This week I was casting for the big one in one of the volcanic lakes on top of Mount Kenya. Mount Kenya is on the eastern border of the Rift Valley (Kenya, Africa). My companion and I were discussing the finer things in life, e.g. MrB's latest news mail ;-)

We were chatting away about the managements of various companies and the following story came up:

You might have heard this story somewhere before or a different version of it. It originates from a ranch not too far from mine, situated on the northern tip of Eagle Mountain Lake (Texas, USA). Trust me on this - you know there is no spinning of fictitious yarns in these news mails.

A good friend of mine, Billy, had two sons but decided that only one of them could inherit his horse breeding business. He was forever busy putting his sons in head-to-head competition with each other to determine which one was better. Although you might disagree with this approach, it was Billy's way of doing things. Actually, most of the time there was a method in his madness. Both sons followed in their father's footsteps and were keen horse breeders. Eventually Billy passed away. However, according to their father's wish, only one of the brothers could inherit the business. Billy had decided, as expressed in his Will, that his sons would have to race for it. However, he determined that the son's horse that lost the race would inherit the business. This type of thinking shows Billy's brain in top form. Not surprisingly, it proved to be a bit of a problem. It was impossible to get the two sons to move from the start position, let alone have a go at reaching the finish line. So after much frustration they came to see me. I pointed them in the direction of Wyatt, an acquaintance who had retired to a small ranch nestled between Grapevine Lake and North Lake. Wyatt has had a colourful life but, more importantly, I consider him the wisest man in the vicinity of Eagle Mountain Lake. In this particular case, once again, he did not disappoint me. He simply said that the two sons must swap horses. The solution, as is the case with many things in life, was simple but not easy.

What is important to our discussion on Mount Kenya, and to our discussion of managements in general, is that this story serves as a simple but powerful example of how critical incentives are in life. This also holds true for investment. If, like me, you are a long-term investor then it is critical to ensure that management has an incentive to create value over the long-term. It is also important to ensure that both the upside and downside is spread equally between investors and management. Making management shareholders is the best way to incentivize the right kind of management behaviour. However, despite what many a CEO in the Western world says, share options are not the best way of achieving this. Firstly, management risks very little. If there is money on the table (in the money options) management will take it, but if there is nothing (out of the money options) they can easily jump ship. Better yet (for them!), they can simply re-price their options (and do so, frequently). If you compare the above to the fate of the long-term shareholder then you see the problem - the risk (i.e. possible downside) is not being equally shared between management and shareholders. Wouldn't it be nice if, as an investor, I could simply re-price my shares? That is why I always search for and invest in companies where management already hold a significant stake in the business. Take Prem Watsa (CEO of Fairfax Financial Holdings, Canada) and Warren Buffett (CEO of Berkshire Hathaway) as examples. They have more than 90% and 99%, respectively, of their personal net worth invested in their companies. Both of them receive very modest salaries compared to the industry norm and receive no other remuneration from their companies. Such an arrangement makes me extremely comfortable. We truly sail in the same boat.

Speaking of Berkshire Hathaway, it must be the finest collection of wholly-owned and partly-owned businesses under one roof. Be warned that I am a Berkshire Hathaway shareholder and, naturally, I'm therefore biased. Berkshire is arguably the best place to look and see which traits outstanding CEO's and managements have in common. In Berkshire Hathaway's annual report of 2000, Warren Buffett writes about what Berkshire looks for in the seller when acquiring a business. This can also be applied to managements and CEO's in general.

'We find it meaningful when an owner cares about whom he sells to. We like to do business with someone who loves his company, not just the money that a sale will bring him (though we certainly understand why he likes that as well). When this emotional attachment exists, it signals that important qualities will likely be found within the business: honest accounting, pride of product, respect for customers, and a loyal group of associates having a strong sense of direction. The reverse is apt to be true, also.'

Love and passion for a business are a potent mix. The single trait I fear most in any competitor is passion. I will take on clever, well-capitalised, hard working competitors any day because I can easily partner with someone possessing any resources I lack. Passion is a very scarce resource, however. Usually I will either partner with it or avoid it. Rarely will I try and compete with it.

A CEO must be an independent thinker and a responsible person by nature. I am not a big believer in shareholder activism because I vote with my money (and my feet, if necessary). If I have to start telling management what to do, the company in question is definitely not an investment proposition. Trust me, when my advice starts counting for anything the company is already beyond the point of no return! As a shareholder my job is to provide the capital. Management's job is to run the company. If I knew more about running the company than management I would do it myself. Warren Buffett says that his idea of a group decision is to look in the mirror, and that is the type of thinking I want from my CEO. I want him/her to think independently and to act on his or her own convictions. I certainly don't want my CEO or management to take their lead from their peers. As my friends up in Alaska love to say, 'Unless you are the lead dog, the scenery never changes.'

Robert Miles' book, The Warren Buffett CEO, compared a large number of

Berkshire Hathaway CEO's and found the following:

They love their work and work autonomously. They have a long-term orientation, strong values and are humble. 'Each believes in doing first-class business in a first-class way'. Most are sceptical of Wall Street, sleep with few worries and took years in building their businesses. Their management style is 'hands-on, friendly, flexible and practical'.

Most work from small but functional offices and 'many CEO's answer their own phone if their secretaries are away from their desks.' 'Leaders are readers. Most list reading as the activity that consumes the largest percentage of their typical day'. All are self-motivated and have boundless energy.

It seems to me that they will all retire the day they stop having fun at work, rather than the day they reach some arbitrary 'retirement age'. It is worth noting that Berkshire has no management contracts and that not one CEO has left to compete with the business. Lastly, Roger Miles found that they are excellent communicators and intensely competitive. 'All want to win - and win big!'

Management is an art not a science and Anna Pavlova, the Russian ballet dancer, told us that 'As is the case in all branches of art, success depends in a very large measure upon individual initiative and exertion, and cannot be achieved except by dint of hard work.'

I am no artist, but I love good art. I therefore buy pieces of art (businesses) by the best artists (CEO's and managements). In business, as opposed to art, the artist (CEO) will usually spend almost his whole life producing a single artwork. The advantage in business is that, as a shareholder, I can own a small piece of that creation. Sometimes I choose to invest with other collectors (e.g. Warren Buffett) because, as the man himself said: 'If you don't know jewellery, know your jeweller'

Whatever you are up to, I hope it is profitable and ethical!

Mr. B

mail_mrb@yahoo.com

Posted: 2002/11/08 15:43 View Archive