Corporate Governance Wars: Leucadia Vs. Berkshire

By Will Ashworth | November 04, 2008 AAA

Corporate governance, especially as related to executive compensation, has captivated my attention recently. Good corporate governance is critical to investment performance. In fact, studies have shown that the firms that protect shareholder rights have higher profits and bigger sales growth compared to their competitors who are less focused on shareholder rights.

While good corporate governance cannot guarantee a stock's increase in value, poor corporate governance can foreshadow future problems. Professors at Rutgers University examined the 1,500 largest U.S. companies between 1992 and 2001, focusing on stock-based compensation. Companies that gave above-average grants saw lower investment returns. However, exceptions do apply, such as Leucadia National (NYSE:LUK), a holding company that is composed of disparate assets, much like its bigger rival Berkshire Hathaway (NYSE:BRK.A, BRK.B).

Poor Corporate Governance
Several institutions provide investors with corporate governance ratings in the form of a quick take on a company's concern for shareholder rights. Institutional Shareholder Services, now part of RiskMetrics Group's (NYSE:RMG) financial risk management business, provides a rating system called CGQ, short for Corporate Governance Quotient. CGQ examines and rates the four areas of board of directors, audit, anti-takeover provisions and executive and director compensation. For the sake of this article, my examination is limited to executive compensation, using Leucadia and Berkshire Hathaway as test subjects.

Leucadia National
Ian Cumming and Joseph Steinberg, chairman and president, respectively, took control of Talcott National in 1979. Its name changed to Leucadia National a year later, following the sale of James Talcott Factors to Lloyds & Scottish Ltd. for $123 million. Cumming and Steinberg were off to the races. In the next 30 years, the duo would successfully increase equity from negative $7.7 million in 1979, at the time they took over, to $5.6 billion at the end of 2007. In the past five years, the company made a total of $2.55 billion. During this period, an initial investment of $100 grew to just under $400 by the end of 2007. In comparison, the S&P 500 gained less than half that amount.

Not everything has been smooth sailing, however. In 2007, Leucadia National would have lost $58 million, if not for a $543 million tax benefit that was part of a $5.1 billion net operating loss carryforward the company kept when it sold WilTel assets in 2005. For their troubles, Cumming and Steinberg were paid $46.8 million in total compensation over the five-year period, including $10.6 million in warrants, potentially adding to their combined ownership of 24%. Whether or not Cumming's and Steinberg's performance legitimates their pay is up for debate. While existing Leucadia shareholders may argue that their officers' pay is in line with their performance, the duo's compensation could be seen by many as highly questionable. (Read more about breaking down officers' pay at Evaluating Executive Compensation and Lifting the Lid on CEO Compensation.)

Berkshire Hathaway
Oracle of Omaha Warren Buffett is one of America's great icons, consistently demonstrating an intuitive understanding of what makes a great business great. Over the years, his company, Berkshire Hathaway, has bought whole companies as well as large stakes in businesses as diverse as Washington Post (NYSE:WPO), Nike (NYSE:NKE) and Coca-Cola (NYSE:KO).

In the past five years, Berkshire Hathaway earned net income of $48.2 billion, nearly 20 times Leucadia's five-year earnings. Buffett and Vice Chairman Charlie Munger together took home less than $3 million in total compensation, which includes $100,000 paid annually to Munger by Blue Chip Stamps. Neither received any stock-based compensation in the five-year period. While Berkshire is down just 11.65% in the last 52 weeks, compared to a drop of 43.73% for Leucadia, Leucadia supporters will point out that its company has seriously outperformed Berkshire Hathaway over the past five years by almost double-digits.

Power In (CGQ) Numbers
Although Leucadia may have excellent returns, with a Corporate Governance Quotient of 16.6%, in comparison to Berkshire Hathaway's 75.1%, it is clear that Warren Buffett and Charlie Munger take issues like CEO compensation far more seriously. Thus, Leucadia's shareholders could benefit by pressing for change in the way Leucadia handles CEO compensation. However, if Wall Street trends of recent years are any indication, they may opt instead for the status quo.

Bottom Line
There is no doubt that extremely intelligent people manage both companies, but the difference in each company's corporate governance principles is palpable. At this critical time in U.S. financial history when inflated CEO compensation has contributed to the downfall of companies and to the deterioration of conditions on Wall Street, a new approach to corporate governance, including executive compensation, needs to be had.

To learn more about how executive pay affects the bottom line, read Governance Pays.

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