The Warren and Charlie Show
The Berkshire Hathaway annual shareholders meeting is like a rock concert where the musicians are two ninety-year-olds and the only instrument they play is a balance sheet. But how the fans love them.
The Warren and Charlie Show
On a blustery Saturday morning in April, we arrived at Omaha’s Qwest Center along with 40,000 Berkshire Hathaway shareholders who queued up as early as 3 am. The marquis at the center featured other acts that were scheduled in the coming weeks, including Usher, Taylor Swift, and the gladiators of the WWE. What set the rock stars of this show apart from the other acts were two things primarily — these guys were in their 90s and although neither could sing worth a damn, one of them played a mean ukelele. The show was technically called the Berkshire Hathaway annual meeting, but it is better known as the annual pilgrimage of shareholder capitalists.
Warren Buffett, 89, and Charlie Munger, 97, make their way to the stage as greeters and old friends from the earliest days of Berkshire Hathaway stumble over themselves to shake hands, get autographs, take selfies, and bask in the aura of Warren Buffett’s glow. Some older Omahans are billionaires thanks to Buffett’s work. The math is deceptively simple, if you bought shares at the time Buffett took over the company, they were valued in 1964 at $19 and are now worth over $25 million EACH. If you are looking for those shareholders, they are easy to spot as they never seem to stop smiling.
There is not another annual meeting quite like this, and the proceedings reveal a corporate governance philosophy as contrarian as it is profound. For the audience, some of whom are Wall Street analysts but mostly mom and pop investors who gave Buffett their ten thousand dollar nest eggs and he returned a 100 million dollar fortune have seen their lives and their future grandchildren's lives changed by the wisdom of Buffett and Munger. To them, this is the Harvard MBA only with peanut brittle.
The proceedings run as smoothly. No shareholder gadflies, no protestors wearing chicken outfits or noisy activists. No phalanx of security other then floor ushers to help find seats. The only groans of protests are from the those in the audience whose spouses skipped the meeting to buy jewelry from at Borsheim’s, which is one of the many companies he owns or invests in through Berkshire Hathaway, including GEICO, Duracell, Dairy Queen, BNSF, Lubrizol, Fruit of the Loom, Helzberg Diamonds, Long & Foster, FlightSafety International, Pampered Chef, and NetJets, and has major holdings in Kraft Heinz Company, American Express, Wells Fargo, The Coca-Cola Company, Bank of America, and Apple.
One reason why the protesters are missing at Berkshire’s meeting is that no other company is so focused on ethical behavior as a component of performance and less focused on personal enrichment. No other company is so transparent — even on issues like compensation, corporate scandal, and succession. Yet no company is so notoriously private. Thus lies the irony. But to Berkshire shareholders, the irony is preferable to the agony of corporate scandal, corruption, and self-enrichment.
One of the features that make the Berkshire annual meeting so unique is the unscripted nature of proceedings. There is a genuine feeling that the company’s leaders really do care about the attitudes of the audience and are there to address their questions, not just deliver canned statements.
For nine hours, Warren Buffett and Charlie Munger answered unscripted questions from the audience alternating with three major financial journalists — Carol Loomis of Fortune magazine, Andrew Ross Sorkin of The New York Times and Becky Quick of CNBC — who have agreed to serve as interlocutors for this annual meeting’s Q&A. Checks and balances of transparency. Buffett has an unshakable faith that telling the truth is the only way to ensure you won’t be testifying to someone else’s version some years later.
Opening Lines
Warren Buffett opens proceedings with typical humor: “Good morning, I’m Warren, he’s Charlie. I can see, he can hear, that’s why we work together.” And so you have the basic requirements for a visionary and his alter ego.
The Questions and Answers
After the initial comments, Buffett launched directly into the issue everyone wants to hear about at this particular meeting: what happened with David Sokol, an executive who was recently let go for profiting from deals Berkshire was making?
The media have been circling their wagons since the news broke and shareholders have been wondering, could this be the iceberg that dents, if not sinks, the Berkshire succession plan?
Buffett lays the groundwork — and provides some insight into his overall perspective on the matter — by playing a clip of testimony he gave in front of Congress regarding Salomon Brothers, the investment bank that he had to bail out in 1991. During that testimony, he promised “full cooperation” to the committee and, offering a fig leaf as well as a sharp-edged sword to his new employees, promised: “Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.”
This is reflective of the stance he has taken toward the current situation involving Sokol, and audience rallies to his message. They, like their chairman, want justice. This is their company. This is their CEO. This is their annual meeting.
He takes it as his duty to explain how business psychology and corporate behavior could cause a Berkshire executive such as David Sokol to violate the company’s code of ethics.
“…In looking at what happened a few months ago with Dave Sokol’s failure to notify me at all that he’d had any kind of contact with Citigroup, in fact, he directed my attention to the fact that they represented Lubrizol and never said a word about any contact with them, and then the purchase of stock immediately prior to recommending Lubrizol to Berkshire…I don’t think there’s any question about the inexcusable part.
One interesting point is that Dave, to my knowledge at least, made no attempt to disguise the fact that he was buying the stock.
The second fact, which is perhaps less puzzling, is that Dave obviously has a net worth in very high numbers. He made I think close to $24 million in 2010. So I would say that there are plenty of activities in this world that are unsavory that are committed by people with lots of money. So I don’t regard that as totally puzzling.
But I will give you one instance that makes it very puzzling to me. I’ve told this story privately a few times but not — I don’t think I’ve done it publicly. Walter Scott (a Berkshire board director) came to me a year or two after we’d bought Mid-American and said, I think we ought to have some special compensation arrangement for Dave Sokol. And he said — I think maybe he suggested something involving equity and he saw me turn white. So he said, why don’t you design one.
So I just scribbled something out on a yellow pad. It didn’t take me five minutes. And we call it sort of in honor of Charlie, although he didn’t know about it, we called it the Lollapalooza, and it provided for a very large cash payout based on the five-year compounded gain in earnings, and we were starting from a high base. But if that figure were achieved, we were going to give $50 million to Dave and $25 million to Greg Abel.
And I had Dave come to the office and I said, here’s what Walter and I are thinking, and…he said, you should split it equally between Greg and me instead of being $50 million for me and $25 for Greg. It should be $37 and a half apiece.
So I witnessed — and Walter witnessed, you can talk to him about it — we witnessed Dave transfer over 12 and a half million dollars, getting no fanfare, no credit whatsoever. And what really makes it extraordinary is that $3 million (his gain on the Lubrizol share trade), you know, ten or so years later would have led to the kind of troubles that it’s led to. I find — that — that is really the fact that I find inexplicable.”
Buffett then turned to Munger for a comment. Munger opines: “I think it’s generally a mistake to assume that rationality is going to be perfect even in very able people. We prove that pretty well regularly.” Buffett asks him:” Do you have any explanation for the irrational?” Munger responds, “Yeah. I think hubris contributes to it.”
Buffett signals the end of Munger’s take on things with: “Well. We’ve gotten quite a bit out of him folks.”
“You can always tell a man to go to hell tomorrow”
Carol Loomis of Fortune opens with the first question from the floor: “Why weren’t you angrier when you first heard about Sokol’s trades?” This question was aimed at the press release Buffett sent after Sokol’s resignation praising him for his contributions over the years.
Buffett: “The facts were complicated, and we didn’t foresee appropriately the nature of the reaction. But I feel like you don’t want to make important decisions in anger.”
Munger: “You can always tell a man to go to hell tomorrow.”
Comply With Me
DealBook’s Sorkin follows up with: Why doesn’t Berkshire institute stricter controls?
Buffett suggests that no matter how much time and money a company spends on compliance it is not a guarantee against poor judgment or rogue behavior. “Berkshire’s employee headcount is the size of Omaha. You can’t have 260,000 people work for you and not have something go wrong.”
And he further adds, “If I held myself to a standard of perfection, I would have committed suicide a long time ago.” Then, he offers, “If there’s anything we can do that will make it even more explicit that rules are not made to be danced around … we will do it.”
Munger underscores that the foundation of the company is its best compliance department: “Berkshire is a culture of extreme meritocracy and extreme ethics.”
A shareholder queried the pair on what they had learned from the situation, to which Buffett responded: “What I’ve learned is that I’m going to let Charlie write the next press release.”
The State of the Business Model:
With the topic of Sokol dealt with, the conversation turned to the overall state of Berkshire’s business model. “Basically, all of our businesses, with the exception of those related to residential housing, are getting better. And you can see it with most of them quarter by quarter.” Buffett is warming up to his mantra these days, which is that no one should misunderstand the expectations for returns at a company as large as Berkshire: “We are a cross-section of the economy.”
Buffett answers a question from Loomis posed by me about whether Berkshire is in danger of becoming a ‘go-go’ Sixties conglomerate — a holding company for a collection of random businesses with no synergies. Buffett knows the go-go years, that was when he raised his fund initially. He delivers a short but brilliant recitation on the business model: “Gulf and Western, LTV, and Teledyne — operated a kind of “perpetual motion machine” to keep issuing their overpriced stock to buy lower-valued businesses,” Buffett said. “Most of those companies, though, I think had very little relationship to Berkshire.”
Although Berkshire is a very different conglomerate, he acknowledges there are negatives. These are outweighed, he believes, by the ability to allocate capital from businesses that do not need cash but throw it off to those that do, tax efficiently. Such a situation is best achieved, in Buffett’s opinion, within a conglomerate structure.
He does not need to mention that having such a diverse business portfolio also helps to mitigate risk. And risk is Berkshire’s single biggest concern. Buffett says proudly, “I’m the company’s chief risk officer.”
One challenge of being a multifaceted conglomerate is effectively and accurately describing the financial picture to shareholders. Buffett, unsurprisingly, has strong feelings on this subject too. “Because of our two-pronged approach to business ownership and because of the limitations of conventional accounting, consolidated reported earnings may reveal relatively little about our true economic performance. Charlie and I, both as owners and managers, virtually ignore such consolidated numbers. The challenge for us is to generate ideas as rapidly as we generate cash.” As to those who spend their time crunching such financial statements, both Buffett and Munger claim this is not Berkshire’s method. Munger says he can’t recall Berkshire ever hiring a number-crunching MBA or an investment banker.
Buffett adds: “I don’t think I’ve ever seen a projection from an investment banker that doesn’t show everything going up. It’s like why you don’t ask a barber if you need a haircut.”
The Consequences of Corporate Failure
Given Buffett’s involvement in the process of bailing out some of the firms stricken by the financial crisis many shareholders, both present at the meeting and in the wider community, are curious about his view on government bailouts and it did not take long for the question to be raised. When it comes to corporate failures, he is unequivocal: “There will always be a need for government interventions just as there will always be companies that are too big to fail.” He adds a post script: “Fannie Mae and Freddie Mac are too big to figure out.”
But there have to be serious consequences for the officers and directors who have brought about the need, Buffett says, for requiring government intervention to prevent corporate failure. First of all, CEOs of those companies — along with their spouses — should be left “dead broke.” And the board should pay their fair share too. He suggests such board directors be forced to give back five years of their fees. It is a tough and provocative stance but one that resonates with the audience which cheers its support.
Move over, Mary Schapiro, this is how shareholders want to kick start accountability again.
Commodities
When asked by Sorkin about Berkshire’s indifference to investing in either gold or oil, Buffett responds by saying, “Gold is something you dig up from the ground in South Africa, transport here, and bury it in the ground again at Fort Knox. He continued by saying, “If you collect all the gold in the world and melt it together, you could form a cube with 67 feet on each side.” What would you do with it? “You could get a ladder and climb on top of it and say I’m sitting on top of the world. You could fondle it, you could polish it, you could stare at it.”
As for oil, “It’s in the ground, but the wrong ground.” Finally, we don’t know how to have an edge in picking oil.
Not to be outdone, Munger tosses in the geopolitical perspective. “There’s something peculiar about an asset that will really only go up if the world really goes to hell,” he says. “I think you’d do better by buying our stock.”
Continuing the questioning regarding Berkshire’s investment strategy one shareholder questioned Buffett on the wisdom of the company holding $37 billion in cash and if this is potentially wasteful and unproductive. Buffett’s reply was typically candid: “Our ability to come up with cash when the rest of the world was petrified for some reason has allowed some deals to get done.” He adds, suggesting the future could be just as uncertain. “What if Bernanke runs off with Paris Hilton tomorrow?”
Of course, with so much cash on hand, some investors would like to see some if it returned to investors. CNBC’s Quick pressed Buffett on when, or if, the company would consider paying a dividend, to which Buffett responded, “I think the day Berkshire declares a dividend is a day when the stock goes down,” he says. “As it should.”
Compensation Berkshire Style:
Buffett makes $100,000 per year in base salary but admits, “The present compensation system has no relevance at all to what my successor should earn.” So while the CEO’s check will be bigger, he tells shareholders, “performance and compensation will be aligned and based on market value over time.” He is talking he says about ‘structured options’ and he adds, the next CEO of Berkshire should make a lot of money.
What kind of plan? He offers, “a base salary supplemented by an option system. The strike price should not be less than what Buffett would call the ‘normalized’ market value of the company meaning it reflects a value it would fetch in a fair market, not during a depressed time.” In other words, above market and above water. And a compounding feature that assumes a standard rate of economic growth.
“You have to create long-term shareholder value, not just grab everything you can.”
Climate Change:
Even Berkshire is not immune from CSR issues such as climate change, and the shareholders lining up to ask questions at the end of the day are vigorous in their debate about whether Berkshire needs to set goals reducing greenhouse gases and emissions. Buffett listens intently but keeps his own counsel while Munger busily nibbles See’s Peanut Brittle.
After more than a half-hour of questions and comments from the audience, Buffet speaks out and recommends ‘against’ adopting a definitive GHG and emissions policy on the basis that the matters are complex and could prove distracting for Berkshire management.
Finally, and to no one’s surprise, the vote does not pass.
America:
Carol Loomis poses a question about America’s economic future and why Buffett always seems so bullish about America.
Buffett describes his first days raising his fund, which became Berkshire (“for six years I operated out of my own house and did my own books”). “I don’t know how anyone can be anything but enthused about this country. I was born on August 30,1930. If somebody had come to me in the womb and told me about what it was like outside (the Great Depression)…it would’ve been like the Woody Allen Movie, ‘Go back, go back!’ We have a system that works magnificently. It just gets numbed-up periodically.”
His father-in-law, an anti- New Dealer, told a young Buffett, “Warren you’re going to fail but it’s not your fault. Then at Columbia Business School, his teacher, Bern Graham said in 1951 “stocks have a good future but don’t start now.”
Buffett sums up his rational and long term view with a quote from Adam Smith: a great civilization has a lot of risk in it.
Maybe the greatest proof of his admiration for America as a place to do business is the fact that despite his known abhorrence of taxes, Berkshire pays two percent of all corporate taxes in the U.S.
The legacy”
A shareholder asks Buffett and Munger what they want to be remembered for in 100 years.
Buffett says he wants to be remembered as old. Munger chimes in that he wishes someone at his funeral would comment: “That’s the oldest corpse I ever saw.”
Munger then quotes his father who said everyone should seek to be remembered “for a fortune fairly won and wisely used.”
Buffett makes it plain that it’s not riches he wants to be remembered for. He would like to be known as a teacher and relates that he benefited from some “fabulous teachers,” starting with his father, then his Columbia professor and value investor Ben Graham, and through to current Berkshire board member Tom Murphy, formerly CEO of ABC.
It is an interesting parallel that this 1930’s depression-era baby, having created one of the world’s greatest enterprises largely on the intellectual foundation of common sense value investing and buttressed by an unshakable belief in the spirit of Capitalism and basic American values, went on nearly 80 years later to play a leading role in removing the threat of a second Depression from our shores.
Sidebar: Berkshire’s Governance Philosophy:
Share Ownership by officers and the board of directors: We eat our own cooking. In line with Berkshire’s owner-orientation, most of our directors have a major portion of their net worth invested in the company. Charlie’s family has 90% or more of its net worth in Berkshire shares; my wife, Susie, and I have more than 99%. In addition, many of my relatives-my sisters and cousins, for example-keep a huge portion of their net worth in Berkshire stock.
What’s in it for these two billionaires? It’s how they learn. Prodding and questioning makes them sharper and more focused. Transparency rules and nothing is oblique. Finally, Buffett has an unshakable faith that telling the complete truth is the only way to ensure you won’t be testifying against someone else’s version some years later.
Although Berkshire is a very different conglomerate, he acknowledges there are negatives associated with the model. But these are vastly outweighed, he believes, by the benefits among which are the ability to allocate capital from businesses that do not need cash but throw it off to those that do, tax efficiently.
Another challenge of being a multifaceted conglomerate is effectively and accurately describing the financial picture to shareholders. Buffett, unsurprisingly, has strong feelings on this subject to which he penned in one of his famous shareholder letters: “Because of our two-pronged approach to business ownership and because of the limitations of conventional accounting, consolidated reported earnings may reveal relatively little about our true economic performance. Charlie and I, both as owners and managers, virtually ignore such consolidated numbers. The challenge for us is to generate ideas as rapidly as we generate cash.” As to those who spend their time crunching such financial statements, both Buffett and Munger claim this is not Berkshire’s method. Munger says he can’t recall Berkshire ever hiring a number-crunching MBA or an investment banker.
Buffett adds: “I don’t think I’ve ever seen a projection from an investment banker that doesn’t show everything going up. It’s like why you don’t ask a barber if you need a haircut.”
He does not need to mention that having such a diverse business portfolio also mitigates risk. And risk is Berkshire’s single biggest focus. Buffett says proudly, “I’m the company’s chief risk officer.”
Government Intervention
Risk was certainly on Buffett’s mind during the financial crisis in which Berkshire played a major role — first as a potential buyer for Lehman until their management’s hubris put a deal in front of him that gave the officers a preference over Buffett. Then this was followed by his spectacularly timed investment in Goldman’s preferred offering. So no surprise many in the audience are curious about his views on government bailouts. It does not take long for the question to be raised. When it comes to corporate failures, he is realistic: “There will always be a need for government interventions just as there will always be companies that are too big to fail.” He adds a postscript: “Fannie Mae and Freddie Mac are too big to figure out.”
But Buffett is unequivocal about the serious consequences in store for the officers and directors who he holds accountable: “The CEOs and, he adds, along with their spouses — should be left “dead broke.” And the board should force them to disgorge up to five years of their fees.” It is a tough stance, no doubt, and it resonates with his audience, which cheers him on. Move over, Mary Schapiro, this is what shareholders want from your enforcement division.
Investment Strategy
When asked by Sorkin about Berkshire’s indifference to investing in gold or oil, Buffett responds by saying, “Gold is something you dig up from the ground in South Africa, transport it to the US, bury it in the ground again at Fort Knox. He continued by saying, “If you collect all the gold in the world and melt it together, you could form a cube with 67 feet on each side.” What would you do with it? “You could get a ladder and climb on top of it and say I’m sitting on top of the world. You could fondle it, you could polish it, you could stare at it.”
As for oil, “It’s in the ground, but the wrong ground.” Finally, we (at Berkshire) don’t know how to have an edge in picking oil.
Not to be outdone, Munger tosses in the geopolitical perspective. “There’s something peculiar about an asset that will really only go up if the world really goes to hell,” he says. “I think you’d do better by buying our stock.”
Continuing the performance thread, one shareholder asks about the wisdom of holding so much cash on the books ($37 billion) and whether this is unproductive. Buffett replies that first it is a fixture of his investing philosophy, and was a lesson his father taught him to follow — hold a portion in cash regardless of how robust the environment seems. Then, he reminds the shareholder of the opportunity gain: “Our ability to come up with cash when the rest of the world was petrified for some reason has allowed some deals to get done.” He adds, suggesting the future could be just as uncertain. “What if Bernanke runs off with Paris Hilton tomorrow?”
So if there is too much cash then, CNBC’s Quick pressed Buffett on when, or if, the company would consider paying a dividend, to which Buffett responded, “I think the day Berkshire declares a dividend is a day when the stock goes down,” he says. “As it should.”
A woman from Minnesota caps the discussion by asking about the value of investing in Berkshire versus a no-load mutual fund. Both Buffett and Munger say most investors are better off in an index fund than trying to pick stocks. But Munger says that Berkshire, with its strict reliance on business savvy and fundamentals, would be good as a second investment. Buffett adds: “Charlie’s big on lowering expectations.”
Munger blurts, “Absolutely. That’s how I got married.” The audience roars.
Succession and an independent chair
Berkshire is not as complicated as it is contrarian in so many ways — that any future CEO may require a long learning curve to adapt traditional business thinking to this uniquely built and governed performance machine. The audience is anxious to hear about Berkshire’s next-gen…especially with the specter of Sokol hovering in the background.
Becky Quick relays a shareholder question: “How do you prevent someone as brilliant but deficient in ethical qualities as was David Sokol — from succeeding as the CEO?”
Buffet responds that what he will look for in a successor is “more the quality of a human being than his or her managerial skills because it’s vital that at Berkshire you have someone who cares more about the company than about himself.”
In a second feint at the question, he also recommends splitting the chairman and CEO role. He believes it’s more difficult to remove a CEO if they hold both roles, and “if the CEO is not performing, then it’s nearly impossible.”
Buffett suggests that his son Howard may assume the role of independent — and very much unpaid — chairman of the Berkshire board after he departs. He believes the independent chair is the ultimate “belt and suspenders” guard against the CEO fallibility.
The closest he gets to revealing his druthers for the next CEO is to compare him to Ajit Jain, who oversees Berkshire’s reinsurance businesses. “He’s as rational a thinker as Charlie is. He loves what he does. He’s creative. Ajit’s mind works like a machine, day after day. I don’t know what his best deal was. But I know what mine was, and that was hiring him. He thinks of Berkshire first. He’s just a remarkable human being.”
With governance matters worked out, Buffett turned his attention to management and compensation.
Compensation Berkshire Style:
Buffett makes $100,000 per year in base salary but admits, “The present compensation system has no relevance at all to what my successor should earn.” So while the CEO’s check will be bigger, he tells shareholders, “performance and compensation will be aligned and based on market value over time.” He is talking he says about ‘structured options’ and he adds, the next CEO of Berkshire should make a lot of money.
What kind of plan? He offers, “a base salary supplemented by an option system. The strike price should not be less than what Buffett would call the ‘normalized’ market value meaning the value it would fetch in a true market, not just at a depressed time.” And a compounding feature that assumes a standard rate of economic growth.
“You have to create long-term shareholder value, not just grab everything you can.” More applause.
