“The choice to operate in a decentralized manner from the beginning reflected a belief in the value of autonomy and a conviction that people properly entrusted with authority will generally exercise it faithfully.” - Lawrence Cunningham, Berkshire Beyond Buffett
For much of its history, Berkshire Hathaway has been regarded primarily as an investment vehicle rather than a bona fide corporation. One reason for this perception is Warren Buffett’s success as an investor and the outsized contribution of investment returns to the company’s growth in its early years under his leadership. However, as Berkshire Hathaway has expanded beyond its core insurance operations—with investments in railroads, energy and regulated utilities, specialty finance, manufacturing, service, and retail companies—more attention is being paid to the structure by which these entities are managed (see Exhibit 1).
[drizzle]Two notable features of the Berkshire Hathaway system are its high degree of decentralization and the considerable autonomy afforded to the managers of its operating subsidiaries. According to the company’s annual report, “There are essentially no centralized or integrated business functions (such as sales, marketing, purchasing, legal or human resources) and there is minimal involvement by our corporate headquarters in the day-to-day business activities of the operating businesses.” Vice Chairman Charlie Munger describes the company’s system as “delegation just short of abdication.”
Other notable features of the Berkshire Hathaway system are its long-term investment horizon, its pledge not to sell subsidiaries, and its emphasis on ethical behavior. As Buffett explains, “We give each [manager] a simple mission: Just run your business as if: 1) you own 100 percent of it; 2) it is the only asset in the world that you and your family have or will ever have; and 3) you can’t sell or merge it for at least a century.” Separately, Buffett has said, “We can afford to lose money. But we can’t afford to lose reputation, not a shred of reputation. … I tell [our managers] if anything is close to the line it’s out.” According to Munger, “We try and buy companies so permeated with a good ethos that they don’t need a lot of direction and checking and so forth from headquarters. …What we’re trying to live in is a seamless web of deserved trust.”
Survey Of Berkshire Hathaway Managers
To better understand the Berkshire Hathaway management system, we surveyed the chief executive officers of approximately 80 Berkshire Hathaway operating subsidiaries. Responses were received from CEOs representing a mix of insurance and non insurance subsidiaries of various size. Respondents have an average tenure of 12 years as CEO (broadly in-line with the average tenure across all subsidiaries) and include a mix of executives that were and were not CEO when Berkshire originally acquired their companies.8 Responses were remarkably consistent across the sample.
The CEOs of smaller subsidiaries (less than $1 billion in revenue) report that one to two months passed between initial discussions with Berkshire Hathaway about a possible acquisition and agreement to acquisition terms. The CEOs of larger subsidiaries report that discussions lasted longer: six to nine months. On average, smaller acquisitions also took less time to close following a signed agreement (one to two months) than larger acquisitions (four to five months).
Respondents report few governance changes following an acquisition by Berkshire Hathaway. The most frequently cited changes are the elimination or change in composition of the board of directors and changes to the terms of CEO compensation contracts. Some insurance subsidiary CEOs report that changes were made to the company’s internal audit and risk management practices. Subsidiaries that were formerly publicly traded companies report that they eliminated their investor relations departments. Still, changes appear to be modest. According to one respondent, “The only change is that I now discuss any major capital acquisitions with Warren. We run the business the way we always have.” The data is largely consistent with public statements made by Warren Buffett about Berkshire Hathaway’s acquisition practices.
Subsidiary CEOs provide monthly financial statements to Berkshire Hathaway headquarters. A few provide this information quarterly. For the most part, Berkshire Hathaway CEOs have infrequent contact with Buffett. Most report having phone conversations with him on a monthly or quarterly basis. None of the respondents talk to him on a pre-established schedule, and all report that they initiate the communications themselves.
In terms of oversight, there is strong agreement that Berkshire Hathaway affords its operating CEOs a high level of independence in managing their businesses. There is also strong agreement among managers that they would have less independence if their business were owned by a company other than Berkshire. In the words of one respondent, “No one else gives a company this kind of freedom.”
Subsidiary CEOs also agree that their financial performance is better than it would be if their company were owned by a company other than Berkshire Hathaway and—interesting enough—also better than if it were a standalone company. This supports a common conjecture that ownership by Berkshire Hathaway provides financial benefits to subsidiaries. According to one respondent, the company’s operating performance has improved under Berkshire’s ownership because it affords management greater freedom to operate independently and encourages a long-term focus. Another respondent cites Berkshire Hathaway’s brand value, which it references in its marketing. The CEO of an insurance subsidiary cites the parent company’s financial strength as removing surplus limitations on growth.
Berkshire Hathaway operating managers also believe that ownership by Berkshire allows them to manage their businesses with a longer performance horizon than would be the case under different ownership. Respondents vary widely in terms of what performance horizon they use to manage their companies, with estimates ranging from 3 years to 50 years (median 5 years, average 12 years). This compares with an estimated 1- to 3-year performance horizon if their business were owned by another company (median 1 year, average 2 years).
Most Berkshire Hathaway CEOs believe their compensation would be higher if their business were owned by a company other than Berkshire. All claim that their annual bonus is calculated using only two performance measures. (A typical large corporation uses 2.4 performance measures, on average.10) The most frequently cited measures are earnings, return on equity, and operating or profit margin. One reports sales growth as a goal. The stock price performance of Berkshire is not a performance measure for even very large subsidiaries.
All respondents have identified at least one successor as CEO and acknowledge that they are responsible for the selection of this individual. They convey their views on succession in a letter to Warren Buffett which includes their primary recommendation for a successor, other potential successors, and the strengths and weaknesses of candidates. (By comparison, only half [51percent] of public and private companies claim to have identified a permanent successor to the current CEO.11)
There is strong agreement among respondents that a common culture is shared across Berkshire Hathaway subsidiaries. The most frequently cited attributes of this culture are honesty, integrity, long-term orientation, and an emphasis on taking care of the customer. Respondents also agree that the culture of Berkshire is directly influenced by the “tone from the top.” According to one respondent, the main messages conveyed by Berkshire Hathaway headquarters are:
- Never lose reputation for the Berkshire Hathaway brand or the company’s brand;
- Run your business as if it is the only family asset