Intelligent Investor Club

Corporate Governance

There are three fundamentally different manager/owner situations that exist in public companies.

The first and most common board situation is where there is no controlling shareholder. Directors should evaluate management’s performance in the long term interest of a “single absentee owner”.

The directors are responsible for changing the management if their performance is poor. A single director would be unable to make such changes on his own. He will need to persuade the other directors to his views.

For this first type of board situation, Warren Buffett believes the number of directors should be little (ten or less) and come mostly from the outside. They should be business savvy, owner-oriented and have interest in the job.

The second board situation is where the controlling owner is also the manager (This situation occurs at Berkshire). In this situation, directors do not act as an agent between owners and management.

There is nothing much a director can do (except object) if the owner/manager is under-performing. If there is no change, the next best thing a director can do is to resign. This will send a signal to outsiders on their doubts about management.

The third situation occurs when there is a controlling owner who is not involved in management (This will be the case at Berkshire after Warren Buffett has passes away).

In this situation, if the directors are unhappy with the competence or intergrity of the management, they can approach the controlling shareholder (who might also be on the board). If the controlling shareholder is intelligent, he can make decisions that are pro-shareholder and fair.

This third scenario is the most effective to ensure first-class management. In the first case, directors often find it difficult to affect change while in the second, a lousy owner is not going to fire himself.

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