{"id":19132,"date":"2023-07-06T23:56:00","date_gmt":"2023-07-06T15:56:00","guid":{"rendered":"https:\/\/www.granitefirm.com\/blog\/us\/?p=19132"},"modified":"2024-07-12T17:49:56","modified_gmt":"2024-07-12T09:49:56","slug":"company-governance","status":"publish","type":"post","link":"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/","title":{"rendered":"Insights on company governance"},"content":{"rendered":"\n<p>In <a href=\"https:\/\/berkshirehathaway.com\/letters\/2002pdf.pdf\" target=\"_blank\" rel=\"noreferrer noopener\">Buffett&#8217;s 2002 shareholder letter<\/a> (all content in italics in this article is from his 2002 shareholder letter), he put forward his views on the company governance. The following is a list of objects, elements, members, and components that must be included in corporate governance for a typical listed company.<\/p>\n\n\n\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_82_2 counter-hierarchy ez-toc-counter ez-toc-custom ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Table of Contents<\/p>\n<span class=\"ez-toc-title-toggle\"><a href=\"#\" class=\"ez-toc-pull-right ez-toc-btn ez-toc-btn-xs ez-toc-btn-default ez-toc-toggle\" aria-label=\"Toggle Table of Content\"><span class=\"ez-toc-js-icon-con\"><span class=\"\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #ffffff;color:#ffffff\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #ffffff;color:#ffffff\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/span><\/a><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#CEO\" >CEO<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#CEO_is_a_butterfly\" >CEO is a butterfly<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#CEOs_self-serving_behavior\" >CEO&#8217;s self-serving behavior<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Board_of_directors\" >Board of directors<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#The_core_of_corporate_governance\" >The core of corporate governance<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Prevent_the_scandals_of_the_management\" >Prevent the scandals of the management<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Safeguard_the_interests_of_shareholders\" >Safeguard the interests of shareholders<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Board_is_amicable\" >Board is amicable<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-9\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Berkshires_directors\" >Berkshire&#8217;s directors<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-10\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#What_should_independent_directors_do\" >What should independent directors do?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-11\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Owner-capitalism\" >Owner-capitalism<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-12\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Qualifications_required_of_directors\" >Qualifications required of directors<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-13\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Independent_director\" >Independent director<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-14\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Requirements_for_independent_directors\" >Requirements for independent directors<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-15\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Independent_directors_bow_to_reality\" >Independent directors bow to reality<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-16\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Regulations_are_improving\" >Regulations are improving<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-17\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Compensation_committee\" >Compensation committee<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-18\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Dont_dare_to_cut_the_CEOs_pay\" >Don&#8217;t dare to cut the CEO&#8217;s pay<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-19\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Tail-wagging_puppy_dogs\" >Tail-wagging puppy dogs<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-20\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Directors_seek_for_their_own_interests\" >Directors seek for their own interests<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-21\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#CEOs_are_too_greedy\" >CEOs are too greedy<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-22\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Board_is_too_weak\" >Board is too weak<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-23\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Directors_covet_their_pay\" >Directors covet their pay<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-24\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#The_audit_committee\" >The audit committee<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-25\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Rely_on_accountants\" >Rely on accountants<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-26\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Accountants_keep_silent\" >Accountants keep silent<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-27\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Accountants_dare_not_offend_the_management\" >Accountants dare not offend the management<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-28\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#How_to_review_the_audit_committee\" >How to review the audit committee?<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-29\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Three_suggestions_for_investors\" >Three suggestions for investors<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-30\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Watch_out_for_questionable_accounting\" >Watch out for questionable accounting<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-31\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Pay_attention_to_the_notes_in_the_report\" >Pay attention to the notes in the report<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-32\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Dont_believe_trumpet_projections_and_expectations\" >Don&#8217;t believe trumpet projections and  expectations<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-33\" href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/#Related_articles\" >Related articles<\/a><\/li><\/ul><\/nav><\/div>\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"CEO\"><\/span>CEO<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"CEO_is_a_butterfly\"><\/span>CEO is a butterfly<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>Most CEOs, it should be noted, are men and women you would be happy to have as trustees for your children\u2019s assets or as next-door neighbors. Too many of these people, however, have in recent years behaved badly at the office, fudging numbers and drawing obscene pay for mediocre business achievements. These otherwise decent people simply followed the career path of Mae West: \u201cI was Snow White but I drifted.\u201d<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"CEOs_self-serving_behavior\"><\/span>CEO&#8217;s <em>self-serving<\/em> <em>behavior <\/em><span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>In our 1992 annual report, discussing the unseemly and self-serving behavior of so many CEOs, I said \u201cthe business elite risks losing its credibility on issues of significance to society \u2013 about which it may have much of value to say \u2013 when it advocates the incredible on issues of significance to itself.\u201d<\/em><\/p>\n\n\n\n<p><em>That loss of credibility has occurred. The job of CEOs is now to regain America\u2019s trust \u2013 and for the country\u2019s sake it\u2019s important that they do so. They will not succeed in this endeavor, however, by way of fatuous ads, meaningless policy statements, or structural changes of boards and committees. Instead, CEOs must embrace stewardship as a way of life and treat their owners as partners, not patsies. It\u2019s time for CEOs to walk the walk.<\/em><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Board_of_directors\"><\/span>Board of directors<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"The_core_of_corporate_governance\"><\/span>The core of corporate governance<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>In theory, corporate boards should have prevented this deterioration of conduct. I last wrote about the responsibilities of directors in the 1993 annual report. (We will send you a copy of this discussion on request, or you may read it on the Internet in the Corporate Governance section of the 1993 letter.) <\/em><\/p>\n\n\n\n<p><em>There, I said that directors \u201cshould behave as if there was a single absentee owner, whose long-term interest they should try to further in all proper ways.\u201d This means that directors must get rid of a manager who is mediocre or worse, no matter how likable he may be. Directors must react as did the chorus-girl bride of an 85-yearold multimillionaire when he asked whether she would love him if he lost his money. \u201cOf course,\u201d the young beauty replied, \u201cI would miss you, but I would still love you.\u201d<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Prevent_the_scandals_of_the_management\"><\/span>Prevent the scandals of the management<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>In the 1993 annual report, I also said directors had another job: \u201cIf able but greedy managers overreach and try to dip too deeply into the shareholders\u2019 pockets, directors must slap their hands.\u201d Since I wrote that, over-reaching has become common but few hands have been slapped.<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Safeguard_the_interests_of_shareholders\"><\/span>Safeguard the interests of shareholders<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>Why have intelligent and decent directors failed so miserably? The answer lies not in inadequate laws \u2013 it\u2019s always been clear that directors are obligated to represent the interests of shareholders \u2013 but rather in what I\u2019d call \u201cboardroom atmosphere.\u201d<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Board_is_amicable\"><\/span>Board is amicable<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>It\u2019s almost impossible, for example, in a boardroom populated by well-mannered people, to raise the question of whether the CEO should be replaced. It\u2019s equally awkward to question a proposed acquisition that has been endorsed by the CEO, particularly when his inside staff and outside advisors are present and unanimously support his decision. (They wouldn\u2019t be in the room if they didn\u2019t.) <\/em><\/p>\n\n\n\n<p><em>Finally, when the compensation committee \u2013 armed, as always, with support from a high-paid consultant \u2013 reports on a megagrant of options to the CEO, it would be like belching at the dinner table for a director to suggest that the committee reconsider.<\/em><\/p>\n\n\n\n<p><em>These \u201csocial\u201d difficulties argue for outside directors regularly meeting without the CEO \u2013 a reform that is being instituted and that I enthusiastically endorse. I doubt, however, that most of the other new governance rules and recommendations will provide benefits commensurate with the monetary and other costs they impose.<\/em><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Berkshires_directors\"><\/span>Berkshire&#8217;s directors<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Buffett stated again in <a href=\"https:\/\/berkshirehathaway.com\/letters\/2003ltr.pdf\" target=\"_blank\" rel=\"noreferrer noopener\">his 2003 shareholder letter<\/a>, taking Berkshire as an example, use the following three paragraphs to illustrate the roles that directors should have.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What_should_independent_directors_do\"><\/span>What should independent directors do?<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>&#8220;True independence \u2013 meaning the willingness to challenge a forceful CEO when something is wrong or foolish \u2013 is an enormously valuable trait in a director. It is also rare. The place to look for it is among high-grade people whose interests are in line with those of rank-and-file shareholders \u2013 and are in line in a very big way.&#8221;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Owner-capitalism\"><\/span>Owner-capitalism<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>&#8220;The bottom line for our directors: You win, they win big; you lose, they lose big. Our approach might be called owner-capitalism. We know of no better way to engender true independence. (This structure does not guarantee perfect behavior, however: I\u2019ve sat on boards of companies in which Berkshire had huge stakes and remained silent as questionable proposals were rubber-stamped.)&#8221;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Qualifications_required_of_directors\"><\/span>Qualifications required of directors<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>In addition to being independent, <\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Directors should have business savvy, <\/li>\n\n\n\n<li>A shareholder orientation<\/li>\n\n\n\n<li>And a genuine interest in the company. <\/li>\n<\/ul>\n\n\n\n<p>The rarest of these qualities is business savvy \u2013 and if it is lacking, the other two are of little help. Many people who are smart, articulate and admired have no real understanding of business. That\u2019s no sin; they may shine elsewhere. But they don\u2019t belong on corporate boards. Similarly, I would be useless on a medical or scientific board (though I would likely be welcomed by a chairman who wanted to run things his way). My name would dress up the list of directors, but I wouldn\u2019t know enough to critically evaluate proposals. Moreover, to cloak my ignorance, I would keep my mouth shut (if you can imagine that). In effect, I could be replaced, without loss, by a potted plant.&#8221;<\/p>\n\n\n\n<p>In his <a href=\"https:\/\/berkshirehathaway.com\/letters\/2006ltr.pdf\" target=\"_blank\" rel=\"noreferrer noopener\">2006 shareholder letter<\/a>, Buffett repeated his requirements for company directors: &#8220;In selecting a new director, we were guided by our long-standing criteria, which are that board members be owner-oriented, business-savvy, interested and truly independent.&#8221;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Independent_director\"><\/span>Independent director<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Requirements_for_independent_directors\"><\/span>Requirements for independent directors<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>The current cry is for \u201cindependent\u201d directors. It is certainly true that it is desirable to have directors who think and speak independently \u2013 but they must also be business-savvy, interested and shareholderoriented. In my 1993 commentary, those are the three qualities I described as essential.<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Independent_directors_bow_to_reality\"><\/span>Independent directors bow to reality<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>Over a span of 40 years, I have been on 19 public-company boards (excluding Berkshire\u2019s) and have interacted with perhaps 250 directors. Most of them were \u201cindependent\u201d as defined by today\u2019s rules. But the great majority of these directors lacked at least one of the three qualities I value. As a result, their contribution to shareholder well-being was minimal at best and, too often, negative. <\/em><\/p>\n\n\n\n<p><em>These people, decent and intelligent though they were, simply did not know enough about business and\/or care enough about shareholders to question foolish acquisitions or egregious compensation. My own behavior, I must ruefully add, frequently fell short as well: Too often I was silent when management made proposals that I judged to be counter to the interests of shareholders. In those cases, collegiality trumped independence.<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Regulations_are_improving\"><\/span>Regulations are improving<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>So that we may further see the failings of \u201cindependence,\u201d let\u2019s look at a 62-year case study covering thousands of companies. Since 1940, federal law has mandated that a large proportion of the directors of investment companies (most of these mutual funds) be independent. The requirement was originally 40% and now it is 50%. In any case, the typical fund has long operated with a majority of directors who qualify as independent.<\/em><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Compensation_committee\"><\/span>Compensation committee<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Dont_dare_to_cut_the_CEOs_pay\"><\/span>Don&#8217;t dare to cut the CEO&#8217;s pay<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>The acid test for reform will be CEO compensation. Managers will cheerfully agree to board \u201cdiversity,\u201d attest to SEC filings and adopt meaningless proposals relating to process. What many will fight, however, is a hard look at their own pay and perks.<\/em><\/p>\n\n\n\n<p>Buffett stated again in <a href=\"https:\/\/berkshirehathaway.com\/letters\/2003ltr.pdf\" target=\"_blank\" rel=\"noreferrer noopener\">his 2003 shareholder letter<\/a>:&#8221;In judging whether Corporate America is serious about reforming itself, CEO pay remains the acid<br>test. To date, the results aren\u2019t encouraging.&#8221;<\/p>\n\n\n\n<p>&#8220;Overreaching by CEOs greatly accelerated in the 1990s as compensation packages gained by the most avaricious\u2013 a title for which there was vigorous competition \u2013 were promptly replicated elsewhere. The couriers for this epidemic of greed were usually consultants and human relations departments, which had no trouble perceiving who buttered their bread. As one compensation consultant commented: \u201cThere are two classes of clients you don\u2019t want to offend \u2013 actual and potential.\u201d<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Tail-wagging_puppy_dogs\"><\/span>Tail-wagging puppy dogs<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>In recent years compensation committees too often have been tail-wagging puppy dogs meekly following recommendations by consultants, a breed not known for allegiance to the faceless shareholders who pay their fees. (If you can\u2019t tell whose side someone is on, they are not on yours.) True, each committee is required by the SEC to state its reasoning about pay in the proxy. But the words are usually boilerplate written by the company\u2019s lawyers or its human-relations department.<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Directors_seek_for_their_own_interests\"><\/span>Directors seek for their own interests<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>This costly charade should cease. Directors should not serve on compensation committees unless they are themselves capable of negotiating on behalf of owners. They should explain both how they think about pay and how they measure performance. Dealing with shareholders\u2019 money, moreover, they should behave as they would were it their own.<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"CEOs_are_too_greedy\"><\/span>CEOs are too greedy<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>In the 1890s, Samuel Gompers described the goal of organized labor as \u201cMore!\u201d In the 1990s, America\u2019s CEOs adopted his battle cry. The upshot is that CEOs have often amassed riches while their shareholders have experienced financial disasters.<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Board_is_too_weak\"><\/span>Board is too weak<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>Directors should stop such piracy. There\u2019s nothing wrong with paying well for truly exceptional business performance. But, for anything short of that, it\u2019s time for directors to shout \u201cLess!\u201d It would be a travesty if the bloated pay of recent years became<\/em> <em>a baseline for future compensation. Compensation committees should go back to the drawing boards.<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Directors_covet_their_pay\"><\/span>Directors covet their pay<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>That gets to an often-overlooked point about directors\u2019 compensation, which at public companies averages perhaps $50,000 annually. It baffles me how the many directors who look to these dollars for perhaps 20% or more of their annual income can be considered independent when Ron Olson, for example, who is on our board, may be deemed not independent because he receives a tiny percentage of his very large income from Berkshire legal fees. <\/em><\/p>\n\n\n\n<p><em>As the investment company saga suggests, a director whose moderate income is heavily dependent on directors\u2019 fees \u2013 and who hopes mightily to be invited to join other boards in order to earn more fees \u2013 is highly unlikely to offend a CEO or fellow directors, who in a major way will determine his reputation in corporate circles. If regulators believe that \u201csignificant\u201d money taints independence (and it certainly can), they have overlooked a massive class of possible offenders.<\/em><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"The_audit_committee\"><\/span>The audit committee<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Rely_on_accountants\"><\/span>Rely on accountants<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>Audit committees can\u2019t audit. Only a company\u2019s outside auditor can determine whether the earnings that a management purports to have made are suspect. Reforms that ignore this reality and that instead focus on the structure and charter of the audit committee will accomplish little.<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Accountants_keep_silent\"><\/span>Accountants keep silent<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>As we\u2019ve discussed, far too many managers have fudged their company\u2019s numbers in recent years, using both accounting and operational techniques that are typically legal but that nevertheless materially mislead investors. Frequently, auditors knew about these deceptions. Too often, however, they remained silent. The key job of the audit committee is simply to get the auditors to divulge what they know.<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Accountants_dare_not_offend_the_management\"><\/span>Accountants dare not offend the management<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>To do this job, the committee must make sure that the auditors worry more about misleading its members than about offending management. In recent years auditors have not felt that way. They have instead generally viewed the CEO, rather than the shareholders or directors, as their client. <\/em><\/p>\n\n\n\n<p><em>That has been a natural result of day-to-day working relationships and also of the auditors\u2019 understanding that, no matter what the book says, the CEO and CFO pay their fees and determine whether they are retained for both auditing and other work. The rules that have been recently instituted won\u2019t materially change this reality. What will break this cozy relationship is audit committees unequivocally putting auditors on the spot, making them understand they will become liable for major monetary penalties if they don\u2019t come forth with what they know or suspect.<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"How_to_review_the_audit_committee\"><\/span>How to review the audit committee?<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>In my opinion, audit committees can accomplish this goal by asking four questions of auditors, the answers to which should be recorded and reported to shareholders. These questions are:<\/em><\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><em>If the auditor were solely responsible for preparation of the company\u2019s financial statements, would they have in any way been prepared differently from the manner selected by management? This question should cover both material and nonmaterial differences. If the auditor would have done something differently, both management\u2019s argument and the auditor\u2019s response should be disclosed. The audit committee should then evaluate the facts.<\/em><\/li>\n\n\n\n<li><em>If the auditor were an investor, would he have received \u2013 in plain English \u2013 the information essential to his understanding the company\u2019s financial performance during the reporting period?<\/em><\/li>\n\n\n\n<li><em>Is the company following the same internal audit procedure that would be followed if the auditor himself were CEO? If not, what are the differences and why?<\/em><\/li>\n\n\n\n<li><em>Is the auditor aware of any actions \u2013 either accounting or operational \u2013 that have had the purpose and effect of moving revenues or expenses from one reporting period to another?<\/em><\/li>\n<\/ol>\n\n\n\n<p><em>If the audit committee asks these questions, its composition \u2013 the focus of most reforms \u2013 is of minor importance. In addition, the procedure will save time and expense. When auditors are put on the spot, they will do their duty. If they are not put on the spot . . . well, we have seen the results of that.<\/em><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Three_suggestions_for_investors\"><\/span>Three suggestions for investors<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Watch_out_for_questionable_accounting\"><\/span>Watch out for questionable accounting<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>First, beware of companies displaying weak accounting. If a company still does not expense options, or if its pension assumptions are fanciful, watch out. When managements take the low road in aspects that are visible, it is likely they are following a similar path behind the scenes. <\/em><\/p>\n\n\n\n<p><em>There is seldom just one cockroach in the kitchen. Trumpeting EBITDA (earnings before interest, taxes, depreciation and amortization) is a particularly pernicious practice. Doing so implies that depreciation is not truly an expense, given that it is a \u201cnon-cash\u201d charge. That\u2019s nonsense. In truth, depreciation is a particularly unattractive expense because the cash outlay it represents is paid up front, before the asset acquired has delivered any benefits to the business. <\/em><\/p>\n\n\n\n<p><em>Imagine, if you will, that at the beginning of this year a company paid all of its employees for the next ten years of their service (in the way they would lay out cash for a fixed asset to be useful for ten years). In the following nine years, compensation would be a \u201cnon-cash\u201d expense \u2013 a reduction of a prepaid compensation asset established this year. Would anyone care to argue that the recording of the expense in years two through ten would be simply a bookkeeping formality?<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Pay_attention_to_the_notes_in_the_report\"><\/span>Pay attention to the notes in the report<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><em>Second, unintelligible footnotes usually indicate untrustworthy management. If you can\u2019t understand a footnote or other managerial explanation, it\u2019s usually because the CEO doesn\u2019t want you to. Enron\u2019s descriptions of certain transactions still baffle me.<\/em><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Dont_believe_trumpet_projections_and_expectations\"><\/span>Don&#8217;t believe trumpet projections and  expectations<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p><br><em>Finally, be suspicious of companies that trumpet earnings projections and growth expectations. Businesses seldom operate in a tranquil, no-surprise environment, and earnings simply don\u2019t advance smoothly (except, of course, in the offering books of investment bankers).<\/em><\/p>\n\n\n\n<p><em>Charlie and I not only don\u2019t know today what our businesses will earn next year \u2013 we don\u2019t even know what they will earn next quarter. We are suspicious of those CEOs who regularly claim they do know the future \u2013 and we become downright incredulous if they consistently reach their declared targets. Managers that always promise to \u201cmake the numbers\u201d will at some point be tempted to make up the numbers.<\/em><\/p>\n\n\n\n<figure class=\"wp-block-image size-full is-resized\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/www.granitefirm.com\/blog\/us\/wp-content\/uploads\/sites\/2\/2023\/03\/g-1600x1200-1.jpg\" alt=\"company governance\" class=\"wp-image-19136\" width=\"171\" height=\"95\"\/><figcaption class=\"wp-element-caption\">credit:ipleaders.in<\/figcaption><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Related_articles\"><\/span>Related articles<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<ul class=\"wp-block-list\">\n<li>&#8220;<a href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/07\/06\/company-governance\/\" target=\"_blank\" rel=\"noreferrer noopener\">Insights on company governance<\/a>&#8220;<\/li>\n\n\n\n<li>&#8220;How does Buffett manage Berkshire?&#8221;<\/li>\n\n\n\n<li>&#8220;<a href=\"https:\/\/www.granitefirm.com\/blog\/us\/2022\/12\/31\/ceo-return\/\">The pros and cons of CEO returning, Boomerang CEO<\/a>&#8220;<\/li>\n\n\n\n<li>&#8220;<a href=\"https:\/\/www.granitefirm.com\/blog\/us\/2023\/03\/06\/founder-ceo-firms\/\">Founder-CEO firms stock shown better performance<\/a>&#8220;<\/li>\n\n\n\n<li>&#8220;The more shares CEO owns, the higher stock return&#8221;<\/li>\n\n\n\n<li>&#8220;Why Can Underperforming CEOs Keep Their Jobs?&#8221;<\/li>\n\n\n\n<li>&#8220;Pros and cons of employee stock options as compensation&#8221;<\/li>\n\n\n\n<li>&#8220;Unreasonable accounting practices in financial statements&#8221;<\/li>\n<\/ul>\n\n\n\n<p><em><strong>Disclaimer<\/strong><\/em><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li><em>The content of this site is the author\u2019s personal opinions and is for reference only. I am not responsible for the correctness, opinions, and immediacy of the content and information of the article. Readers must make their own judgments.<\/em><\/li>\n\n\n\n<li><em>I shall not be liable for any damages or other legal liabilities for the direct or indirect losses caused by the readers&#8217; direct or indirect reliance on and reference to the information on this site, or all the responsibilities arising therefrom, as a result of any investment behavior.<\/em><\/li>\n<\/ul>\n","protected":false},"excerpt":{"rendered":"<p>In Buffett&#8217;s 2002 shareholder letter, he put forward his views on the company governance. The following is a list of objects, elements, members, and components that must be included in corporate governance for a typical listed company.<\/p>\n","protected":false},"author":1,"featured_media":19136,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[221,193,222,223,172,171,206,11],"tags":[],"class_list":["post-19132","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-board-of-directors","category-accounting-fraud","category-ceo","category-cfo","category-ebitda","category-financial-statements","category-management-team","category-buffett"],"_links":{"self":[{"href":"https:\/\/www.granitefirm.com\/blog\/us\/wp-json\/wp\/v2\/posts\/19132","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.granitefirm.com\/blog\/us\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.granitefirm.com\/blog\/us\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.granitefirm.com\/blog\/us\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.granitefirm.com\/blog\/us\/wp-json\/wp\/v2\/comments?post=19132"}],"version-history":[{"count":56,"href":"https:\/\/www.granitefirm.com\/blog\/us\/wp-json\/wp\/v2\/posts\/19132\/revisions"}],"predecessor-version":[{"id":28234,"href":"https:\/\/www.granitefirm.com\/blog\/us\/wp-json\/wp\/v2\/posts\/19132\/revisions\/28234"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.granitefirm.com\/blog\/us\/wp-json\/wp\/v2\/media\/19136"}],"wp:attachment":[{"href":"https:\/\/www.granitefirm.com\/blog\/us\/wp-json\/wp\/v2\/media?parent=19132"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.granitefirm.com\/blog\/us\/wp-json\/wp\/v2\/categories?post=19132"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.granitefirm.com\/blog\/us\/wp-json\/wp\/v2\/tags?post=19132"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}