Again with the ping pong, come on. Photographer: Daniel Acker/Bloomberg

Warren Buffett Didn't Belch at Coke Pay Plan

By Matt Levine

The question of why Warren Buffett abstained from voting on of a Coke executive compensation plan that he said he disagreed with has been discussed to death but I just want to give its corpse a little poke, both because it was a popular topic of conversation at this weekend's Buffettfest, and because I think it fits nicely with Buffett's way of doing business.
My model of Warren Buffett is that he's a sharp-elbowed deal guy with a clever schtick, and the schtick is "simple folksy value investor." It's pretty obvious why that schtick would be nice for him. It's good PR, for one thing; somehow he's convinced people that the shareholder meeting of an insurance company in Omaha is a fun event. And being a beloved folk hero probably helps when you do a lot of investing in highly regulated industries such as insurance and banking: If Warren Buffett does it, it must be okay, right? Plus I'm sure the folksiness is its own reward; some people really like ping pong and Cherry Coke and all indications are that Buffett is one of them.




But Buffett's job is not just to be a comforting and familiar presence to the public, or to bask in childlike enjoyment of the simple things in life. Buffett's actual job is to source investments. And when you manage a gajillion dollars for a company that is "again on the prowl for a significant acquisition that could bolster its earnings power," and when you measure yourself against the S&P 500 index and miss, you need to think carefully and strategically about how you source investments..
How do you source investments? A lot of people work very hard on analyzing industries and going around meeting with companies, but Warren Buffett mostly sits in the bathtub and lets the deals come to him.¹ And when they come to him, he gets very good terms and makes very large profits.
That is a superlative business model! If you could take baths and have billions of dollars thrown at you, you'd do it all day long, or at least until your skin got pruney. And Buffett's schtick is a key part of this business model: He's set himself up not as a hard-charging manager who will meddle with the companies in which he invests, but as a source of abundant and unintrusive capital who will confer his folksy halo to all his portfolio companies. All he asks in return is extremely favorable economic terms.
It's a trade that many companies -- and by "companies" I mean "corporate management teams" -- would be thrilled to take. Sure, a strategic buyer or a big private equity firm might offer you better economic terms, but Warren Buffett will give you gobs of money without asking you to change your routine. He's just a value investor, not an operator or an activist. You give him value, he'll let you take care of the rest.
Buffett's Coke (non-)vote lets him perform two roles for two audiences. For the public, he gets to be a plainspoken critic of excessive executive compensation and boardroom chumminess.² But for corporate managements, he signals that he will allow excessive executive compensation and be chummy in the boardroom. I mean, he literally said that he abstained from voting on a plan that he didn't like because he wanted to stay chummy with corporate management.³ If you are a corporate manager looking for investors or buyers, that is a strong reminder that he is a great guy to call.⁴
Carl Icahn objects:

My colleagues and I have fought long and hard to change fellow board members' attitudes and beliefs concerning their responsibility to shareholders, even if this change angers the CEO and some of his cronies sitting on the board. But if a man of Warren Buffett's stature openly states he abstains from voting on plans he doesn't agree with because he "loves" management and he doesn't want to "express any disapproval," how can we expect other board members in this country to voice their opinions, especially if they are opposed to the CEO's interest?

I mean, sure. But that's your business, Carl. Your job is to acquire large concentrated stakes in companies, shake them up, mess with management, and make a profit by maximizing shareholder value. That is a good business for you, and maybe it's good for the world, why not. But it's not the only business model. When everyone else is a strident activist setting out to fight corporate managers, Buffett's soothing approach becomes even more valuable. Ask yourself: Why would anyone show Carl Icahn an attractive below-market investment opportunity?
Buffett's job is not to maximize the value of each investment. It's to maximize the value of his portfolio, and in particular the option value from being shown future investments. How much does Coke's "excessive" compensation cost shareholders? Its most strident critic thinks the plan dilutes shareholders by one-sixth, but no one else really believes that;⁵ a more plausible guess is that management is giving itself 1 or 2 percent of the company more than it "deserves." Berkshire Hathaway owns 400 million Coke shares -- worth $16 billion and change -- so the costs of this plan to Berkshire are probably in the low hundreds of millions of dollars.
Meanwhile, Berkshire makes billions by being shown investments and moving quickly on them. It made about $1.3 billion on the first day of its Bank of America investment. That's where the money is: not in pinching pennies at mature companies such as Coke, but in being the first call for companies that want to sell you stock at a huge discount.⁶
This is all pretty obvious, but I guess it's in Buffett's best interests if it remains a bit obscure. Making your money by sourcing and negotiating attractive deals just feels somehow less homey and all-American than making your money by buying open-market stakes in Coca-Cola and watching the money roll in.⁷ And differentiating yourself as a management-friendly investor is a little out of favor in today's climate of shareholder activism. But of course, out-of-favor investment approaches are the best places to find hidden value. And Warren Buffett is very good at spotting value.

¹ I exaggerate -- in the Bank of America bathtub deal, he called them after thinking up the idea in the bathtub. But "the deal was done in 24 hours."

² This Wall Street Journal article, from yesterday, quotes 2009-era Buffett:

"The way to get big shots to change their behavior is to embarrass them," he said then. "It would act as a restraining factor that might set in corporate America…The restraining factor isn't there right now."

And I guess his public criticism of Coke is embarrassing for them? But only sort of?

³ I mean:

He said it should be "no surprise" to people that corporate boards are "clubby" and partially "social organizations." "There's a great tendency to act in a socially acceptable way instead of a business maximizing way."

Or:

In defending Howard Buffett, who as a Coke director went along with the compensation plan, the elder Mr. Buffett argued that corporate boards are built largely on cooperation and not conflict.
Many directors are chosen not because they are “Dobermans” but because they are “cocker spaniels,” he argued. And raising a fuss was the equivalent of belching at the dinner table -- and liable to lead to exile in the kitchen.

And the embarrassing (?) public criticism goes along with a private campaign to convince Coke to "tweak" the executive compensation plan in ways that, I suspect, won't do much to limit Coke's executives' paychecks. Everyone will talk piously about modifications to enhance shareholder value, but nobody's compensation will be cut.

⁴ I mean, obviously everyone already knew that Warren Buffett is a good guy to call for money. My point is not that this is a new idea he had to source investments. My point is that this is the sort of thing that he's been doing forever, with positive results for him.
Buffett's partnership with 3G Capital -- "a highly efficient cost-cutter and corporate operator" that he praised at the shareholder meeting -- cuts against this a little bit. I guess it just means that Buffett wants to do some cost-cutting and operating -- but he can't do it himself, because that would interfere with his well-established persona. So he outsources it to 3G.

⁵ For one thing, that includes shares granted under all previous plans. For another, a chunk of that is in options, which are not 100 percent dilutive: If I grant you 100 options at $40, and you exercise at $50 and net share settle (as Coke's executives seem to), you only get 20 shares (you pay the $4,000 strike price with 80 shares valued at $50, leaving you with 20 shares). Some of Coke's defenses -- e.g. that many shares don't vest -- make sense; some -- e.g. that Coke spends cash to buy back shares and offset the dilution -- are less compelling.

⁶ And can you imagine a bank calling an investor known for cutting back on employee compensation? Banks' whole raison d'être is to compensate employees. If you position yourself as a compensation gadfly, you'll never hear from a bank again.

⁷ Doesn't it? Why? Presumably Berkshire's direct investments in companies are, like, better for the world than just trading secondary stakes, right?