2004: How does Berkshire pay for performance at Berkshire Hathaway energy?

AUDIENCE MEMBER: Good morning, gentleman. My name is Matt Sauer and I’m from Durham, North Carolina.

Regarding compensation, you have commented along the lines of people willing to bet big on their (inaudible) usually have a lot of bet on.

A MidAmerican regulatory filing indicated some attractive prospective compensation possibilities for its senior executive team, subject, of course, to meeting profitability milestones.

Perhaps you might provide some details on the thought process that went into crafting that compensation structure, and in doing so, use this specific example as a reminder about Berkshire’s compensation philosophy, related to pay for performance versus the more popular approaches.

If it’s easier to figure out and administer, better for owners, and can still attract talented people, why don’t more companies adopt such practices?

WARREN BUFFETT: Yeah, we — you could make a lot of money working for Berkshire. Not if you’re chairman or vice chairman, but there’s a chance to make a lot of money. But it will relate to performance. No one is going to make lots of money at Berkshire for average performance.

And you mentioned the MidAmerican situation. We’ve got some extraordinary management at MidAmerican. And it’s — in terms of how that compensation arrangement was worked out, I was thinking one day about what would be appropriate for the two individuals who are key to the success of MidAmerican. And I took a yellow pad and I spent about three minutes sketching out a proposal.

And I went to Walter Scott, who is our partner in the business and now actually heads the comp committee. And I said, “Walter this is an idea I have, what do you think of it?” And he looked at it and he said, “It looks fine to me.”

And we talked to the two managers about it and actually, as we presented it, we had it so that something over 50 percent went to the CEO, Dave Sokol and something under 50 percent went to the number two man, Greg Abel, who’s enormously well named.

And when we gave it to David, he said, “Let’s just” — he said, “I like it fine, but let’s make it 50/50.” That’s the extent of it.

As you have commented, that’s wildly different than the approach at companies. I mean, most companies go through very elaborate procedures in working out executive compensation. I don’t think that Charlie and I have spent ever, maybe five minutes, on thinking about any.

We have an arrangement at See’s Candy with Chuck Huggins. We worked it out in 1972. It’s still in force now.

John Holland took over Fruit of the Loom a couple of years ago. I met with him for a couple of minutes, suggested something, takes up a paragraph or two. And that’s what we’ll have with John the rest of his life.

It’s not highly complex. You have to understand the businesses. There is no one formula we could use at Berkshire that would fit across our businesses, that’s asinine.

You don’t want them complicated. We don’t have anything that goes on for pages and pages. It’s not needed. It establishes a relationship between us and the manager that’s not good.

So all of our stuff is very, very simple.

At GEICO we have two variables and they’re what count, you know. So we make — from Tony Nicely on down, we have everybody participating based on that. We worked that out whenever we took over at GEICO and it’s worked fine since and it’ll keep working.

But we do not bring in compensation consultants. We don’t have a human relations department. We don’t have — at the headquarters, as you could see, we don’t have any human relations department. We don’t have a legal department. We don’t have a public relations department. We don’t have an investor relations department.

We don’t have those things because they make life way more complicated and everybody gets a vested interest in going to conferences and calling on other consultants and it takes on a life of its own.

In the typical large corporation, there’s a comp committee. And, as I pointed out in the past, they don’t put Dobermans on the comp committees, usually. They — they look for Chihuahuas that have been sedated and — (Laughter)

I’ve been on 19 boards. They put me on one committee once, and I was chairman and I got outvoted. Do you remember that, Charlie? (Laughs)

CHARLIE MUNGER: I certainly do.

WARREN BUFFETT: Yeah. The —

CHARLIE MUNGER: By two very fine guys.

WARREN BUFFETT: Yeah, terrific guys, actually. And they — you know, the nature of it is that now, particularly with Sarbanes-Oxley, there’s lot of committee meetings. The directors meetings are filled up with process.

And you have on one side of the table, some people that usually are spending an hour or two and getting presented with a bunch of material by the human relations department and some outside consultants.

And I’ve never seen the head of a human relations department or a consultant come in and say, “This bozo you’ve got is only worth about half what you’ve been paying him.” This just isn’t going to happen.

So it’s, you know — it’s a situation where the intensity of interest on both sides is seldom equal. The directors are often dealing with something my friend Tom Murphy in the past has called, “play money,” and the CEO is dealing with something very dear to his heart.

So you’ve got to expect a situation like that to get gamed over time. Not over time, promptly, actually.

And there is some change in that that’s taking place. But it’s not being — in large part, it’s not being led by CEOs and it’s difficult for directors to do — to get a lot done.

They get handed a sheet of paper that shows them comparables elsewhere, and everybody thinks their CEO is in the top 25 percent or something. And so there’s a ratcheting effect that takes place.

And now stock options are coming out of favor, so restricted stock comes in. But the idea is to keep the pie very large for CEOs. And if I needed the money, I’d probably be doing the same thing.

Charlie?

CHARLIE MUNGER: Well, I would rather throw a viper down my shirtfront than hire a compensation consultant. (Laughter and applause)

WARREN BUFFETT: Tell me which kind of consultants you actually like, Charlie? (Laughter)

He’s not going to answer that.