Explaining the Premiums Paid for by Acquisitions

Warren E. Buffett, 1995

There are several assumptions Warren Buffett might have made when he purchased GEICO. He is famed for saying that acquiring executives think of themselves as beautiful princesses whose kisses will turn ‘frogs’ — underperforming companies — into handsome princes. Believing they can “release the imprisoned princes” (Hambrick & Hayward, 1997, p. 103+). He also said that he’d observed many kisses but very few miracles.

Why, then, might he have bought GEICO, a company admittedly perking along just fine without him, especially considering the acquisition premiums. In view of the increase in share price, it is likely Buffett was relying on the target’s pre-existing stock price inadequately reflecting the value of the firm’s resources and its prospects. This has been called hubris by some analysts, but it is hubris only if it fails. In the case of Buffett, it did not fail.

In fact, Buffett may have been operating from a position of having identified one or more of the main motives for takeovers being present at GEICO. Poor company management is one possibility. In fact, it is a more plausible possibility than a desire to rely on synergy; Berkshire Hathaway and GEICO would not, seemingly, have much opportunity for that.

In fact, Buffett probably expected to eliminate inefficiencies in the target company and/or increase its market share. When he took over The Buffalo News, a daily in upstate New York, he increased the news hole, a maneuver that would necessarily decrease the advertising page count. His contrarian move worked, however, because the news hole “attracts a wide spectrum of readers and thereby boosts penetration. High penetration, in turn, makes a newspaper particularly valuable to retailers since it allows them to talk to the entire community through a single megaphone” (Buffett, quoted by Henry, 1998, p. 58).

It is arguable that Buffett did much the same thing with GEICO. He did not interfere with the executive structure, the same tactic he used at the Buffalo newspaper, but he did — at least if the advertising is any indication — expand GEICO’s penetration of the market.

Buffett’s problem with GEICO might be characterized as the lack of significant problems. When he became involved with Salomon Brothers, however, it was a far different story. That firm had suffered a scandal in which the firm’s chief trader of U.S. debt instruments had cheated in Treasury auctions, a move that threatened Salomon’s core business (U.S. News & World Report, 1992, n/a). By stepping in and cleaning financial house, Buffett was able to retain that monstrously big client and save Salomon Brothers. The fact that the U.S. Treasury was probably also spared additional upheaval arguably added to Buffett’s reputation.

As far as Champion International, that was probably the most predictable of the Buffett takeovers, and offered the greatest single chance to a stunning, and financially rewarding, turnaround. It was a classic case in which the CEO, Andrew Sigler, was being wildly overpaid for decidedly lackluster results. In his 18 years as CEO of Champion, Sigler had produced investor returns of only 4.7%, less than a Treasury bill, and yet was paid at the base rate of $1.2 million per year, plus stock options on 250,000 shares (Colvin, 1992, n/a). IT would be difficult to see why Buffett would not buy this one, and how he could fail to succeed, simply by doing what he does best: cleaning up and clearing out.


Colvin, G. (1992, June 1) Champion pay for a nonchamp CEO. Fortune. Retrieved October 9, 2005 from www.highbeam.com.

Hambrick, D.C. And M.L.A. Hayward. (1997) Explaining the Premiums Paid for Large Acquisitions: Evidence of CEO Hubris, Administrative Science Quarterly, 42 (1), 103+. Retrieved October 9, 2005 from www.questia.com.

Henry, J. (1998, November). Buffett in Buffalo, Columbia Journalism Review, p. 58. Retrieved October 9, 2005 from www.questia.com.

How Buffett cleaned up Salomon. (1994, June 20) U.S. News & World Report. Retrieved October 9, 2005 from www.highbeam.com.

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