Greg Abel’s Bet on Berkshire Hathaway
The company's heir apparent has put to rest concerns regarding his long-term intentions and alignment of incentives with shareholders
Note to Readers: This article started as the lead for the Weekly Digest, but its length makes it more appropriate to send out on a stand-alone basis. The Weekly Digest will be sent out tomorrow morning.
If you enjoy reading this article, which is free for all subscribers, please click the ❤️️ button, which helps boost the article’s distribution, and consider sharing the article with your friends and colleagues or spreading the word on social media.
Thanks for reading!
“Greg will keep the culture.”
— Charlie Munger, Berkshire Hathaway’s 2021 Annual Meeting
On September 29, Berkshire Hathaway Vice Chairman Greg Abel purchased 168 Class A shares of the company for a total of $68.3 million which works out to an average cost per share of $406,730.Even taken in isolation, this is a very significant purchase that is worthy of some analysis. However, it is even more interesting in the context of the backstory behind Mr. Abel’s ownership of Berkshire Hathaway Energy (BHE).
Mr. Abel is in charge of Berkshire Hathaway’s non-insurance operations and was promoted to his current position in January 2018. At the time, Ajit Jain was also named Vice Chairman and was assigned oversight of Berkshire’s insurance operations. Both men were subsequently viewed as the top candidates to take over as CEO when Warren Buffett eventually steps down.
This news set in motion discussions among Berkshire shareholders regarding how Mr. Abel would be compensated as CEO and whether there is sufficient alignment of incentives. I wrote an article on May 9, 2021 which went into detail regarding Mr. Abel’s salary, holdings in Berkshire, and his interest in BHE.
On April 26, 2022, I published How Berkshire Could Deploy $6 Billion: Buffett could buy out the minority interests in Berkshire Hathaway Energy. In the article, I suggested that Berkshire Hathaway could propose buying out the minority interests of BHE which were owned by Greg Abel and the estate of Walter Scott, a former director of Berkshire and a longtime friend of Warren Buffett.
I was not alone in raising the possibility of Berkshire acquiring Mr. Abel’s interest in BHE. The question was asked by a shareholder during the afternoon session of the company’s 2022 annual meeting which took place on April 30:
Eric Urda: Now, there’s a wise man named Charlie that in 1995, at a speech to Harvard, taught us how important incentives are to human behavior. I would conservatively say that Greg’s stake in BHE is worth more than $500 million at present. And I’m curious if you can share any plans that you have to convert is Berkshire Hathaway energy ownership to Berkshire stock? And if there isn’t a plan to do this, can you please explain why we shouldn’t be concerned about Greg’s incentive structure going forward?
Warren Buffett handed this question to Charlie Munger who responded as follows:
Charlie Munger: It’s a historical accident. It’s not causing any big tension or breaches of fiduciary duty. We had the same problem with Walter Scott, who was the director for years and years, and owned stock in the same company, also an historical accident. I just don’t think it’s a big problem at all. I see no behavior from Greg ever that isn’t in the best interests of Berkshire.
Mr. Buffett added that he sees no issue in terms of alignment of incentives and if he thought that doing something to explicitly align incentives was needed, then Mr. Abel would not be the right person to run Berkshire Hathaway. He then put the matter squarely in Mr. Abel’s court:
Warren Buffett: But there’s no reason to try and do anything with either the Scott interests or Greg, unless they want to do it. And the logical thing is if anything happened with the Scotts, we’d certainly offer it to Greg. But who knows what happens in the future.
The entire discussion is worth listening to and can be found starting at about the 46 minute mark of the afternoon session.
The concern that Berkshire Hathaway shareholders had is not unwarranted because Mr. Abel’s economic interests were tied to BHE which is just one part of the Berkshire Hathaway conglomerate, yet his current and future role involves oversight of the entire company. Having economic interests tied to one part of the company could conceivably skew decision making, particularly regarding capital allocation, to favor BHE over the rest of Berkshire. Mr. Abel keeps a low profile and most Berkshire shareholders have had limited exposure to him over the years.
However, Mr. Buffett has worked closely with Mr. Abel for over two decades and knows his character well. If Mr. Buffett was willing to vouch for Mr. Abel as strongly as he did during the annual meeting, that was enough to put to rest the concerns of most Berkshire shareholders. That was certainly the case for me.
Based on this backstory, it was interesting to read that Berkshire did end up buying Mr. Abel’s entire stake in BHE. This was disclosed in the company’s second quarter results which I wrote about in early August. In that article, I covered the details regarding Mr. Abel’s sale and the valuation that was agreed to. The section of the article regarding Mr. Abel is paywalled, so I’ll provide the last paragraph below:
I suspect that Mr. Abel will acquire Berkshire shares on the open market with part of the proceeds of his sale of BHE. If he does so, we will likely see a Form 4 filed since he is a director of the Berkshire. Shareholders can monitor Mr. Abel’s SEC filings on the EDGAR system or subscribe to an RSS feed to be notified of new filings.
We did not see any purchases for several weeks, but that changed on September 29 when Mr. Abel made his large purchase of Class A stock.
Berkshire Hathaway has a cultural ethos with skin in the game as the central element. The fact that Mr. Abel took a very significant amount of cash and invested it in Berkshire Hathaway is entirely in keeping with the company’s culture and he may not be done with his purchases yet given that his after-tax gains from the BHE sale has left him with several hundred million dollars of cash to allocate. It would not surprise me to see additional Form 4 filings indicating additional purchases.
When most companies talk about aligning incentives between management and shareholders, they do so by granting executives restricted stock or options. There are a number of problems with this approach starting with the fact that such grants are often made in addition to extremely generous cash compensation. Additionally, option grants typically do not adjust for simple retention of earnings that make a fixed-price stock option more valuable without any skill on the part of the manager.
But perhaps most importantly, there is a major psychological difference between taking your own hard-earned cash sitting in your brokerage account and actually buying shares on the open market versus being given equity as part of your compensation. By purchasing his stock on the open market, Mr. Abel did what any of us could do and is literally in the same boat we are in as Berkshire shareholders.
Mr. Abel’s future compensation at Berkshire may well also include equity grants. During the morning session of the 1997 annual meeting, Warren Buffett made some extended comments regarding how to properly structure an option plan for the top executive at a company. Here is a brief excerpt (h/t to @JRGFinance for the link to this meeting):
Warren Buffett: So I think any option should have a step-up in price that reflects the fact that money is reinvested by the shareholders annually. That if somebody wants to pay out a hundred percent of the earnings every year, then I’d say that you can have a fixed-price option. If you give me the money every year, and you do more with the money that’s left with you than the original sum, that’s fine.
But if money is left with someone for ten years, there’s going to be some increase in value even if they spend every day golfing. And to give a piece of that away simply over — to have a royalty on the passage of time for them is a mistake.
Berkshire Hathaway shareholders should not necessarily be surprised if the board grants Mr. Abel equity as part of his compensation when he takes over as CEO. However, such compensation will now supplement an already substantial ownership interest in the company purchased by Mr. Abel himself with his own money.
Greg Abel is not yet Chief Executive Officer of Berkshire Hathaway, and I hope he will not be for several years, but he has already passed the first test of the position: He has voluntarily put himself in the shoes of his fellow shareholders.
No one forced Mr. Abel to sell his BHE stock to the company, and I am certain that his purchase of Berkshire Hathaway stock was not something he was asked to do by Warren Buffett or in any way a condition of his future role as CEO.
As Charlie Munger said last year, “Greg will keep the culture.”
Rational Reflections is a reader supported publication
This article is free for all readers. To receive additional content, including in-depth business profiles, please consider signing up for a paid subscription. Thank you!
This is a partial list of recent articles available exclusively for paid subscribers:
Union Pacific Corporation, September 26, 2022
America's Car-Mart: Business Update, September 15, 2022
Burlington Northern Santa Fe, August 25, 2022
CarMax: A Disrupter Faces Disruption, August 16, 2022
Berkshire’s Ownership of Occidental Exceeds 20%, August 11, 2022
Berkshire Hathaway’s Q2 2022 Results, August 8, 2022
Buffett's Bet on Occidental Petroleum, July 21, 2022
Tractor Supply Company, July 13, 2022
Investors Title Company, June 30, 2022
America’s Car-Mart, June 8, 2022
DaVita: An Essential Provider of Dialysis Services, May 20, 2022
If you enjoyed reading this article, please click on the ❤️️ button and consider sharing this issue with your friends and colleagues.
Thanks for reading!
Copyright and Disclaimer
Nothing in this newsletter constitutes investment advice and all content is subject to the copyright and disclaimer policy of The Rational Walk LLC.
Your privacy is taken very seriously. No email addresses or any other subscriber information is ever sold or provided to third parties. If you choose to unsubscribe at any time, you will no longer receive any further communications of any kind.
The Rational Walk is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.
Individuals associated with The Rational Walk own shares of Berkshire Hathaway.
The total purchase of 168 Class A shares were reported on October 3 in four separate Form 4 filings. There were 113 separate lots. I have downloaded the individual purchases and calculated a total cost of $68,330,561.48 which works out to an average cost of $406,729.53. The form 4 filings can be found at the links below: