Is Buffett Hazardous To Your Wealth?

First stock options, then earnings guidance, and now taxes on dividends. America's most successful investor has taken positions on key issues that could harm businesses and their shareholders.

According to our latest Billionaires List, Warren Buffett is the world's second-richest person. He got that way by being a very savvy investor.

However, it seems that the severe bear market, the dozen or so corporate scandals that have taken place in recent years, and the "unfair" distribution of wealth have convinced Mr. Buffett that systemic reforms are required, that corporate managements cannot be trusted and that the double taxation of corporate profits is perfectly fair and logical.

Although Mr. Buffett has long been a champion of shareholder rights, we concluded that despite Berkshire Hathaway's strong stock price performance the company ranks poorly when it comes to corporate governance (see "Does the Board Have a Backbone"). What's worse, in recent periods Mr. Buffett has supported measures that may not necessarily be in the best interests of shareholders.

Take the matter of executive stock options. There have certainly been some abuses, such as the repricing of options when stock prices fall. However, options serve a useful purpose. They help high-risk, cash-poor corporations attract good employees. In effect, the company gets away with paying its employees a lower cash salary in exchange for a promise to reap larger rewards if the market one day assigns a higher value to the company's shares.

Option grants do not result in any cash expenditure. Furthermore, if for whatever reason they are never exercised, the firm ends up having received the employees' services at a bargain-basement price. Yet, when options are exercised, the corporation actually gets a cash infusion.

While it makes perfect sense to expense the difference between the stock's market price and the option's exercise price when the options are actually exercised, expensing them when they are granted, as Mr. Buffett and others favor, only increases the distortion between the firm's financial accounts and economic reality. How does this serve shareholders? Intel's (nyse: INTC - news - people ) shareholders recently concluded it doesn't. They narrowly--but wisely--defeated a measure that would have required expensing options when they are granted.

Mr. Buffett also advocates the elimination of earnings guidance. This is the management practice of telling analysts and investors what they should expect in earnings for upcoming quarters. Critics argue that guidance encourages investors to focus on short-term results rather than long-term goals, and management to manage expectations rather than the business.

Yet, as I have argued elsewhere (see "In Defense of Earnings Guidance"), eliminating guidance will not divert investors' attention from the short term. They will still scrutinize the company's quarterly financial reports, as they should.

Furthermore, less guidance simply results in greater uncertainty and makes buying the company's stock more risky. In effect, those who favor the elimination of guidance are saying that investors are better off having less information--a nonsensical argument. It's especially ironic that Mr. Buffett is pushing this view at a time when regulators and the investing public are screaming for more disclosure and greater transparency.

Finally, we come to dividends and taxes. Corporations subtract expenses from revenue and pay taxes on the difference. The remainder is called net income. They can do one of two things with these after-tax profits: keep them or distribute them to shareholders in the form of dividends or share repurchases. Unless those shares are held in some sort of tax-favored account, like a 401(k) plan or IRA, investors must pay taxes on these distributions, even though the corporation has already paid taxes on these very same funds.

President Bush is about to sign into law a tax-reform bill that goes a long way toward eliminating the unfair double taxation of corporate income. However, Mr. Buffett argues that the new law favors the rich. This is indisputable. Clearly, any tax reduction favors those who actually pay the tax. In this country, that usually means those with higher incomes.

More importantly, however, Mr. Buffett seems to overlook the point that the elimination of double taxation frees capital, makes it less costly and spurs the economy by allowing investors to more efficiently redirect cash flows from mature firms to growing firms. The so-called "poor" benefit from better job opportunities.

Mr. Buffett has almost a cult-like following of fans who hang on his every word. At Berkshire Hathaway's (nyse: BRK.A - news - people ) annual meetings, shareholders behave much like groupies at a rock concert. And with good reason. After all, the man is personally responsible for turning a large number of individuals into millionaires. No one can argue with his success, but investors may pay a heavy price if Mr. Buffett's positions on the issues discussed above become the norm.

Once the tax cut package is signed into law, who will verify Warren Buffett keeps his word? Who will certify that Warren Buffett will refund all of his ill-received tax benefits back to the US Treasury for debt reduction? Who at Berkshire Hathaway will ensure that the corporation will return all those ill-gotten dividend gains from KO and the the others? After all, Warren & his faithful are not deceitful liberal liars are they?

Liberal?

Buffett, Gates, Soros, all of them are in the ~I got mine and now you should fork over yours~ club. Socialists all of them except for Soros who's tripping close to Communism and all of these ideologies are nothing more than systems to keep the serfs in order.

Nothing more than a worldwide oligarchy. I know my vote counts for squat.

2 posted on 05/27/2003 3:36:44 PM PDT by OpusatFR (Using pretentious arcane words to buttress your argument means you don't have one)

Gates is somewhat of an exception to his dad & those other two IMO because Gates, himself, has said things & acted much differently than his father who rails in support for the death tax, etc..

Buffett has one small problem with dividends...he does not pay them. He keeps all profits and uses them to buy other companies. Unlike a utility, bank or other safe investments, he has another system for his stock which has sold for 16,000+ a share. Buffett thinks that little guys investing in forty dollar stocks should not get or be paid dividends. He is smart and rich and dangerous.

Here's another little secret that Warren probably doesn't want the riff-raff to know. Corporations receive a 70% exclusion on dividend income for tax purposes. This means that when corporations hold stock in other companies that pay dividends, the first 70% of dividends received is excluded from taxable income. So if his Berkshire Hathaway coporation receives $10,000,000 in dividend income, it only reports $3,000,000 as taxable income, enjoying the remaining $7,000,000 as tax-free income. Private investors do not enjoy any such luxury (just as they are not allowed to deduct the interest they pay other than mortgage interest the way corporations do).

you are right - the liberals including Buffett love to play a duplicitous game in which they profit while everybody else must be resigned to play the role of losers.

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