Words of Wisdom from Warren Buffet that Raises Questions on Executive Pay

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JP Morgan's CEO was just awarded a huge stock option bonus. According to Warren Buffet Jamie Dimon is over paid. Buffet invests in companies that have pricing power. Companies that have pricing power do not need great management. JP Morgan and other Wall Street banks have pricing power, and that is why they are so profitable. Buffet did not refer to Wall Street's extravagant bonus plans but the simple explanation for Wall Street's bonus plans is that the banks are extremely profitable because they do not compete on price.

Buffet has made a related point in another context. He said that if you put a manager with a good reputation in a business with a bad reputation, it will be the reputation of the manager that will suffer. There are many more examples of this paradigm than that of the corporate savior who comes in and rescues a failing business.

Of course it is also possible for businesses with pricing power to lose their advantage and eventually fail. Buffet owns newspapers because there is usually only one major newspaper in a city and they have pricing power. Changes in technology, however, have made newspapers less profitable and many are failing. There is little that management might have done to deal with the advent of new technology that has led to declining revenues from advertising and from subscriptions.

There are also examples of businesses with pricing power that have failed because of management failure. The US auto industry is a classical example of the failure of management to respond effectively to changes which turned the auto industry into a globally competitive market. Most businesses and most managements, are not very effective at dealing with changes that make currently profitable practices unprofitable.

I think that Buffet raises a very important question for economics. If management does not add much value to a business with pricing power then how can we justify the fact that the top 5 managers from F500 companies collect up to 10% of corporate profits in compensation?