Buffett Wants Options for Berkshire's Next CEO

U.S. stocks kept rising on Tuesday, as the benchmark S&P 500 gained 0.5% to put within seven-tenths of a percent of its early April record high. The narrower Dow Jones Industrial Average (DJINDICES: ^DJI  ) also rose 0.5%, while the technology-heavy Nasdaq Composite Index (NASDAQINDEX: ^IXIC  ) was up 0.7%.

This week, one event trumps all others for value investors, and it isn't the Federal Reserve's policy meeting, which concludes tomorrow. It's a meeting of a different kind: Berkshire Hathaway's (NYSE: BRK-B  ) annual shareholder meeting, which takes place in Omaha, Nebraska, this coming Saturday.

In the run-up to the meeting, there is heavy media coverage of Warren Buffett and Berkshire (you have to be selective with the coverage, however -- Berkshire and Buffett are highly misunderstood), and one piece that caught my eye today was a short interview in Fortune, in which Buffett discusses tax rates and executive compensation.

Warren Buffett. Source: Work of Mark Hirschey.

Last week, I strongly criticized Buffett's decision to abstain from voting on Coca-Cola's (NYSE: KO  ) executive compensation plan rather than voting against it, despite his belief that the plan is "excessive." In the Fortune interview, Buffett defends that decision, arguing that abstaining is already a "very loud voice coming from Berkshire." He continued: "It obviously means we don't approve of the plan."

I don't disagree with that statement, but it doesn't alter the fact that Buffett had an opportunity to use his influence to prod Coca-Cola into (possibly) revising the plan, had he taken a stronger stand by voting against it and making his opposition known to other large shareholders beforehand. For a champion of proper corporate governance, Buffett's decision remains befuddling and, frankly, disappointing.

Another interesting tidbit that emerges in the discussion is that Buffett has suggested to Berkshire's board of directors that his successor should receive Berkshire Hathaway stock options:

I actually have written -- I may put it in the annual report next year -- a memo to the board of directors of Berkshire as to what I think would be a sensible option plan for the CEO of Berkshire who succeeds me. And he would be -- in this case it would be a he at the present time -- the only one who would receive options, because he would be the only one who is responsible for the overall success of the operation.

That would be a first, as far as I know, Berkshire Hathaway has never awarded stock options to any employee, corporate officer, or board member, including Buffett and Vice Chairman Charlie Munger. As such, I thought this might represent a recent evolution in Buffett's thinking; however, it turns out that Buffett had hinted at this at least as far back as his 2004 letter to Berkshire sharholders (link opens a PDF file):

[M]y successor at Berkshire may well receive much of his pay via options, albeit logically structured ones in respect to (1) an appropriate strike price, (2) an escalation in price that reflects the retention of earnings, and (3) a ban on his quickly disposing of any shares purchased through options. We cheer arrangements that motivate managers, whether these be cash bonuses or options.

It will be interesting to see the terms of such a package, when the time comes. With any luck -- and a dose of the investor-friendly corporate culture Buffett has created -- Berkshire's management and board will never give shareholders cause to vote against its new compensation plan.

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