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Berkshire's Shareholders Say: Create Value, Don't Extract It

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At a time when the activist hedge funds’ agenda of extracting value from corporations by cost-cutting, share buybacks and financial engineering has also become the default boardroom agenda, it is heartening to read in Warren Buffett’s 50thannual letter to Berkshire Hathaway’s shareholders that its management and shareholders almost unanimously rejected that agenda.

Buffett reported that at last year’s annual meeting, Berkshire's shareholders were offered a proxy resolution:

RESOLVED: Whereas the corporation has more money than it needs and since the owners unlike Warren are not multi billionaires, the board shall consider paying a meaningful annual dividend on the shares.

Apparently the sponsoring shareholder of the resolution didn’t come to the meeting. As a result, the motion was not officially put forward.

Nevertheless, Berkshire tallied the proxy votes and they were, as Buffett notes, “enlightening.”

Berkshire’s directors had recommended a “no” vote, as did almost all the A shares – owned by Berkshire insiders, by a margin of 89 to 1. This was hardly surprising.

What was striking was that the hundreds of thousands of B shareholders also voted a resounding “no,” with 660,759,855 “no” and 13,927,026 “yes.” That makes a ratio of about 47 to 1 against.

Thus Buffett concludes: “98% of the shares voting said, in effect, ‘Don’t send us a dividend but instead reinvest all of the earnings.’ To have our fellow owners – large and small – be so in sync with our managerial philosophy is both remarkable and rewarding. I am a lucky fellow to have you as partners. “

A radical idea: invest for the long term

Dennis K. Berman lamented recently in the Wall Street Journal that other companies are not so fortunate. They are subject to a vast campaign from activist hedge funds that is striking “for its sheer scale and ferocity, with some $119 billion placed in their hands. Last year, they pursued 343 companies, up 27% from the year before.”

The sameness of their value extraction agenda is also striking for its short-term focus—“raise the dividend, buy back shares, cut these costs, spin off that division, sell the company."

Activists are short-term tourists with little interest in the long-term health of the firm. According to FactSet, which tracks activist activity, 84% of activists hold their shares for less than two years. Activists so rarely call for greater long-term investment in innovation that FactSet’s database doesn’t even have a category for it.

Perhaps the most worrisome thing about activist hedge funds is that they have succeeded in getting managements and boards to think in the same unproductive way. A survey last month confirmed that US firms give low priority to innovation programs. As Gautam Mukunda points out in his HBR article, now many corporations don’t need to be forced to cut back on innovation. Now they want to do what the activists want.

A movement for long-term investing

Yet Berman also reports that there is “a burgeoning movement across asset managers to push more long-term investing in the markets. They are, in fact, forming a new coalition called Focusing Capital on the Long-Term, and will meet in New York in March to press their agenda. The group includes fund manager BlackRock [BLK], insurer AXA [Euronext: CS], and Singapore’s sovereign wealth fund GIC.”

Berman half-jokingly suggests that activists might differentiate themselves by offering funds supporting long-term investing and even offers the pitch in proper Wall Street-ese:

“A fund that identifies and aggressively advocates for new approaches in companies suffering from chronic underinvestment and short-term management focus. Designed for patient investors who want to build real, sustainable value.”

Of course, such a fund already exists: it’s called Berkshire Hathaway .

The track record of this approach is available and it appears to be rather profitable. “Over the last 50 years (that is, since present management took over),” Buffett reports, “per-share book value has grown from $19 to $146,186, a rate of 19.4% compounded annually.”

Why don’t more corporations and activists follow it?

And read also:

The Seven Deadly Sins of Activist Shareholders

Salesforce CEO slams ‘the world’s dumbest idea

How hedge funds transfer wealth from investors to managers

When pension funds become vampires

Berkshire: Rats In The Granary

The five biggest surprises of radical management

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Follow Steve Denning on Twitter at @stevedenning