkshire subsidiary CEOs have a proven track record in their respective companies or in the same industry. Buffett is unlikely to hire a person from one industry to run a company in another industry.
This coincides with his principle of staying in your circle of competence. There is a good example of this thought: When Robert Nardelli, who had successfully run General Electric’s (GE) mines and locomotive businesses was asked to serve at Home Depot (HD) as CEO and failed.
Second, CEO compensation should be examined for abuse. Nothing is wrong with paying CEOs well, but to pay them exorbitantly may indicate an extremely flexible corporate governance culture. Turning back to Nardelli’s case, at Home Depot, his problems probably started with the fact that he was from a different industry but that he had also negotiated a generous compensation contract. He had access to several corporate jets and other expensive benefits, for which he was criticized.
CEOs receiving large amounts of money as compensation tend to create a money-based culture in the organization. They are not respected by employees and in hard times, they are unable to lead efficiently. Such organizations are not likely to do well for shareholders in the long run, either.
Third, a CEO should have a conceptual framework that he or she can articulate well. Analysts should listen carefully to a CEO’s answers at public meetings or conference calls. Buffett also pays attention when CEOs forecast earnings. As he himself points out, “We are suspicious of those CEOs who regularly claim they do know the future — and we become downright incredulous if they consistently reach their declared targets. Managers that always promise to ‘make the numbers’ will at some point be tempted to make up the numbers.”
Buffett suggests that it is better to avoid investing in companies for which CEOs claim to regularly accomplish seemingly impossible targets.
Fourth, it is important to read the company chairman’s annual letters to the shareholders from several years. Investors should be suspicious of letters generally offering excuses for weak results. This may involve poor quality of management. In many of these letters, success is often attributed to management efforts, but failures are attributed to exogenous reasons.
Fifth, attending annual shareholder meetings is paramount. It gives a unique opportunity to evaluate the company’s managers by examining their responses to shareholder questions and to learn more about management attitude towards shareholders. It helps you build trust on management or not. Buffett and Munger have often emphasized the importance of trust and have mentioned that they would not invest in a company if they did not trust its management. For instance, to show his trust in various company managements, Buffett transferred his voting rights at different points in time in American Express (AXP), Washington Post, and Salomon Inc. to their respective management.
Last and probably overarching, a very high level of integrity among company employees and the CEO is important. Buffett wrote to the employees, “Lose money for the firm and I will understand it; lose a shred of reputation for the firm and I will be ruthless.” Clearly, money is important but money alone must not be the main driving force for a CEO.
Integrity is more important for the long-term survival of a company.
These six thoughts are not exhaustive, but are worth following before making investments.
It is essential that a CEO has interests in the company’s stock and does not receive excessive compensation.
If the top management is owner-oriented, fairly compensated, and has well-thought-out incentive plans, the consequences are likely to be transmitted down the ranks. All employees are then motivated to work hard and the company will probably produce extraordinary results, just as Berkshire Hathaway (BRK.A)(BRK.B) does.
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