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.
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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.