Is Warren Buffett's Stock Option Reversal Hypocritical?

Source: thetaxhaven.

Warren Buffett startled the investment community when he said the next Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) CEO should be the only one to get stock options.

This seems like a complete reversal from a younger Buffett. Younger Buffett had complete disdain for stock options. In 1965, he refused to give his newly hired Berkshire Hathaway president any options at all, citing fairness for public shareholders.

Instead, Buffett put his own money on the line, cosigning an $18,000 loan for the new company president to buy stock on the option market. That principle is something you'd find at very few public companies today, many of which grant options to seemingly everyone on the payroll.

Is Buffett a hypocrite?
Buffett's stance against options can be found in many of his writings and comments at Berkshire Hathaway meetings.

Without historical perspective, however, many get the wrong impression. Buffett's words were mostly on option excess and improper accounting, not options at all. In fact, in 1999, he said the following:

That doesn't mean that we're against options. They could make sense here at some point, but not with Charlie and me.

Charlie Munger's comments at a 2002 annual shareholders meeting helped clarify Berkshire Hathaway's position on options:

If you look at the impact of stock options, you'll see a lot of terrible behavior. To give a lot of options to a CEO who built the business and is in his 60s to incent loyalty is demented. Would the doctors at the Mayo Clinic or the lawyers at Cravath in their 60s work harder if they had options?

Clearly, it's a matter of incentives. Options for Buffett and Munger make little sense. You couldn't pay them to leave, let alone stay. But for Buffett and Mungers' successor, who will likely have many working years ahead of him, options may make sense.

Aligning the company's varied interests
Buffett's stance isn't hypocritical. If anything, it serves to provide a lesson in managing a company's culture appropriately for employees and shareholders.

Berkshire Hathaway has long rewarded its executives and workers with incentives to work in the best interests of the business. At GEICO, the company rewards managers based on growth and profitability of policies in force for at least one year. At Clayton Homes, it splits profits 50-50 with managers, to align underwriting interests among owners and workers. And at National Indemnity, Berkshire goes so far to never fire employees during slow business cycles, fearing they will write bad insurance policies just to keep their jobs.

GEICO, National Indemnity, and Clayton Homes are just cogs in the Berkshire Hathaway wheel. Their employees shouldn't be rewarded in Berkshire Hathaway stock, which will rise or fall based on the whole business, not just the performance of one unit.

For the CEO, however, the stakes are higher. The next Berkshire CEO will make the bulk of the investment decisions for Berkshire Hathaway, and thus it makes sense he would be rewarded with options on the whole company based on performance.

Berkshire Hathaway shareholders should remember that Buffett has held 350,000 Class A shares in the company for decades. His interests have been aligned with investors since day one. The next CEO won't have such a substantial interest in Berkshire. Options help bridge that gap. 

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