Academics who study corporate finance overwhelmingly believe that conglomerates — giant companies that operate in a wide range of industries, often built through acquisitions — are an awfully inefficient way to organize businesses.
One of the most successful US companies of the past 50 years is a conglomerate called Berkshire Hathaway, run by the renowned investor Warren Buffett, which is the fourth-most valuable firm in the US, behind Apple, Google and Exxon Mobil. It employs 340,000 people, roughly the population of Honolulu.
Buffett gave his best go at explaining this seeming contradiction in his latest letter to shareholders, released on Feb. 28, which was in effect a guide to why he has been able to build such a vast corporate empire and a US$72 billion personal net worth.
It lays out two theories of why Berkshire has been so successful.
However, those two theories have radically different implications for how the company might fare after the 84-year-old chairman’s retirement or death.
It helps to understand why finance economists do not much like the idea of conglomerates in the first place.
Back in the 1960s, a popular strategy was to buy up random industrial companies and use accounting tricks to create the illusion of growth even when the underlying performance of the acquired companies was no better, and often worse, than it had been when they were run separately.
It is easy to look at Berkshire Hathaway over the past couple of generations and see a version of the same thing.
Buffett has bought enough seemingly random companies over the years that the combined entity defies any simple description (In short: A giant insurance company, a giant railroad, a giant electric utility and a giant stock portfolio along with various and sundry investments, including in private jet travel, mobile homes, men’s and women’s underwear and dairy-based desserts. Oh, and half of Heinz ketchup).
Finance theory would say that there is no real reason for all those unrelated businesses to be underneath the same corporate umbrella.
The company is an extreme example of decentralization, with Berkshire Hathaway’s corporate headquarters in Omaha, Nebraska, employing only 25 people to oversee this vast empire.
All meaningful operational responsibility remains with executives who run all those portfolio companies.
Why should they not each exist on their own, or as part of a larger company with a narrower focus?
Here is Buffett’s explanation:
“One of the heralded virtues of capitalism is that it efficiently allocates funds,” he wrote. “Nevertheless, there are often obstacles to the rational movement of capital,” for example, the reluctance of a chief executive officer in a declining business to shut down factories and return capital to shareholders to be reinvested elsewhere, or the tax and transaction costs for investors who wish to shift money from one sector to another.
“At Berkshire, we can — without incurring taxes or much in the way of other costs — move huge sums from businesses that have limited opportunities for incremental investment to other sectors with greater promise. Moreover, we are free of historical biases created by lifelong association with a given industry and are not subject to pressures from colleagues having a vested interest in maintaining the ‘status quo.’ That is important: If horses had controlled investment decisions, there would have been no auto industry,” Buffet added.
In effect, Buffett is arguing that he, Berkshire Hathaway vice chairman Charlie Munger and their 25-person team in Omaha are better at deciding the appropriate allocation of capital among different potential investments than the entire infrastructure of the modern financial system — banks, stock and bond markets, buyout funds and so on — that are supposed to do just that.
The key advantages that Berkshire might have, in other words, are that the company decides how to allocate capital with neither the self-interested decisionmaking of many operating executives (most people do not want to dismantle the company they lead, after all, even if its business prospects have collapsed), nor the high fees and short-term perspective of private equity and other buyout artists.
If you believe Buffett, Berkshire is able to achieve the analytical rigor of the latter mixed with the long-term perspective of the former.
However, there is a bit more to his success than just being really good at capital allocation.
There are surely thousands of people who can match Buffett’s talent for evaluating the prospects of a business and deciding which should get more investment and which less, but most of them will not end up with a US$72 billion net worth and 340,000 employees.
Buffett acknowledges a second reason for his company’s success: “We are now the home of choice for the owners and managers of many outstanding businesses.”
In other words, if you are a family looking to cash out of a business, but want to leave the company intact and keep longtime employees in place to run it, selling to Berkshire Hathaway looks mighty attractive.
However, there is a good chance you are going to have to accept less money than a private equity firm or a strategic acquirer would offer.
The unique art of Buffett and Berkshire, as Bloomberg View columnist Matt Levine wrote, is in the ability to “be rigorous while seeming sentimental, to drive a hard bargain by looking like a teddy bear.”
In effect, he is able to get favorable deals on his acquisition because of a reputation built over a lifetime for buying good companies and more or less leaving them alone.
That is the giant question for the future of this enormous company.
To the degree that this new-style conglomerate has succeeded because it has found a better way to allocate capital than the one the rest of the world uses, it should have a long and bright future under its next chief executive, thought to be either reinsurance executive Ajit Jain or Berkshire Hathaway Energy chief executive Greg Abel.
However, if you want to chalk up Berkshire’s success to its ability to persuade sellers of businesses to accept less than a market value for some of the Buffett Mystique, the new leadership, whenever it takes charge, is set to face a steep challenge in building the same sort of reputation.
Neil Irwin is a senior economics correspondent, who writes for The Upshot, a New York Times site for analysis of politics, economics and more.
Two major Chinese Communist Party (CCP)-People’s Liberation Army (PLA) power demonstrations in November 2024 highlight the urgency for Taiwan to pursue a military buildup and deterrence agenda that can take back control of its destiny. First, the CCP-PLA’s planned future for Taiwan of war, bloody suppression, and use as a base for regional aggression was foreshadowed by the 9th and largest PLA-Russia Joint Bomber Exercise of Nov. 29 and 30. It was double that of previous bomber exercises, with both days featuring combined combat strike groups of PLA Air Force and Russian bombers escorted by PLAAF and Russian fighters, airborne early warning
Chinese Ministry of National Defense spokesman Wu Qian (吳謙) announced at a news conference that General Miao Hua (苗華) — director of the Political Work Department of the Central Military Commission — has been suspended from his duties pending an investigation of serious disciplinary breaches. Miao’s role within the Chinese People’s Liberation Army (PLA) affects not only its loyalty to the Chinese Communist Party (CCP), but also ideological control. This reflects the PLA’s complex internal power struggles, as well as its long-existing structural problems. Since its establishment, the PLA has emphasized that “the party commands the gun,” and that the military is
Since the end of former president Ma Ying-jeou’s (馬英九) administration, the Ma Ying-jeou Foundation has taken Taiwanese students to visit China and invited Chinese students to Taiwan. Ma calls those activities “cross-strait exchanges,” yet the trips completely avoid topics prohibited by the Chinese Communist Party (CCP), such as democracy, freedom and human rights — all of which are universal values. During the foundation’s most recent Chinese student tour group, a Fudan University student used terms such as “China, Taipei” and “the motherland” when discussing Taiwan’s recent baseball victory. The group’s visit to Zhongshan Girls’ High School also received prominent coverage in
India and China have taken a significant step toward disengagement of their military troops after reaching an agreement on the long-standing disputes in the Galwan Valley. For government officials and policy experts, this move is welcome, signaling the potential resolution of the enduring border issues between the two countries. However, it is crucial to consider the potential impact of this disengagement on India’s relationship with Taiwan. Over the past few years, there have been important developments in India-Taiwan relations, including exchanges between heads of state soon after Indian Prime Minister Narendra Modi’s third electoral victory. This raises the pressing question:
RSS