Why Warren Buffett Should Step Down As CEO Of Berkshire Hathaway

Investors are increasingly worried about Warren Buffett’s succession and the sustainability of Berkshire Hathaway. Some concerns were expressed this weekend in the annual gathering of 38,000 shareholders in Omaha, the self-styled ‘Woodstock For Capitalists’.

They are well-founded, as the investment company’s stock price trades at a premium of 40% to net assets, in a world where diversified businesses typically attract a discount. Many of these investors have enjoyed fantastic returns, over not just years but decades. An investor who bought one Berkshire Hathaway share at just over $11 when Warren Buffett took control of the firm 50 years ago, and kept it, would have seen its value hit an all-time peak above $190,000 in recent days, an annual return of 20%.

The 83-year old Buffett, who was successfully treated for prostate cancer, says that he has a plan for his succession. He has said his job will be divided into three once he is gone – a CEO, a non-executive chairman and investment managers. In 2012, he said the board had picked a CEO candidate and two backup candidates, but didn't disclose their names.

The main CEO candidates are thought to be:

1) Ajit Jain, Berkshire Reinsurance

2) Greg Abel, Midamerican Energy CEO

3) Matthew Rose, Burlington Northern Santa Fe CEO

Buffett has confirmed that the contenders are currently all male, and that an insider will take the role. He has also hired two investment managers, Ted Weschler and Todd Combs, who will eventually oversee Berkshire's $107 billion stock portfolio.

In naming his son Howard “Howie” Buffett as the future non-executive chairman, Warren Buffett has said that this is mainly to guard what he sees as the firm’s core values and culture.

Being chairman of Berkshire won't be “rocket science”, Howard Buffett told The Wall Street Journal: “I understand exactly what my dad wants me to do conceptually, and I can certainly do it.” That includes making sure top executives don't misuse their power, he says, while simultaneously staying ‘out of the CEO's way.’”

Warren Buffett traditionally has a record of making the right big calls. But as he nears the end of his career, should investors be concerned? And will his succession plan work?

What Needs To Be Continued At Berkshire Hathaway?

A leader in last week’s Economist went as far as to suggest that, because there is so much shareholder value wrapped up in Warren Buffett, the so-called “Oracle Of Omaha” personally, that when he steps down Berkshire Hathaway should be broken up and sold off. If this outcome is to be avoided, I believe that there are three main things which need to be preserved:

(1) The Core Investment Philosophy & Business Model

With an investment model of buying operating assets with an insurance wrapper, Buffett has been able to use the “float” from Berkshire Hathaway’s insurance operations to fund his investments. The secret to his success has been to buy up companies and stocks that are selling for less than they are worth. Initially focusing on buying publicly quoted stocks and keeping the shares long-term, he has typically retained stakes in firms for at least 10 years. He kept faith with high-profile deals, such as with the Chinese battery and electric vehicle company BYD, which collapsed after the deal but then subsequently recovered.

Buffett set out some investment advice of what “to do or not to do” in his most recent annual letter to shareholders. This gives a sense of his underpinning investment philosophy and principles. They are beautifully straightforward and timeless, but require strong discipline to uphold in practice:

• You don't need to be an expert in order to achieve satisfactory investment returns.
• Focus on the future productivity of the asset you are considering. If you instead focus on the prospective price change of a contemplated purchase, you are speculating.
• Games are won by players who focus on the playing field - not by those whose eyes are glued to the scoreboard.
• Forming macro opinions or listening to the macro or market predictions of others is a waste of time.

Throughout his decades of investment he has been careful to avoid getting into debt and keep plenty of cash to hand, saying that he sleeps better when he has between $10-$20bn of liquid assets to hand.

The key tenets of Buffett’s value investing philosophy and business model are well-established. Although executing them over time is the challenge. You would hope that the new CEO would be able to maintain them, although evolving the model is likely to be more difficult.

(2) A Fellowship Of Top People To Make The Biggest Investment Decisions

The challenge up ahead for Berkshire Hathaway is not just to replace Chairman & CEO Warren Buffett, it is also to replace the enduring investment partnership of him and the 90-year-old Charlie Munger, who has served as Vice President since 1978. Buffett explains that he and Munger “hunt for elephants”. The elephants are the transformational value-adding deals which Berkshire Hathaway has become famous for. Charlie Munger has often been “the guy who says no”. So Berkshire needs to replace their joint radar, as well as their investment intuition.

Many companies that were successful in the past few decades, such as Infosys and Nokia, had iconic leaders but they also were supported by a trusted fellowship or with BP and Virgin a complementary trusted partnership. However, when the fellowship changed both Infosys and Nokia ran into problems as they were not able to bottle the magic characteristics of the leaders. Both Infosys’s Narayana Murthy and Nokia’s Jorma Ollila subsequently returned to try and reinvigorate the company after a period of difficulties. In Infosys’s case many members of the fellowship who were loyal executors tried unsuccessfully to lead and this is a significant risk for Berkshire Hathaway.

The hope is that Warren Buffett has done enough to bring on new blood. In his annual shareholder’s letter, he explicitly gave credit to some of the CEO contenders, e.g.:

“From a standing start in 1985, Ajit has created an insurance business with float of $37 billion and a large cumulative underwriting profit, a feat no other insurance CEO has come close to matching. Ajit’s mind is an idea factory that is always looking for more lines of business he can add to his current assortment.”

“In a year in which most equity managers found it impossible to outperform the S&P 500, both Todd Combs and Ted Weschler handily did so. Each now runs a portfolio exceeding $7 billion. They’ve earned it. I must again confess that their investments outperformed mine. (Charlie says I should add ‘by a lot.’) If such humiliating comparisons continue, I’ll have no choice but to cease talking about them. Todd and Ted have also created significant value for you in several matters unrelated to their portfolio activities. Their contributions are just beginning: Both men have Berkshire blood in their veins.”

One of Warren Buffett’s endlessly quoted investing mottos is,

Be greedy when others are fearful, be fearful when others are greedy.”

That’s hard to do in practice, and even Buffett acknowledges mistakes. He wrote: “Most of you have never heard of Energy Future Holdings. Consider yourselves lucky; I certainly wish I hadn’t.” Buffett put up $2bn towards aggressive leveraged buyouts of electricity assets, “pursuant to a decision I made without consulting with Charlie. That was a big mistake… we suffered a pre-tax loss of $873 million. Next time I’ll call Charlie.”

At this weekend’s shareholder meeting in Omaha, the 8-hour question and answer session was still very much the Warren & Charlie show. New team members are in place, but they are not yet practiced as the public face of the company. Recent experience shows that anointed successors, such as Apple's Tim Cook, can struggle when faced with the sudden glare of publicity that follows the succession of an iconic leader.

And the real test for any new leadership team will be when it comes up against really difficult situation, when the market is again engulfed by fear. It will be vital that the new team makes decisions effectively and back each other - not afraid to "call Charlie".

(3) Don’t Forget The Human Side And The Culture

One of the reasons we all love Warren Buffett is not just his investment track record, but the fact he is a warm, decent man with integrity – and witty with it.

Buffett’s leadership style is simple – he believes being pleasant to people gets results:

“Be a nice person. It's so simple that it's almost too obvious to notice. Look around at the people you like. Isn't it a logical assumption that if you like traits in other people, then other people would like you if you developed those same traits?”

Buffett has written that integrity sums up the company culture: “It takes a lifetime to build a reputation, and five minutes to lose it.”

“As I’ve said in these memos for more than 25 years: ‘We can afford to lose money – even a lot of money. But we can’t afford to lose reputation – even a shred of reputation.” We must continue to measure every act against not only what is legal but also what we would be happy to have written about on the front page of a national newspaper in an article written by an unfriendly but intelligent reporter.

Sometimes your associates will say “Everybody else is doing it.” This rationale is almost always a bad one if it is the main justification for a business action. It is totally unacceptable when evaluating a moral decision. Whenever somebody offers that phrase as a rationale, in effect they are saying that they can’t come up with a good reason. If anyone gives this explanation, tell them to try using it with a reporter or a judge and see how far it gets them.”

So it would be a failure if the spirit of Berkshire Hathaway was lost and it became a tough, harsh, self-oriented organization like many other investment companies.

In his proposed new role, Howard Buffett will be the guardian of culture and values. However, as a non-executive director. I predict that this will be hard for him, as in my experience, culture is what you need to influence in practice day-to-day.

Can Buffett Bottle The Business Model, Fellowship AND Culture?

In an ideal CEO transition, iconic leaders are somehow able to bottle their “spirit” and blend the essence of their business model and leadership style with the new talent and innovation coming through in the fellowship.

In my experience, replicating the business model is possible, yes, but replicating the fellowship and decision-making process is harder, and replicating the culture is hardest of all.

Beware China’s Warren Buffett

In the future, Berkshire Hathaway will not just be competing with the ghost of Warren Buffett’s glorious past, but with the new companies that have been created in his image. Guo Guangchang has been called “China’s Warren Buffett”, inspired to create Fosun, an investment business that began as a Chinese conglomerate, now expanding to acquire travel firm Club Med and the Chase Manhattan building in New York.

Guangchang says that central is him making big calls over the short to medium term, which he terms the next 10-20 years! Interestingly enough, when I interviewed him for the BBC’s ‘CEO Guru’, he felt that he was central and that the company would suffer if he were to step aside:

“The core capability of an investment company is decision-making. I play a central role in the entire Fosun. If the company can function without me then I am worthless. In the process of decision-making, information and wisdom are not lost but concentrated. It makes us choose wisely. I am important in this process.”

It is perhaps telling that a man who has fashioned a company in Warren Buffett’s image believes that he personally is so central to its continued development. In the next couple of decades, Berkshire Hathaway will be competing will companies like Fosun, so it's important that the fellowship has enough knowledge not just of America, but emerging markets, especially China.

Closing Thoughts For Mr. Buffett

Investors are clearly concerned about succession and whether the Buffett “magic” premium will be lost. Could it be better for investors going forward if Berkshire Hathaway were split up and restructured along more traditional lines?

No. My sense is you have a special company, with a unique structure that should be preserved. However, to continue to deliver outstanding returns, I believe that you need a special solution to your impending succession.

I'm not proposing that you leave the company, but rather that you consider stepping down from the formal CEO role. Good CEOs know when to go.

I think that you have three main options:

(1) If you believe your CEO candidate is ready and you are confident, I would strongly consider stepping down soon from the CEO role, while retaining your position as the non-executive Chairman.

This would be a safer succession for both the CEO and Berkshire Hathaway than your going on and on for say another 10 years. It would allow the CEO to pick up the reins and establish their credibility with investors, while you are on-hand to mentor and guide them as required. Given your hands-off leadership style, there would be little risk of you micro-managing… this would create an environment where you could let go to your successor in a less pressurized situation. It would also give confidence to investors who worry about a disconnect if you left and a potential vacuum which the CEO would struggle to fill.

(2) If you believe you have the right candidate, but that they are not ready, then perhaps it is best to continue in the status quo with you in both roles.

This sensibly allows the successor to develop from within, without the full pressure of being in the limelight. However, the longer this situation continues, the more investors are likely to question this, and you will need a transparent gameplan for handover.

(3) If you are not completely certain about your choice of successor and/or worried about sustaining the culture and values, there could be contrarian option: co-CEO.

I didn’t believe in the co-CEO model, as I struggled to find it working for any company of scale, as it often ended up being a power struggle and created confusion.

However, Whole Foods Market has a co-CEO model and has got it to work well. John Mackey and Walter Robb run the Fortune 500 US food retailer, which has dominated organic food market. It works for them as they have very complementary skills. It is not a compromise of power, but at the core of it is deep care for the company and deep belief in each other, which is the glue that makes them stronger together. On a larger scale still, Korean conglomerate Samsung recently moved to a 3 co-CEOs model.

This could give you the opportunity to blend the ongoing business and family interest. Clearly this would be too risky and dangerous to do this with an external appointment. But going for an internally appointed co-CEO, alongside Howard as a co-CEO rather than a non-executive chairman, could be a innovative solution. One co-CEO could focus on the investment agenda, with the other co-CEO taking responsibility for culture and values and the softer agenda.

Sir, I hope you find this advice helpful and take it in the spirit it is given, from a big supporter of you and your company. I would love to see Berkshire Hathaway repeat the success of the last 50 years again over the 50, and successfully evolve in the right way... well led and powered by the next generation working in fellowship, but retaining your founder’s spirit.

Do this well, and you will indeed realise your dream to create enduring value for your shareholders. In your own words:

"Our favorite holding period is forever."

Image credit: Photo by Nati Harnik / Associated Press

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By Steve Tappin

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Steve is a personal confidant to many of the world’s top CEOs. He is the host of BBC ‘CEO Guru’, which features in-depth, on-the-record interviews with the CEOs of the biggest and fastest-growing companies. Founder Of WorldOfCEOs.com, Steve is the author of ‘The Secrets Of CEOs’, which interviews 200 CEOs on business life and leadership.