Warren Buffett is My Homeboy: Lessons in Corporate Responsibility at the Other Berkshire

Somewhere deep in the bottom of my closet, there is a t-shirt that reads, “Warren Buffett is my home boy.” It may be a bit pueri­le, but Buffett’s shadow looms large in the financial industry. If you are employed by a leveraged buyout firm called ‘Berkshire Partners,’ you can either spend half your time explaining the considerable distinctions between your firm and Berkshire Hathaway (NYSE:BRK)[i] or you can lean in and learn from one the great investors of our time. I chose the latter and, along the way, was rewarded with wisdom that is as much about personal decorum as investing, running businesses well and for the long term.

As an investor interested in corporate social responsibility (CSR), Buffett provides practical insights into sustainability, investment policy, and governance grounded in Enlightenment philosophies of Adam Smith and Immanuel Kant, but rooted in twenty-first-century realities. Buffett and BRK are brilliant managers of risk, allocators of capital, and disciples of market trends, yet the source of their sustained competitive advantage is reputation. Reputation as a source of competitive strength for the fifth largest company by market capitalization[ii] is good news those interested in CSR. In this paper, I will argue that Buffett has employed his managerial values and social responsibility (in the historical sense) for developing, marketing, and influencing stakeholders thereby building a sustained competitive advantage.

Building Distinctive Competency. In Buffett’s case, his reputation provided an access advantage. He has built a reputation for trusting managers to run their businesses independently and compensating them fairly for strong performance. As a result, he has been able to attract founders and managers with significant ownership stakes who willingly relinquish voting control to partner with BRK while other investors engage in bidding wars and hostile takeovers. In fact, a 2015 survey of 80 BRK subsidiary CEOs reinforced this positive view, noting that BRK’s “brand value and financial strength” improved their companies’ performance.[iii] Importantly, Buffett is mindful that reputation is the source of his competitive advantage. In fact, after taking over Saloman, Buffett told employees, “Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.”[iv] His managers remark about their independence as leaders unless there is a material restatement of financials or a reputational concern.[v]

BRK’s access advantage facilitated its maturity as a “fast-growth” company that operates, like GE Capital, as a financial portfolio.[vi] Using “leverage and skill” for acquisitions,[vii] it has enhanced its position through experience effects and economies of scope. BRK encourages low turnover through its management style and seeks long-tenured managers which heightens the benefits of experience. Moreover, BRK benefits from a scope economy by utilizing the strengths of seemingly disparate industries, such as insurance and beverage companies, whereby the strong cash flow from one feeds the high growth of another.[viii] In addition, Buffett excels in sustainability; achieving his current goals without sacrificing future opportunities.[ix]

Sustainability. Buffett began his company modestly, seeking small investments from friends and family.[x] This personal connection to his investors may have amplified the stewardship model Buffett follows with the assets he oversees today. He is known to track and be loyal to long-term investors and those with large stakes.[xi] Recognized as a value investor, Buffett also invests in sociological values.[xii] These values include integrity (treating all stakeholders with respect and honesty), diligence (hard work/primary research without shortcuts), curiosity (a Saturday learning expedition to GEICO by a twenty-one-year-old Buffett led to one of his greatest investments), and humility (acknowledging and learning from personal failings). Ethics are the cornerstone of BRK, lending stability to its operations and performance.

Risk & Reward. As a result, Buffett has led BRK for over a half-century with remarkably steady performance (19% compound annual growth rate of its book value) despite operating in volatile industries, such as consumer discretionary and financials.[xiii] The consistency of BRK’s returns is due in part to Buffett’s attention to sustainability and understanding risk premium appropriately. Through one of his early investments, National Indemnity, Buffett became well versed in risk profiles and cash flow projections. As an insurance company, National Indemnity underwrote risk, but in turn received a premium for the risk that it could invest for a profit in the near term. Over time, Buffett would augment this portfolio with additional insurance providers (National Fire and Marine, GEICO, and Berkshire Hathaway Reinsurance) and through this experience, he excelled at capital allocation and weighing risks and rewards.

Preferable & Defensible Terms. When addressing core competencies, C.K. Prahalad and Gary Hamel note that they do not “diminish with use. Unlike physical assets, which do deteriorate over time, competencies are enhanced as they are applied and shared.”[xiv] Pankaj Ghemawat further notes that for an access-based advantage to be sustainable, “it must be secured under better terms than competitors” and be “enforceable over the long run.” As one of the earliest entrants in value investing, BRK benefits from a first-mover advantage and is bolstered by its consistent returns. Both are difficult for another firm to replicate.

Investment Policy. Buffett developed and improved upon his investment processes over the years. An HBS case study and many other analysts have explored his revolutionary approach to investment management, including his attention to aligned interests, long-term vision, and free cash flow.[xv] Less apparent, but equally important to his success is his discipline to invest only in areas that he understands deeply, to conduct independent primary research, and to account for opportunity cost.

Adaptability. “Invention breeds invention,” Ghemawat borrowed from Emerson to describe fast followers that often benefit more from initial discoveries. Similarly, Buffett’s practices were quickly adapted (or analogous concepts were advanced) by prudent firms (like my former employer) who also had ample capital to deploy. His investment policy was important but did not differentiate BRK. Buffett’s mentor, Benjamin Graham, had taught him to focus on an attractive purchase price to relieve the pressure of timing the market for an ideal future exit. Even as BRK advanced these frameworks, additional participants joined the buyout market competing on price. To develop and sustain an advantage, Buffett had to shift from pure value. Understanding that nonprice instruments are harder to match[xvi] and at the urging of Charlie Munger, he began to focus on the fundamentals, seeking out fair prices for healthy businesses in attractive, stable industries rather than bargain investment prices.

Governance. Consistency. Three hallmarks of governance distinguish the performance of BRK: consistency, transparency, and alignment. Once invested, Buffett remains clear and unwavering in his expectations for management. BRK seeks profitability over the long term measured by return on capital with allowances for capital-intensive businesses. Success metrics fulfill the criteria for organizational objectives and targets outlined by Parada; they are tangible, challenging yet achievable, and well communicated across the company.[xvii] Subsidiaries are charged a cost of capital and provided reasonable hurdles to meet and incentives for surpassing them.[xviii] Finally, Buffett is consistent with his allocation of resources.

Transparency. Not only are expectations well communicated, but the performance targets also clearly align with reality and benefit the parties involved. To exploit capital allocation as a distinctive core competency and with the understanding that core competencies are “corporate resources and may be reallocated by corporate management,” BRK collects and redeploys the capital earned by subsidiaries.[xix] This requires a common vision and sense of community, which BRK cultivates across its vast portfolio. The Stanford study noted a common culture across subsidiaries, which is “focused on honesty, integrity, long-term orientation, and customer service.”[xx] Despite being a diversified holding company, subsidiaries recognize their place in the BRK ‘family.’

Influencing stakeholders is a cornerstone of strategic CSR but requires responsibility. Buffett works to present BRK’s financial and strategic position to shareholders with radical transparency, readily disclosing successes and failures alike.[xxi] Similarly, Buffett and Munger plainly communicate pending organizational changes and their implications. This transparency grants them greater credibility and latitude with stakeholders. Since legal responsibility for major operating and capitalization decisions lie with the board of directors, a chief concern for BRK is ensuring their true independence. This concern was only heightened in the aftermath of the financial crisis, where governance failures led to untenable capital structures. Like other investment firms, BRK set up whistleblower lines and scheduled board meetings without the CEO present,[xxii] but long before the crisis, Buffett encouraged openness with employees and managers to intercept misconduct early.

Alignment. Like Smith and Kant, Buffett understands that the right incentive system is key to driving results.[xxiii] The attention paid toward aligning interests of managers, directors, and BRK investment staff toward shareholder interests was crucial to ensuring strong performance over the long term. Buffett famously eschews option awards and other traditional bonus structures that provided managers with upside rewards without downside risks in the event of poor performance. He believes decision-makers should approach business with the same incentives as equity holders and, as a result, favors parity between equity ownership and voting rights.[xxiv] When possible, he implements cash compensation schemes with the ability to purchase BRK stock with a loan, preferring that managers have significant stakes in the businesses they lead. BRK board members, paid under 10,000 USD annually, are among the lowest compensated of any S&P 500 company. Still, the directors have acquired large percentages of BRK-A and BRK-B shares on the open market.[xxv] Importantly, Buffett has consistently employed this alignment of interests. For six decades, he has compensated himself in a manner that mirrors shareholder returns.[xxvi]

            Summary. Skeptics rightly object to the elevation of shareholder interests above other stakeholders, particularly when it supplants those of employees and the families and communities they represent. However, the capitalist economy, particularly in the western world, centers around this constraint. As such, practitioners of CSR are wise to study the success of BRK under Buffett and the ways in which his managerial values and social responsibility led to prudent sustainability, investment, and governance policy. Just as climate change scientists seek common ground with business leaders and politicians through mutually beneficial economic and public gains, those who believe in business as an engine for economic and social progress must find ways to make such efforts good for the individuals whose equity is at stake in an organization. In the same manner that Buffett views reputation as a bottom line worthy of care equal to the profit margin, so too is social wellbeing of all stakeholders. Under this type of holistic thinking, many responsible businesses ought to track the “triple bottom line” – the economic, sociocultural, and environmental outcomes of their organizations and so contribute to a sustainable competitive advantage for their organization.

[i] Berkshire Hathaway has both A-Shares (NYSE:BRK-A) and B-Shares (NYSE:BRK-B). The two share classes have been aggregated here for simplicity.

[ii] “List of public corporations by market capitalization.” Wikipedia, Wikimedia Foundation, 12 Sept. 2017, en.wikipedia.org/wiki/List_of_public_corporations_by_market_capitalization. Accessed 19 Sept. 2017.

[iii] Lynch, Shana. “What Is It Like to Be Owned by Warren Buffett?” Stanford Graduate School of Business, 25 Oct. 2015, www.gsb.stanford.edu/insights/what-it-be-owned-warren-buffett. Accessed 19 Sept. 2017.

[iv] Crippen, Alex. “Warren Buffett's 9 essential rules for running a business.” CNBC, CNBC, 21 Nov. 2016, www.cnbc.com/2016/11/21/warren-buffett-9-essential-rules-for-running-a-business.html. Accessed 19 Sept. 2017.

[v] Lynch, Shana. “What Is It Like to Be Owned by Warren Buffett?” Stanford Graduate School of Business, 25 Oct. 2015, www.gsb.stanford.edu/insights/what-it-be-owned-warren-buffett. Accessed 19 Sept. 2017.

[vi] Parada, Pedro, and Marcel Planellas. “Diversification in Developed and Emerging Economies.” Effective Executive, May 2008, pp. 60–67., Accessed 1 Aug. 2017.

[vii] Parada, Pedro, and Marcel Planellas. “Diversification in Developed and Emerging Economies: How to Facilitate the Executive Decision.” Effective Executive, May 2008, pp. 60–67., Accessed 1 Aug. 2017.

[viii] Ghemawat, Pankaj. “Sustainable Advantage.” Harvard Business Review, 1986, pp. 53–58., Accessed 1 Aug. 2017.

[ix] “Humanity has the ability to make development sustainable to ensure that it meets the needs of the present without compromising the ability of future generations to meet their own needs.” United Nations, World Commission on Environment and Development, and Gro Harlem. Brundtland. “Report of the World Commission on environment and development: “our common future.”  United Nations, 1987. http://www.un-documents.net/our-common-future.pdf. Accessed 19 Sept. 2017.

[x] Adjusted for inflation, Buffett’s initial $105,000 fund is equivalent to about $946,000 in current dollars. HBS Case and Inflation-Adjusted Values, www.dollartimes.com/inflation/inflation.php?amount=100&year=1956. Accessed 19 Sept. 2017.

[xi] Anand, Bharat N., and Samhita A.P. Jayanti. “Berkshire Hathaway.” Harvard Business School, 2009, pp. 1–29., Accessed 1 Aug. 2017.

[xii] Cunningham, Lawrence A. Berkshire beyond Buffett: the enduring value of values. New York, Columbia Business School Publishing, 2014.

[xiii] As his portfolio has become increasingly larger, alpha has become more elusive as his returns inevitably mirror the economy at large. See Maxfield, John. “An Interesting Chart About Berkshire Hathaway $BRK-A, $BRK-B.” The Motley Fool, 1 Jan. 1970, www.fool.com/investing/2017/07/23/an-interesting-chart-about-berkshire-hathaway.aspx. Accessed 19 Sept. 2017.

[xiv] Prahalad, C. K., and G. Hamel. “The Core Competence of the Corporation.” Harvard Business Review, 2003, pp. 1–16., Accessed 1 Aug. 2017.

[xv] Anand, Bharat N., and Samhita A.P. Jayanti. “Berkshire Hathaway.” Harvard Business School, 2009, pp. 1–29., Accessed 1 Aug. 2017.

[xvi] Ghemawat Sustainable Advantage

[xvii] Parada, Pedro. “Who said that leading change is easy?” Harvard Deusto Business Review, pp. 49–66., Accessed 1 Aug. 2017.

[xviii] Anand, Bharat N., and Samhita A.P. Jayanti. “Berkshire Hathaway.” Harvard Business School, 2009, pp. 1–29., Accessed 1 Aug. 2017.

[xix] Prahalad, C. K., and G. Hamel. “The Core Competence of the Corporation.” Harvard Business Review, 2003, pp. 1–16., Accessed 1 Aug. 2017.

[xx] Lynch, Shana. “What Is It Like to Be Owned by Warren Buffett?” Stanford Graduate School of Business, 25 Oct. 2015, www.gsb.stanford.edu/insights/what-it-be-owned-warren-buffett. Accessed 19 Sept. 2017.

[xxi] Anand, Bharat N., and Samhita A.P. Jayanti. “Berkshire Hathaway.” Harvard Business School, 2009, pp. 1–29., Accessed 1 Aug. 2017.

[xxii] Anand, Bharat N., and Samhita A.P. Jayanti. “Berkshire Hathaway.” Harvard Business School, 2009, pp. 1–29., Accessed 1 Aug. 2017.

[xxiii] Denis, Lara, and Eric Wilson. “Kant and Hume on Morality.” Stanford Encyclopedia of Philosophy, Stanford University, 26 Mar. 2008, plato.stanford.edu/entries/kant-hume-morality/. Accessed 25 Sept. 2017.

[xxiv] Anand, Bharat N., and Samhita A.P. Jayanti. “Berkshire Hathaway.” Harvard Business School, 2009, pp. 1–29., Accessed 1 Aug. 2017.

[xxv] Anand, Bharat N., and Samhita A.P. Jayanti. “Berkshire Hathaway.” Harvard Business School, 2009, pp. 1–29., Accessed 1 Aug. 2017. and “Berkshire Hathaway Recent Public Filings.” EDGAR Search Results, www.sec.gov/cgi-bin/browse-edgar?CIK=0001067983&action=getcompany. Accessed 19 Sept. 2017.

[xxvi] Anand, Bharat N., and Samhita A.P. Jayanti. “Berkshire Hathaway.” Harvard Business School, 2009, pp. 1–29., Accessed 1 Aug. 2017.