Buffett's 2005-06 letters: On moats, managers and money

A business decline rarely starts with incompetence. It starts with indifference towards customers, capital, or shareholders. It starts with managers chasing short-term numbers while quietly dismantling the foundations they were hired to protect. And it thrives in boardrooms where tough questions go unasked because everyone is too polite—or too well paid—to ask them.

In his 2005 and 2006 letters to shareholders, Warren Buffett returns to a few familiar themes: competitive advantage, capital allocation and executive compensation. These are not just lessons in business. They are warnings. Ignore the moat and your business will crumble. Get the incentives wrong and even a flatlining company can make its CEO rich. Hire the wrong investment manager, and one mistake could undo decades of work.

This story, part of our series on Buffett's annual letters, brings together those ideas. Because the real risk in business is not failure. It is success managed poorly.

Widening the moat, quietly

The best businesses are rarely built in a dramatic fashion. Instead, they are fortified one small decision at a time—by delighting customers, cutting bloat, and strengthening products or services. Day by day, these changes may not seem like much. But over the years, they amount to something powerful.

Buffett calls this process "widening the moat"—that is, increasing the long-term competitive advantage of a business. And when short-term results conflict with this goal, he is clear about what matters more. A company that sacrifices its moat for the sake of quarterly numbers is compromising its future. The damage may not show up immediately, but eventually, no amount of effort can undo it.

This principle may sound basic. But it's one of those fundamentals that investors and managers forget when short-term pressures take over.

The comp game is rigged

Executive compensation, as Buffett puts it, is too often detached from performance and stacked against shareholders. CEOs can end up earning enormous sums even when the business itself goes nowhere.

Take the classic 10-year, fixed-price stock option. A CEO could keep a company's earnings flat—or even see them decline—and still walk away with tens or hundreds of millions, simply by using profits to buy back shares and boost earnings per share. In many such cases, real economic performance has stagnated, but the illusion of growth (via EPS) persists, and shareholders pay the price.

The problem is not just flawed math. It's a structural issue. Compensation committees are often influenced by management, guided by consultants whose allegiance lies with the people writing their cheques. Even options designed to "align" management with shareholders rarely account for the natural increase in value from retained earnings. It's possible to fix this, Buffett says. It's just that most boards choose not to.

Buffett's solution is simple: pay CEOs based on the performance they control. If a business thrives under their watch, they are rewarded. If not, there should be no payout just because other parts of the company are doing well.

Picking an investment manager

In 2006, Buffett was preparing Berkshire for a future beyond him. That meant looking for investment managers. But intelligence alone wouldn't cut it. After all, the markets don't just test your IQ—they test your temperament.

What Buffett wanted was someone who could handle chaos without blinking. Someone with emotional stability, independent thought and the ability to understand human behaviour—especially their own. Because one big mistake in this game can erase a lifetime of wins.

If you can't control your impulses, it doesn't matter how sharp your models are.

The final word

Businesses receive what they reward. Misaligned incentives and mediocrity becomes expensive. Ignore the moat, and time will quietly erode whatever scale and reputation was once built. Trust brilliance without temperament and markets will humble you.

Buffett's letters from 2005 and 2006 are a reminder that fundamentals never go out of fashion. Build enduring businesses. Reward real performance. Choose people who can think straight when the world goes sideways. The rest is just noise.

Also read: Buffett's 1989 letter on avoiding costly myths and mistakes

This article was originally published on April 25, 2025.