In the time of covid-19, paying in cash definitely seems like an anachronism. This is an investing post, however, and I’m not writing about buying items with paper money. Rather, I’m thinking about companies that do not pay their execs and boards by issuing stock.
This is probably even more rare than cash payments during covid. It could also be a telling signal about the culture of a company and its people.
Warren Buffett, Charlie Munger, and many others have talked extensively about stock-based executive compensation through the years. Often, Berkshire has talked about (railed against?) the potential problems that come from paying executives with stock options (and other forms of equity grants or derivatives).
Here’s a link to one such discussion, from the CNBC video archive of the Berkshire Hathaway 1997 Annual Meeting. One of the issues Buffett has noted during this particular version of his diatribe on this subject is with paying executives in stock options (or grants) is not very good incentive plan (which is, of course, why they were purportedly originally devised…to give management some “skin in the game”).
Buffett notes that the result/outcome is not very tightly aligned with what they can control (the process). In short, the stock of a company is likely to move for all sorts of reasons, only a few of which are related to how the executives are performing in managing the business for the creation of long term value. For everyone other than the CEO (and maybe a few other high-level executives in some companies), the link between their efforts and the outcomes for the entire company are especially tenuous.
As Buffett discussed at this annual meeting, even if the CEO is responsible for the whole company (and so perhaps a stock grant is reasonably linked to a job well done), many other factors not within the CEO’s influence (or that factors that a shareholder would prefer they ignore) can impact the stock price. For example, the company’s entire sector can become “hot.” Or maybe the CEO has been very accessible to investment bankers, and analysts have started to think the company is “in play,” or otherwise likely to pay a bunch of investment banking fees, so they closely follow the story (and are inclined, consciously or not, to be positive). Flirting with deals, charming investment bankers, and otherwise cultivating glamour around the company’s stock is probably not behavior shareholders should particularly desire.
In addition, Buffett has noted many times that if the options or stock grants are based on a fixed share price they effectively bestow a royalty on the company growth over time just due to the growth in accumulated retained earnings (and perhaps inflation). Buffett has cited the example of a savings account that will increase in balance every year if the interest (earnings) are retained/reinvested in the account regardless of any management. The outcome is similar when a company retains earnings which accumulate year after year (assuming management doesn’t destroy them). The price of the stock should rise over time just from building up the money/assets on the balance sheet (all else being equal).
For these and other reasons equity dilution is expensive. It is also hard to keep tabs on just how expensive. The opacity of someone getting paid in stock or derivatives that have complex valuation and vesting features is evident. If an executive is getting $50 million in cash, it is much easier to track versus $50MM in notional value options which will then be offset by cash that is used to buy back shares (and which could be worth $100MM if the CEO is able to juice the stock at the right time during the term of her options).
I have been thinking about this post for a while, but the proximate cause of getting me off my duff to arrange the electrons on our screens was a recent podcast episode. This issue of stock compensation was discussed during an episode of a good new investing podcast: This Week in Intelligent Investing.
I think we all understand the desire to have executives have some skin in the game, but as host Chris Bloomstran noted (@ChrisBloomstran on twitter; good follow btw), there are better ways to achieve this. First, execs can buy stock with cash just like anyone else. He also observed that companies could offer executives and/or employees loans (or discounts) to buy shares if they want employees to have some equity. These seem much preferable to (levered) derivatives or even restricted shares that are subject to vesting cliffs that could incentivize bad behavior, short-term focus, and are opaque.
If you want to read more about this compensation stuff, just check out the Berkshire annual meetings and letters. They talk about it almost every other year (all of the debate about expensing of options is now moot, so if you hit that you might skip it, but can you believe all the execs and the accounting firms argued for years that options and equity grants exchanged in return for labor/management were not compensation expense!?).
Paying in Cash? Berkshire Does That!?
Given all the problems discussed above (and in countless other sources), Berkshire Hathaway does not pay its executives (or board members) in stock. (The most recent proxy is here if you want to check it out.) In 2019, Greg Abel and Ajit Jain were each paid $16MM cash each. No stonk. They also got $3MM bonuses. If you work at Berkshire and you want some stock, you can buy it just like everyone else.
If even a portion of the negative behavioral and other implications of the usual stock-based, consultant-driven, compensation model used by most corporations is true, it seems like avoiding those pitfalls could be a huge benefit to those who are able to leave the herd and “avoid doing something stupid” (like building up massive incentives for the c-suite to manipulate quarterly numbers over the short-term period during which their levered calls on equity are awarded and vest, versus keeping their eye on the horizon).
So, Berkshire’s approach seems pretty extraordinary and attractive. But, just how extraordinary is it?
Many, many, many people in business and investing claim to revere the wisdom of Buffett and Munger. Buffett and Munger are renowned for their ability to understand and profit from human behavior. Perhaps one of their best skills is to identify talented managers and to figure out how to keep them interested and design proper incentive systems.
Most informed investors and business people would probably acknowledge the two are perhaps unmatched at thinking about and designing behavioral incentive systems (perhaps for their own use, the use of executives, business owners, investors in their funds and shareholders of Berkshire).
Given this, I wondered how many companies actually follow their example on this critical issue. I am planning to start to track companies that follow this example (and maybe do more than just parrot the words of Buffett). I will start trying build a list on this site of companies who don’t rely on stock based compensation. Sadly, not many come immediately to mind.
And there were two
I can only think of one other example at present. That company is Boston Omaha. This is the tiny ~$500MM holding company started by Buffett’s grand-nephew, Alex Rozek and his co-founder/partner Adam Petersen. These two do take cash compensation equal to 20% of growth in book value above a 6% hurdle (just like Buffett’s partnership). I do not personally own any shares of BOMN presently. I need more than a good compensation system (and truly exquisite annual letters) to pay a big premium to book for this one. But BOMN definitely on the cash comp/watch list. I will write more about the company in the future, I’m sure.
Three Companies
Hold the presses! Dear Reader, I just found a third company that uses only cash compensation (and expressly ties compensation to the specific processes/sphere of influence that the employees/executive being compensated controls). Oh my. This Canadian software company is also in the <gasp> software bidness.
You know and love the CEO’s……covid-19 beard.
No, it’s not SHOP! It’s Constellation Software (“CSU.TO”)!
I’ve never done much “work” on Constellation. To be honest, I kind of rolled my eyes when people gushed….another Canadian Berkshire (the first of these is discussed below), but this one rolls up discrete software verticals? The CEO has almost never been photographed? Seems maybe sketchy.
But you know what? This compensation/incentives thing is a big deal (kind of a goodly portion of the influence behind my whole blog/nom de guerre as well). By implementing this, it really seems like Constellation might be a rare bird. Definitely going on my watch/study list. No more eye rolls from me….for now. Ok, so we have three!
No List for you!
I must also note a couple of companies to be excluded from the list (since I spent the time to check). Fairfax Financial Holdings (“FFH”) pays execs (and the board) in stock. So it seems, despite all the talk about Buffett, Fairfax (again…think repeated huge macro bets) doesn’t seem to be emulating his behavior. In fairness, it seems FFH paid only about $28MM (Canadian) the last couple of years. Or at least, that is the value I see presented in the financials.
I must also strike “baby Berk-alike” Markel from the list. For people who travel to Omaha to pitch their stock, they sure do seem to pay a lot of people in stock (and the insiders have been dumping that paper). I counted 10 buys on Forms 4 the past 2 years, for a grand total of about $1.5 million. The dispositions number 280 transactions, for over $20 million.
That’s one reason I don’t own any Markel. I been troubled by several of these instances where they don’t really seem to “walk the walk” (whilst singing loudly from the gospel of Berk…which always puts me on alert). To be fair, $20 million is probably not a ton of $$$ for these guys, but they also issue the stock compensation based in amounts based on rolling growth in book value, which Buffett and Munger would (I think) note does not really align with what is controllable for most of the executives. (Not to argue it’s a terrible approach.)
MKL also retains 100% of earnings and there’s no “passbook savings account” adjustment in the stock compensation formula. Markel also talks a lot about EITBA, while issuing all this stonk. I think they also just kind of buy in shares blithely in steady amounts, like some tech company trying to offset/obscure dilution, rather than being rational about price versus intrinsic value (and picking spots to make “lumpy buybacks”).
Not to make this a Markel take down. I didn’t see any form 4/sells from Tom Gayner and it’s not like he’s totally running the show (yet…he might be if these other guys keep dumping stonk and he keeps getting those sweet sweet grants). I think the other guys are mostly just “insurance guys.”
I also checked FAST, and LKQ…nope. I think one of the “compounder-bro” industrial companies has a cash only compensation policy, but the name eludes me. The compounder-bros also usually like CSU (and I didn’t even know it actually emulated BRK in this critical fashion until writing this post, so maybe they are onto something).
In any case, it looks like for now I am working with a list of three: BRK, CSU, and BOMN.
Do you know of any other companies that might fit this mold of paying their executives (and/or board) in cash? If so, I would appreciate you dropping a comment below (or shooting me a message). If we’re able to build up a reasonably long list, I will set up a section on the resources page of this site, so we will have it handy.
Thanks for reading!