Executive Compensation

From the Berkshire Hathaway 1991 Annual Letter to Shareholders:

"A distinguishing characteristic of H.H. Brown is one of the most unusual compensation systems I've encountered - but one that warms my heart: A number of key managers are paid an annual salary of $7,800, to which is added a designated percentage of the profits of the company after these are reduced by a charge for capital employed. These managers therefore truly stand in the shoes of owners. In contrast, most managers talk the talk but don't walk the walk, choosing instead to employ compensation systems that are long on carrots but short on sticks (and that almost invariably treat equity capital as if it were cost-free)."

That's the first executive compensation plan I've ever seen that actually makes sense to me. You want good executives to be paid very well, because there's a limited number of good executives out there, and transitioning in new people is expensive. Therefore, you want every good executive's salary to exceed the salary they could get anywhere else. Limiting executive compensation makes no sense.

However, this also leads to inflated salaries for people who aren't great managers, but can give the appearance of being good managers, or for people who are friends with the board of directors, or whatever else. Variations on this system can reward great managers well if you make the baseline just high enough to live on (greater than $7,800, admittedly, but not excessive), percentages paid appropriate and ensure some of it is in the form of equity. The system doesn't reward poor managers, and gives them only enough salary to do a better job next year.

This can be transitioned to lower level managers by treating their division or their shift as its own entity, and providing salary proportional to profits minus capital that they were responsible for, plus a cost-of-living bare minimum. The only problem is convincing managers to take this system and not the golden parachute-laden guaranteed windfalls of other corporations. But if the percentages are good enough, a good manager with confidence may actually take it.

I'm a fan!