He says it is hard to know what is right for the world and even if we did, should CEOs spend shareholders’ money on stakeholder concerns? These thought-provoking statements may not hold up under deeper scrutiny.
Warren Buffett is a fan of eating at McDonald’s, paying higher taxes, and living frugally. He commands respect for building Berkshire Hathaway into one of the world’s largest and most powerful investment firms. But one thing he adamantly dislikes: stakeholder capitalism.
To invest in Berkshire, you really have to love the company and the investment philosophies of Buffett, the standard-bearer for decades. This is especially true because Berkshire has trailed the S&P 500 over the last decade. Berkshire is the sixth largest company in the United States by market capitalization, and the company is a significant shareholder in major U.S. brands, including American Express, Bank of America, General Motors, Apple, and Coca Cola. Berkshire’s size and Buffett’s influence brings significant responsibility as we tend to listen when Buffett speaks.
But during Buffett’s decades as CEO, Berkshire Hathaway has consistently opposed diversity and climate disclosure proposals pushed by ESG investors and NGOs. Buffett has also consistently resisted standardizing and mandating ESG reporting. Because Buffett’s new shareholder letter just got published, I thought this might be an opportune moment to understand the basis of Buffett’s reluctance about stakeholder capitalism and ESG reporting.
What is right for the world?
Buffett states:
it is hard to know what was right for the world (“I like to eat candy. Is candy good for me? I don’t know”); and
even if he knew what was right for the world, it would be wrong to invest on that basis because CEOs were just agents of the company’s shareholders (“many corporate managers deplore governmental allocation of the taxpayer’s dollar, but embrace enthusiastically their own allocation of the shareholder’s dollar”).
It’s easy to embrace these statements. But these somewhat simplistic comparisons disregard major issues, in my mind, relating to three points: (i) companies tend to assign a zero cost to natural capital they use, absent regulation; (ii) companies may not be required to internalize the cost of externalities that knowingly or inadvertently impose on society; and (iii) what is the time horizon of the decision and indirectly that of the investor?
Most reasonable folks would agree that climate is a concern and the right thing for the world is to come up with a transition plan to move out of fossil fuels. If you agree that greater emissions are not right for the world, whose responsibility is it to deal with that externality? Perhaps it is the federal government via the U.S. Environmental Protection Agency (EPA). We know that the EPA’s penalties are miniscule relative to the social cost imposed by pollution. The state of our politics is such that a carbon tax, the theoretically right response, might never pass in Congress. So, what should a company that emits significant carbon do in the meanwhile? Nothing?
Buffett should arguably be more worried about climate change because he owns his private company investments. One has to wonder, given his age, whether his horizon problem (or the limited number of years he will stay CEO of Berkshire) affects his views. Maybe he wants to avoid costs (investments) that will pay off after he is out of office.
Let us not forget that a big part of Berkshire’s business is property and casualty (P&C) insurance. I have often wondered why P&C insurance companies are not more actively advocating for pro climate policies. On reflection, the answer is pretty obvious. P&C insurance companies, include Berkshire, write annual insurance contracts unlike life insurance that gets written for 15-30 years. With life insurance, actuaries are forced to worry about the long-term. P&C insurance socializes last year’s losses on account of climate change via increased premiums this year. If you work on a “cost plus” annual pricing model, you are less likely to worry about bigger losses coming down the pike.
I realize that Berkshire’s strategy is to hold small-focused portfolios and hence is not similar to the “universal owner” BlackRock or Vanguard’s highly-diversified, long-term portfolios that are sufficiently representative of global capital markets making their investment returns dependent on the continuing good health of the overall economy including the impact of climate change.
Remember this also comes at a time when the Supreme Court is reviewing the limits of the authority of the EPA and that the right end of the political spectrum wants government to have as small a role as possible. Of course, they do not want companies to do much either and are already gearing up to pushback on an upcoming ruling from the SEC on climate disclosure. So, either they do not believe climate change is a real problem, or it is someone else’s problem, or they hope for some miracle technologies to come along and bail us out.
Let us think some more about the externality issue outside of climate change. Selling sugary candy is a profitable business. Consume too much of it and you will get diabetes. The health care costs associated with excess consumption of sugar will be borne by taxpayers may be a decade from now. Moreover, it is virtually impossible to trace those health care costs to the consumption of candy and to the company that makes the candy. So, what should anyone do about this problem? Build an estimate of those health care costs into the price of candy via a “tax” like that on tobacco?
Aren’t CEOs simply agents of shareholders?
What about the objection that a CEO spends shareholder money on social problems? Who is this mythical shareholder we keep talking about for a typical S&P 500 company? On paper, the top three shareholders are BlackRock, State Street and Vanguard. But these are the top asset managers who are custodians of 401(k) money of the real shareholders. Who knows what these real shareholders want? Will they trade off expected returns to address the company’s externalities voluntarily?
Impasse
Of course, all this leads to the next objection Buffett raises. Even if Congress does impose a carbon tax and a sugar tax, do we trust governments to use the funds in a socially appropriate manner? The track record of the U.S. government’s spending patterns does not exactly fill us with confidence.
So, we are back to the impasse. It is strictly not the company’s comparative advantage to know what is right for the world and spending shareholder money on fixing externalities is not within the CEO’s remit, absent regulation. On top of that, we do not trust central planners to use the regulated new tax money we give them to fix these externalities. So, what is the end game here?
Perhaps, green technology will evolve to take us to climate nirvana. Or consumers, may be in the next generation, will become nutrition-friendly and stop buying product from sugar vendors. Maybe incentives (carrots), as opposed to sticks (regulation), will take us to a better place.
Now that we have the big issue associated with stakeholder capitalism out of the way, Buffett’s latest letter does contain a few interesting nuggets on stakeholder capitalism.
The “what have you done for me” report
I was struck by the great pains that Buffett went through to articulate what Berkshire has done for society. Consider the following statements in Buffett’s 2021 letter:
“Every year, your company makes substantial federal income tax payments. “I gave at the office” is an unassailable assertion when made by Berkshire shareholders.”
“Berkshire’s history vividly illustrates the invisible and often unrecognized financial partnership between government and American businesses.”
If Buffett feels obligated to spend some time in his letter detailing what Berkshire has done for society, I am inclined to argue that businesses will very soon be asked to explain how shareholder value was created (the income statement) and what the company has done, to borrow from the World Economic Forum document, for the planet (say emissions), its own people (developing human capital) and for prosperity (wealth creation, innovation, community and social vitality).
I tried sketching such a statement detailing externalities, positive and negative, that Coca Cola imposes on society. Finding data from a sustainability report, as of now, to create such a stakeholder value statement is very challenging. Buffett’s own companies barely share any of this data beyond the statements reproduced here from his annual letter.
Taxes represent the sole social responsibility of business
One of the more striking statements in Buffett’s letter is his implicit thinking that taxes represent the primary social responsibility of business (“Berkshire pays roughly $9 million daily to the Treasury.”)
On the surface, this is perfectly fine. But evidence suggests that socially responsible companies actually seem to have lower effective tax rates. In my executive education programs for boards of directors at Columbia, I usually ask our participants the following question:
“A Big 4 accounting firm has just pitched an aggressive but mostly legal tax planning scheme that will reduce the company’s effective tax rate from 20% at present to 15% of income. The plan involves channeling overseas revenue through an Irish subsidiary purely for tax planning purposes and will save billions in taxes. Would you vote for the proposal?”
Year after year, roughly half of our participants vote for this proposal. This is after several references to stakeholder capitalism from our expert panel. I also ask executives if they would invest in societal good if given the option.
“You are on the board of a large technology company on the West Coast. The presence and growth of your company has driven up the cost of housing in the county. Housing is no longer affordable for residents who do not work for tech companies in the region including teachers, municipal administration and public services, nurses, hospital staff, etc. The CEO proposes that the company make a $750 million regional community grant for affordable housing to be followed by grants in future years. How would you vote on the proposal?” Just over half of participants (54%) vote yes.
That is, directors of companies and senior leaders often think they have to legally minimize their tax bill. They often do not see any conflict between their stated commitment to stakeholder capitalism and minimizing their tax bill. Buffett’s statements about taxes constituting the sole responsibility of business do not seem to address this tension either.
Consider the following statement:
“In fairness to our governmental partner, our shareholders should acknowledge – indeed trumpet – the fact that Berkshire’s prosperity has been fostered mightily because the company has operated in America. When you see the flag, say thanks.”
This quote perhaps raises the obvious question of who is responsible for keeping America such a great place. Berkshire’s 2021 effective tax rate is 19%, which is pretty close to the federal rate of 21%. However, corporate income taxes as a share of total U.S.’s revenues have fallen to a mere 9% in 2021 relative to 15% in 1974, the earliest year for which I could find U.S. annual reports.
Management in the private sector can work miracles
One of Buffett’s statements that really resonated with me was the value that energetic management can resolve seemingly formidable problems:
“Early in 1965, things changed. Berkshire installed new management that redeployed available cash and steered essentially all earnings into a variety of good businesses, most of which remained good through the years. Coupling reinvestment of earnings with the power of compounding worked its magic, and shareholders prospered.”
I am not sure we can say the same for the quality of management in government. Perhaps, the stakeholder movement, naively, hopes that high quality private sector management can bring the same energy to solving social problems. The hard question, of course, is to make private company managements’ incentives align well with addressing stakeholder’s problems.
If you want to have real social impact, own and control the company
It is quite revealing to note that Buffett says almost nothing about the societal contribution of his relatively passive holdings in companies such as American Express and Coco Cola. One reason could be that Berkshire himself a passive investor in publicly traded firms and does not interfere with management.
Instead, he devotes extensive energy in the letter to Berkshire Hathaway Energy’s (BHE) environmental record. Berkshire owns 91% of BHE.
“BHE has been faithfully detailing its plans and performance in renewables and transmissions every year since 2007. To further review this information, visit BHE’s website at brkenergy.com. There, you will see that the company has long been making climate-conscious moves that soak up all of its earnings. More opportunities lie ahead. BHE has the management, the experience, the capital and the appetite for the huge power projects that our country needs.
BHE’s record of societal accomplishment is as remarkable as its financial performance. The company had no wind or solar generation in 2000. It was then regarded simply as a relatively new and minor participant in the huge electric utility industry. Subsequently, under David Sokol’s and Greg Abel’s leadership, BHE has become a utility powerhouse (no groaning, please) and a leading force in wind, solar and transmission throughout much of the United States. Greg’s report on these accomplishments appears on pages A-3 and A-4. The profile you will find there is not in any way one of those currently-fashionable “green-washing” stories.”
The takeaway for me is that it is very hard for outside minority investors to get companies to become stakeholder friendly. Venture capitalists or private equity firms or private companies that own and control the firm are perhaps the only owners who can direct management to have social impact.
The path not taken angle to ESG reporting
I was struck by the following statement that Buffett makes:
“BNSF, our third Giant, continues to be the number one artery of American commerce, which makes it an indispensable asset for America as well as for Berkshire. If the many essential products BNSF carries were instead hauled by truck, America’s carbon emissions would soar. BNSF trains traveled 143 million miles last year and carried 535 million tons of cargo. Both accomplishments far exceed those of any other American carrier. You can be proud of your railroad.”
My friend, Bob Eccles, has castigated BNSF for transporting tons of coal across the country. Buffett cleverly changes the frame of reference to talk about the emissions avoided by trucks that would have otherwise carried goods that BNSF transports. This is ingenious but also somewhat disingenuous. Most reporting focuses on what was done (“historical”) as opposed to the path not taken (“the opportunity cost or benefit”). This is a bit like saying, “if they had not smoked cigarettes, they would have consumed hard drugs.”
Stock repurchases are not evil
And to close on a more positive note, Buffett reiterates that stock buybacks can be useful to the company and to society, if the firm has excess cash.
“Repurchases are modestly beneficial to the seller of the repurchased shares and to society as well.”
In 2018, overall U.S. buybacks topped $1 trillion for the first time ever. The trend had been increasing for years. Goldman Sachs found that from 2010 to 2019, corporations have put more money into their own stocks, $3.8 trillion, than every other type of investment combined. Boards have incentivized executive teams to focus on shareholder price by granting stock and stock options to senior leaders. Politicians have openly fretted about the destructive impact of stock buybacks. Yes, buybacks can come at a heavy cost to investment in productive areas but sitting on cash is not a good idea either. Buffett’s statement is timely reminder that good “G” in ESG requires shareholders to figure out when management is better off returning capital to investors rather than frittering it away on unworthy investments or acquisitions.
Bottom line
My friends that believe in traditional shareholder capitalism might find this piece bewildering. For instance, they will point that somebody has got to move the coal if its mined, and better freight cars than trucks for the reason Buffett cites. They also suggest that Buffett has been practicing ESG all his life in the sense that all good businessmen do. That is, taking care of stakeholders is good for shareholder value too or what Michael Jensen calls, “enlightened value maximization.” I have used this argument myself in my earlier work.
But my latest thinking on the topic is as follows: there is no argument or dispute as long as the interests of the shareholders and stakeholders align, as posited by Jensen. The question is what happens beyond that point when shareholder and stakeholder interests do not converge. That’s where the action is. Buffett seems to think this non-convergence area where shareholders’ and stakeholders’ interests do not align is not Berkshire’s problem.
In sum, I think Buffett’s objections are valid and thought provoking, but I am not sure they stand up to deeper scrutiny.
