Berkshire is a holding company run by a handful of people at the top and dozens of largely autonomous operating businesses beneath them, so the question of how to pick, motivate, and pay managers sits at the center of Buffett's thinking. His answers are unusually consistent across four decades: tie pay to the things a manager can actually control, keep the arrangements simple and rational, treat option grants as the real expense they are, and give trusted operators the freedom to run their own shows.
At Berkshire, however, we use an incentive-compensation system that rewards key managers for meeting targets in their own bailiwicks. If See's does well, that does not produce incentive compensation at the News - nor vice versa. Neither do we look at the price of Berkshire stock when we write bonus checks.
If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And, if expenses shouldn't go into the calculation of earnings, where in the world should they go?
We shun "lottery ticket" arrangements, such as options on Berkshire shares, whose ultimate value - which could range from zero to huge - is totally out of the control of the person whose behavior we would like to affect.
We give each a simple mission: Just run your business as if: 1) you own 100% 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.
Too often, executive compensation in the U.S. is ridiculously out of line with performance. That won't change, moreover, because the deck is stacked against investors when it comes to the CEO's pay.
So I've taken the easy route, just sitting back and working through great managers who run their own shows. My only tasks are to cheer them on, sculpt and harden our corporate culture, and make major capital-allocation decisions.
Buffett in his own words on camera. Transcribed from the interview; click through to watch the moment.
We've done them ourselves. I mean, you can cause people to do the wrong thing because they will do what they're incented to do.