I think I've been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.
-- Charlie Munger
The right incentives can make all the difference in the world when it comes to the long-term well-being of companies and their shareholders. When you have a smart management team working under the right incentives, chances are decisions will be made with a strategic mentality, prioritizing the company's future as opposed to short-term profit maximization and executive compensation.
Tap-dancing to work
Warren Buffett is one of the richest men on earth, but that's not because he makes a lot of money as chairman, CEO and chief investment officer at Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B).
On the contrary, Buffett's salary has remained unchanged for 25 years; the Oracle of Omaha makes a relatively modest salary of $100,000 per year in spite of his unquestionable talent and the enormous amounts of money he has made for Berkshire shareholders over the decades.
Buffett's total compensation declined 14% to $423,923 in 2012 as Berkshire Hathaway spent less money on his personal security, and he even reimbursed the company $50,000 for other personal costs. Buffett has been quite vocal in his critiques against excessive CEO pay, and it's good to know that he is putting his money where his mouth is.
Buffett has most of his net worth invested in Berkshire Hathaway, aligning the interests of shareholders with his own interests in an indisputable way. He gets richer when Berkshire investors get richer, and he is playing this game for the long term.
Buffett would never take unreasonable risks in the search for easy short-term profits like many greedy and ill-incentivized CEOs in the financial sector did during the credit bubble.
When buying a share of Berkshire, you get one of the most successful investors in history to manage your capital, and he does it with the same care and talent as he manages his own money.
Jeff Bezos is an extraordinary CEO, not only due to his vision and leadership, but also because he has his economic interests well aligned with those of Amazon (NASDAQ:AMZN) shareholders. Bezos received $81,840 in salary during 2012, which makes him one of the lowest-paid CEOs among leaders of large technology companies.
Still, Bezos is one of the richest executives in the world since he owns nearly 87 million Amazon shares, a stake of about 19% in the company. Bezos strives to keep the rest of his management team well incentivized by having their compensation closely tied to building shareholder value.
This is especially important in Amazon's case because the online retail giant is choosing future growth above current profitability. Amazon keeps product prices as low as possible to gain market share versus the competition, and the company is heavily investing in areas like warehouses, digital content and cloud computing to build a sound foundation for growth over the coming years. This has produced sustained revenue growth, but profit margins and earnings are under intense pressure.
Bezos is asking shareholders to forget about profitability now in exchange for extraordinary growth prospects over years to come, and is backing that vision with his own money.
John Mackey co-founded Whole Foods Market (NASDAQ:WFM) in 1978, and he has led the company from a single store in Texas back then to more than 355 stores and growing as of the end of the last quarter. This has been very beneficial for Mackey financially, but money is far from the only thing on his mind.
Mackey is a major proponent of "conscious capitalism," a way of thinking about capitalism and the role of businesses in the economy that is more conscious of its higher purpose and the relationships it has with its various constituencies and stakeholders. Since 2007, Mackey makes only $1 annually in salary, and he wrote in a letter to Whole Foods employees explaining this decision:
The tremendous success of Whole Foods Market has provided me with far more money than I ever dreamed I'd have and far more than is necessary for either my financial security or personal happiness. ... I am now 53 years old and I have reached a place in my life where I no longer want to work for money, but simply for the joy of the work itself and to better answer the call to service that I feel so clearly in my own heart.
Whole Foods caps executive compensation at 19 times the average employee's salary, and the company has a smart incentive program allowing employees to financially benefit from improved productivity in their stores.
A happy CEO and happy employees mean happy shareholders at Whole Foods; the company has compounded earnings-per-share growth at 14.5% annually over the last five years, and the stock is trading near historical highs in the area of $65 per share due to strong financial performance and avid demand for fresh and healthy food served with a purpose.
Incentives are crucially important to keep management focused on those things that are really beneficial for the company and its shareholders in the long term. When investing in businesses like Berkshire, Amazon, and Whole Foods, it's good to know that these talented CEOs are in the same boat with the average investor.