Warren Buffett on Business E-Book

Warren Buffett

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 370

Veröffentlichungsjahr: 2009

Beschreibung

The proven business principles of Warren Buffett

Warren Buffett is one of the most admired and prolific investors and managers in corporate America. Warren Buffett on Business is a timeless guide to strategies that can help you run a successful business. This book is a one-of-a-kind collection of Buffett's letters to the shareholders of Berkshire Hathaway written over the past few decades, and in a clear, simple style distills the basic principles of sound business practices.

Through Buffett's own remarkable words, this practical management handbook shares valuable insights on communicating with, and treating employees and shareholders fairly; responsible corporate governance; ethical behavior; patience and perseverance; admitting mistakes; and having a passion for work.

• Contains priceless pearls of business and management wisdom, woven into a delightful narrative
• Designed in an accessible manner and organized by business and management topics with strong lessons from Buffett
• Provides direct, hands-on information on major topics concerning managers, entrepreneurs, business students, and anyone interested in business

Informative and inspiring, this unique book puts Warren Buffett's business beliefs in perspective.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Epigraph

Acknowledgements

Introduction

Chapter 1 - Shareholders as Partners

Chapter 2 - Corporate Culture

Give Warren a Call

Some Thoughts on Selling Your Business

Chapter 3 - Corporate Governance

Accountability and Stewardship

The Audit Committee

Chapter 4 - Berkshire Managers

“How Do You Know When You’re Dealing with an Honest Person?”

Chapter 5 - Communication

Full Disclosure—Both the Good and the Bad

Chapter 6 - Acquisition of Nebraska Furniture Mart

A Business Story Like No Other

Chapter 7 - Acquisition of GEICO

Chapter 8 - Acquisition of General Reinsurance

Derivatives

Chapter 9 - The Assessment and Management of Risk

Chapter 10 - Executive Compensation

Chapter 11 - Time Management

Chapter 12 - How to Manage a Crisis

Background

Contrition

Full Disclosure

A Second Job

A Plan of Action

The Salomon Interlude

Lessons Learned According to Charlie Munger

Lessons Learned According to Buffett

Chapter 13 - Management Principles and Practices

Long-Term Economic Goals

Measuring Managerial Economic Performance

Businesses—the Great, the Good, and the Gruesome

Cost of Capital

Capital Allocation

Dividend Policy

Franchises, Businesses, and Moats

Acquisition Policies

Planning and Administrative Practices

Hiring Policies

Debt and Costs

Stock Ownership and Stock Activity

Chapter 14 - Executive Behavior

Chapter 15 - Mistakes I’ve Made

Mistakes of the First Twenty-Five Years (A Condensed Version)

Mistake Du Jour

Chapter 16 - Personal Investing

The Only Investment Advice You Will Ever Need

Aesop’s Investment Axiom

How We Think About Market Fluctuations

Excerpt from the Warren Buffett Article, “The Superinvestors of Graham-And-Doddsville”

Chapter 17 - Buffett, the Teacher

Cynthia Milligan Interview

Speech before University of Florida MBA Students—September 4, 2006

Chapter 18 - Humor and Stories

Appendix A - Warren E. Buffett, A Chronological History

Appendix B - Berkshire Hathaway Inc., An Owner’s Manual, Owner-Related Business ...

Appendix C - Berkshire Hathaway Inc., Code of Business Conduct and Ethics

Appendix D - July 23, 2008, Memo to Berkshire Hathaway Managers

Appendix E - Berkshire Hathaway Inc., Corporate Governance Guidelines, as ...

Appendix F - Intrinsic Value

Appendix G - The Superinvestors of Graham-and-Doddsville

Appendix H - Berkshire’s Corporate Performance versus the S&P 500

Appendix I - Berkshire Hathaway Common Stock

Notes

About the Author

Copyright © 2010 by Richard J. Connors. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax [phone], or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax [phone], or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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Library of Congress Cataloging-in-Publication Data:

Connors, Richard J., 1940-

Warren Buffett on business : principles from the sage of Omaha/Richard J. Connors.

p. cm.

Includes bibliographical references.

eISBN : 978-0-470-57071-5

1. Management. 2. Buffett, Warren. 3. Berkshire Hathaway Inc.—Management. I. Title.

HD31.C6244 2010

658—dc22

2009024946

To my father, a great investor, who would have loved to have met Warren Buffett

To my grandchildren, Bridget, Frankie, Richie, Patrick, Catherine, and Sean

I wish I knew what I know now when I was younger.

—ROD STEWART

The wisdom of the wise, and the experience of ages, may be preserved by quotation.

—ISAAC DISRAELI

Acknowledgments

Unknowingly, this book began in April 2006, when I wrote Judith Schwartz, the executive director of the Washington University in St. Louis Lifelong Learning Institute (LLI) proposing a course on Warren Buffett. Rather than throwing the letter away, she forwarded it to Harry Estill. After several planning meetings with Harry and Butch Sterbenz, the course was born. Thanks to Charlie Moore of the LLI for his encouragement and input. I thank them all for their interest and support and the LLI for its great facility, and its administrators and volunteers for their extraordinary contribution to the senior citizens in St. Louis.

I thank the many participants who have attended the course over the past three years. Their enthusiasm and participation were all A+. At the last class of each course, we feasted on Cherry Cokes, See’s Candies, and Dairy Queen, all Warren ’s favorites. We had a lot of fun.

Thanks to Bob Shirrell, Alice Aslin, Bob Leggat and Bob Leonard for their early readings of the first draft. I am blessed to have signed up with John Wiley & Sons and its wonderful team, especially Debra Englander, Adrianna Johnson, Judy Howarth, and Mary Daniello. They had to work with a totally inexperienced rookie. Also, I thank Emma Harris who worked tirelessly to produce the initial electronic version of the manuscript and to Carrie Kizer, an assistant to Warren, who always promptly responded to my e-mails.

Last, and most importantly, I thank Warren for his time and extraordinary generous support over the past three years. Whenever I e-mailed him about my course or the book, I always received a quick response, usually the next day. He always had time for me, for which I will always be grateful.

Introduction

Most books written about Warren Buffett have focused on how he invests and how you can invest just like him. When I am asked “How can I invest like Warren Buffett?,” my answer is simple and direct: Buy either Berkshire Class A or Class B stock. In his 1987 Berkshire stockholder letter, Buffett also advised, “If they want to participate in whatever Berkshire is buying they can always purchase Berkshire stock. But perhaps that is too simple.”1 Buffett also says that most individual investors should purchase stock index funds because they are very low cost and they outperform most professional investment managers. In January 2008, to prove his point, Buffett entered into a bet (each side put up roughly $320,000, with the final proceeds going to the winner’s favorite charity) with Protege Partners, a fund-of-funds hedge fund, that their handpicked funds will not beat the S&P 500 index over the next 10 years. A principal of Protege said, “Fortunately, for us, we ’re betting against the S&P’s performance, not Buffett’s.”2

For the past three years, I have presented a course on Buffett at the Washington University in St. Louis Lifelong Learning Institute. It all began in April 2006, when I sent a letter to Buffett telling him that I was going to present the course. Four days later, he wrote back encouraging me and supporting the course. I was very excited to receive his letter, but no more than the woman who framed it for display on my office wall. Since then, Buffett and I have regularly exchanged e-mails about the course. In January 2007, at his invitation, I traveled to Omaha and met him in his office. As busy as he is, he has always had time for me.

This book is different. It is not about how Buffett invests or how you can invest like him. Rather, it is about his business management principles and practices. It is about his way of communicating with and treating employees and shareholders fairly and honestly; responsible corporate governance; ethical behavior; patience and perseverance; admitting mistakes; having a passion for work; and having fun and a sense of humor. Can all this be learned from one man? In my view, yes. There are some people who are simply so unique, so very special, that no words can do them justice. His genius is in his character. His integrity is unsurpassed. His patience, discipline, and rationality are extraordinary.

The Buffett/Berkshire Hathaway model of managing a business, large or small, should be required reading for all business executives, entrepreneurs, and business school students. Shareholders, employees, and the public would all benefit by employing his management principles and by emulating his straightforward, genuine, and sincere behavior. His ideas and philosophy of life will last far beyond his own. When you strip it all away, effective business management—the Warren Buffett way—is remarkably obvious and simple. He describes his business principles as “simple, old, and few.”3

In the words of Charlie Rose, “When we spend a year with someone in conversations in a variety of places, you learn what makes them tick. What do you come away with from conversations with Warren Buffett? It is his passion for his company, passion for his friends, passion for his work and a passion for living life. This is a man that has fun.”4

This book is mainly a carefully selected compilation, by topic, in Buffett’s own words from his Berkshire Hathaway shareholders letters, written over four decades (1977-2008). My most difficult task was deciding what not to include. I strongly urge you to read his letters in their entirety. They are freely available on the Berkshire Hathaway web site. Also, I recommend you read the Intelligent Investor by Benjamin Graham.

I hope this book will both educate and inspire you to be a better manager.

Chapter 1

Shareholders as Partners

Although our form is corporate, our attitude is partnership.Charlie Munger and I think of our shareholders as owners- partners, and ourselves as managing partners. . . . We do notview the company itself as the owner of our business assets butinstead view the company as a conduit through which ourshareholders own the assets.1

CEOs must embrace stewardship as a way of life and treat their owners as partners not patsies. It’s time for CEOs to walk the walk.2

—WARREN BUFFETT

Charlie and I hope that you do not think of yourself as merely owning a piece of paper whose price wiggles around daily and that is a candidate for sale when some economic or political event makes you nervous. We hope you instead visualize yourself as a part owner of a business that you expect to stay with indefinitely, much as you might if you owned a farm or apartment house in partnership with members of your family. For our part, we do not view Berkshire shareholders as faceless members of an ever-shifting crowd, but rather as co-venturers who have entrusted their funds to us for what may well turn out to be the remainder of their lives.

The evidence suggests that most Berkshire shareholders have indeed embraced this long-term partnership concept. The annual percentage turnover in Berkshire’s shares is a small fraction of that occurring in the stocks of other major American corporations, even when the shares I own are excluded from the calculation.

In effect, our shareholders behave in respect to their Berkshire stock much as Berkshire itself behaves in respect to companies in which it has an investment. As owners of, say, Coca-Cola or Gillette shares, we think of Berkshire as being a non-managing partner in two extraordinary businesses, in which we measure our success by the long-term progress of the companies rather than by the month-to-month movements of their stocks. In fact, we would not care in the least if several years went by in which there was no trading, or quotation of prices, in the stocks of those companies. If we have good long-term expectations, short-term price changes are meaningless for us except to the extent they offer us an opportunity to increase our ownership at an attractive price.

Charlie and I cannot promise you results. But we can guarantee that your financial fortunes will move in lockstep with ours for whatever period of time you elect to be our partner. We have no interest in large salaries or options or other means of gaining an “edge” over you. We want to make money only when our partners do and in exactly the same proportion. Moreover, when I do something dumb, I want you to be able to derive some solace from the fact that my financial suffering is proportional to yours.3

At Berkshire, we believe that the company’s money is the owners’ money, just as it would be in a closely-held corporation, partnership, or sole proprietorship.4

What we promise you—along with more modest gains—is that during your ownership of Berkshire, you will fare just as Charlie and I do. If you suffer, we will suffer; if we prosper, so will you. And we will not break this bond by introducing compensation arrangements that give us a greater participation in the upside than the downside.

We further promise you that our personal fortunes will remain overwhelmingly concentrated in Berkshire shares: We will not ask you to invest with us and then put our own money elsewhere. In addition, Berkshire dominates both the investment portfolios of most members of our families and of a great many friends who belonged to partnerships that Charlie and I ran in the 1960s. We could not be more motivated to do our best.5

Though our primary goal is to maximize the amount that our shareholders, in total, reap from their ownership of Berkshire, we wish also to minimize the benefits going to some shareholders at the expense of others. These are goals we would have were we managing a family partnership, and we believe they make equal sense for the manager of a public company. In a partnership, fairness requires that partnership interests be valued equitably when partners enter or exit; in a public company, fairness prevails when market price and intrinsic value are in sync. Obviously, they won’t always meet that ideal, but a manager—by his policies and communications—can do much to foster equity.6

Chapter 2

Corporate Culture

Why Don’t More Companies and Investors Copy BerkshireHathaway? It’s a good question. Our approach has worked forus. Look at the fun we, our managers and our shareholders arehaving. More people should copy us. It’s not difficult, but itlooks difficult because it’s unconventional—it isn’t the waythings are normally done. We have low overhead, don’t havequarterly goals and budgets or a standard personnel system, andour investing is much more concentrated than is the average. It’ssimple and common sense.1

—CHARLIE MUNGER

The priority is that all of us continue to zealously guard Berkshire’s reputation. We can’t be perfect but we can try to be. . . . We can afford to lose money—even a lot of money. But we can’t afford to lose reputation—even a shred of reputation. We must continue to measure every act against not only what is legal but also what we would be happy to have written about on the front page of a national newspaper in an article written by an unfriendly but intelligent reporter.2

—WARREN BUFFETT

I think we have a very good culture virtually everyplace inBerkshire. I hope it’s everyplace. This is what we are lookingfor, and it’s more a question of culture than controls. If you havea good culture, I think you can make the rules pretty simple.3

—WARREN BUFFETT

Give Warren a Call

Our long-avowed goal is to be the “buyer of choice” for businesses—particularly those built and owned by families. The way to achieve this goal is to deserve it. That means we must keep our promises; avoid leveraging up acquired businesses; grant unusual autonomy to our managers; and hold the purchased companies through thick and thin (though we prefer thick and thicker).

Our record matches our rhetoric. Most buyers competing against us, however, follow a different path. For them, acquisitions are “merchandise.” Before the ink dries on their purchase contracts, these operators are contemplating “exit strategies.” We have a decided advantage, therefore, when we encounter sellers who truly care about the future of their businesses.

Some years back our competitors were known as “leveraged-buyout operators.” But LBO became a bad name. So in Orwellian fashion, the buyout firms decided to change their moniker. What they did not change, though, were the essential ingredients of their previous operations, including their cherished fee structures and love of leverage.

Their new label became “private equity,” a name that turns the facts upside-down: A purchase of a business by these firms almost invariably results in dramatic reductions in the equity portion of the acquiree’s capital structure compared to that previously existing. A number of these acquirees, purchased only two to three years ago, are now in mortal danger because of the debt piled on them by their private-equity buyers. Much of the bank debt is selling below 70¢ on the dollar, and the public debt has taken a far greater beating. The private equity firms, it should be noted, are not rushing in to inject the equity their wards now desperately need. Instead, they’ re keeping their remaining funds very private.4

If we fail, we will have no excuses. Charlie and I operate in an ideal environment. To begin with, we are supported by an incredible group of men and women who run our operating units. If there were a Corporate Cooperstown, its roster would surely include many of our CEOs. Any shortfall in Berkshire’s results will not be caused by our managers.

Additionally, we enjoy a rare sort of managerial freedom. Most companies are saddled with institutional constraints. A company’s history, for example, may commit it to an industry that now offers limited opportunity. A more common problem is a shareholder constituency that pressures its manager to dance to Wall Street’s tune. Many CEOs resist, but others give in and adopt operating and capital allocation policies far different from those they would choose if left to themselves.

At Berkshire, neither history nor the demands of owners impede intelligent decision-making. When Charlie and I make mistakes, they are—in tennis parlance—unforced errors.5

Very few CEOs of public companies operate under a similar mandate, mainly because they have owners who focus on short-term prospects and reported earnings. Berkshire, however, has a shareholder base—which it will have for decades to come—that has the longest investment horizon to be found in the public-company universe. Indeed, a majority of our shares are held by investors who expect to die still holding them. We can therefore ask our CEOs to manage for maximum long-term value, rather than for next quarter’s earnings. We certainly don’t ignore the current results of our businesses—in most cases, they are of great importance—but we never want them to be achieved at the expense of our building ever-greater competitive strengths.6

We find it meaningful when an owner cares about whom he sells to. We like to do business with someone who loves his company, not just the money that a sale will bring him (though we certainly understand why he likes that as well). When this emotional attachment exists, it signals that important qualities will likely be found within the business: honest accounting, pride of product, respect for customers, and a loyal group of associates having a strong sense of direction. The reverse is apt to be true, also. When an owner auctions off his business, exhibiting a total lack of interest in what follows, you will frequently find that it has been dressed up for sale, particularly when the seller is a “financial owner.” And if owners behave with little regard for their business and its people, their conduct will often contaminate attitudes and practices throughout the company.

When a business masterpiece has been created by a lifetime—or several lifetimes—of unstinting care and exceptional talent, it should be important to the owner what corporation is entrusted to carry on its history. Charlie and I believe Berkshire provides an almost unique home. We take our obligations to the people who created a business very seriously, and Berkshire’s ownership structure ensures that we can fulfill our promises.

How much better it is for the “painter” of a business Rembrandt to personally select its permanent home than to have a trust officer or uninterested heirs auction it off. Throughout the years we have had great experiences with those who recognize that truth and apply it to their business creations. We’ll leave the auctions to others.7

I think there’s more chance of our corporate culture being maintained intact for many decades than any company I can think of. We have a board that’s bought into it entirely. They’ re big owners themselves in almost every case. They’ve seen it work. We’ve got 70 managers at 76 businesses out there. They have come to us because of that culture. They’ve seen it work, too. You’ve had it communicated through annual reports, at annual meetings. I think it’s as strong a culture as you could possibly have. I think that anybody that tried to fool with it would not be around here very long and the fact is that I would come back and haunt them, too.8

They would not have sold to anybody but us. It’s that simple because they know what they’ re getting. They know what museum they’ re going into. They know that their picture is going to hang there and not get stuck in the basement, and they know that we ’re not going to come in and tell somebody to paint over it.9

We will not engage in unfriendly takeovers. We can promise complete confidentiality and a very fast answer—customarily within five minutes—as to whether we’ re interested. (With Brown, we didn’t even need to take five.) We prefer to buy for cash, but will consider issuing stock when we receive as much in intrinsic business value as we give.10

Unlike many business buyers, Berkshire has no “exit strategy.” We buy to keep. We do, though, have an entrance strategy, looking for businesses in this country or abroad that meet our six criteria and are available at a price that will produce a reasonable return. If you have a business that fits, give me a call. Like a hopeful teenage girl, I’ll be waiting by the phone.11

Sometimes your associates will say “Everybody else is doing it.” This rationale is almost always a bad one if it is the main justification for a business action. It is totally unacceptable when evaluating a moral decision. Whenever somebody offers that phrase as a rationale, in effect they are saying that they can’t come up with a good reason. If anyone offers this explanation, tell them to try using it with a reporter or a judge and see how far it gets them.12

Our culture is very old-fashioned, like Ben Franklin’s or Andrew Carnegie’s. Can you imagine Carnegie hiring consultants? It’s amazing how well this approach still works. A lot of the businesses we buy are kind of cranky and old-fashioned like us.

For many of our shareholders, our stock is all they own, and we’ re acutely aware of that. Our culture (of conservatism) runs pretty deep. This is an amazingly sound place. We are more disaster-resistant than most other places. We haven’t pushed it as hard as other people would have pushed it.13

Some Thoughts on Selling Your Businessa

Dear _____________:

Here are a few thoughts pursuant to our conversation of the other day.

Most business owners spend the better part of their lifetimes building their businesses. By experience built upon endless repetition, they sharpen their skills in merchandising, purchasing, personnel selection, etc. It’s a learning process, and mistakes made in one year often contribute to competence and success in succeeding years.

In contrast, owner-managers sell their business only once—frequently in an emotionally charged atmosphere with a multitude of pressures coming from different directions. Often, much of the pressure comes from brokers whose compensation is contingent upon consummation of a sale, regardless of its consequences for both buyer and seller. The fact that the decision is so important, both financially and personally, to the owner can make the process more, rather than less, prone to error. And, mistakes made in the once -in-a-lifetime sale of a business are not reversible.

Price is very important, but often is not the most critical aspect of the sale. You and your family have an extraordinary business—one of a kind in your field—and any buyer is going to recognize that. It’s also a business that is going to get more valuable as the years go by. So if you decide not to sell now, you are very likely to realize more money later on. With that knowledge you can deal from strength and take the time required to select the buyer you want.

If you should decide to sell, I think Berkshire Hathaway offers some advantages that most other buyers do not. Practically all of these buyers will fall into one of two categories:

1. A company located elsewhere but operating in your business or in a business somewhat akin to yours. Such a buyer—no matter what promises are made—will usually have managers who feel they know how to run your business operations and, sooner or later, will want to apply some hands-on “help.” If the acquiring company is much larger, it often will have squads of managers, recruited over the years in part by promises that they will get to run future acquisitions. They will have their own way of doing things and, even though your business record undoubtedly will be far better than theirs, human nature will at some point cause them to believe that their methods of operating are superior. You and your family probably have friends who have sold their businesses to larger companies, and I suspect that their experiences will confirm the tendency of parent companies to take over the running of their subsidiaries, particularly when the parent knows the industry, or thinks it does.

2. A financial maneuverer, invariably operating with large amounts of borrowed money, who plans to resell either to the public or to another corporation as soon as the time is favorable. Frequently, this buyer’s major contribution will be to change accounting methods so that earnings can be presented in the most favorable light just prior to his bailing out. I’ m enclosing a recent article that describes this sort of transaction, which is becoming much more frequent because of a rising stock market and the great supply of funds available for such transactions.

If the sole motive of the present owners is to cash their chips and put the business behind them—and plenty of sellers fall in this category—either type of buyer that I’ve just described is satisfactory. But if the sellers’ business represents the creative work of a lifetime and forms an integral part of their personality and sense of being, buyers of either type have serious flaws.

Berkshire is another kind of buyer—a rather unusual one. We buy to keep, but we don’t have, and don’t expect to have, operating people in our parent organization. All of the businesses we own are run autonomously to an extraordinary degree. In most cases, the managers of important businesses we have owned for many years have not been to Omaha or even met each other. When we buy a business, the sellers go on running it just as they did before the sale; we adapt to their methods rather than vice versa.

We have no one—family, recently recruited MBAs, etc.—to whom we have promised a chance to run businesses we have bought from owner-managers. And we won’t have.

You know of some of our past purchases. I ’m enclosing a list of everyone from whom we have ever bought a business, and I invite you to check with them as to our performance versus our promises. You should be particularly interested in checking with the few whose businesses did not do well in order to ascertain how we behaved under difficult conditions.

Any buyer will tell you that he needs you personally—and if he has any brains, he most certainly does need you. But a great many buyers, for the reasons mentioned above, don’t match their subsequent actions to their earlier words. We will behave exactly as promised, both because we have so promised, and because we need to in order to achieve the best business results.

This need explains why we would want the operating members of your family to retain a 20% interest in the business. We need 80% to consolidate earnings for tax purposes, which is a step important to us. It is equally important to us that the family members who run the business remain as owners. Very simply, we would not want to buy unless we felt key members of present management would stay on as our partners. Contracts cannot guarantee your continued interest; we would simply rely on your word.

The areas I get involved in are capital allocation and selection and compensation of the top man. Other personnel decisions, operating strategies, etc. are his bailiwick. Some Berkshire managers talk over some of their decisions with me; some don’t. It depends upon their personalities and, to an extent, upon their own personal relationship with me.

If you should decide to do business with Berkshire, we would pay in cash. Your business would not be used as collateral for any loan by Berkshire. There would be no brokers involved.

Furthermore, there would be no chance that a deal would be announced and that the buyer would then back off or start suggesting adjustments (with apologies, of course, and with an explanation that banks, lawyers, boards of directors, etc. were to be blamed). And finally, you would know exactly with whom you are dealing. You would not have one executive negotiate the deal only to have someone else in charge a few years later, or have the president regretfully tell you that his board of directors required this change or that (or possibly required sale of your business to finance some new interest of the parent’s).

It’s only fair to tell you that you would be no richer after the sale than now. The ownership of your business already makes you wealthy and soundly invested. A sale would change the form of your wealth, but it wouldn’t change its amount. If you sell, you will have exchanged a 100%-owned valuable asset that you understand for another valuable asset—cash—that will probably be invested in small pieces (stocks) of other businesses that you understand less well. There is often a sound reason to sell but, if the transaction is a fair one, the reason is not so that the seller can become wealthier.

I will not pester you; if you have any possible interest in selling, I would appreciate your call. I would be extraordinarily proud to have Berkshire, along with the key members of your family, own _______; I believe we would do very well financially; and I believe you would have just as much fun running the business over the next 20 years as you have had during the past 20.

Sincerely,

Warren E. Buffett14

Chapter 3

Corporate Governance

If able but greedy managers overreach and try to dip too deeply into the shareholders’ pockets, directors must slap their hands.1

—WARREN BUFFETT

Accountability and Stewardship

True independence—meaning the willingness to challenge a forceful CEO when something is wrong or foolish—is an enormously valuable trait in a director. It is also rare. The place to look for it is among high - grade people whose interests are in line with those of rank-and-file shareholders—and are in line in a very big way.

We’ve made that search at Berkshire. We now have eleven directors and each of them, combined with members of their families, owns more than $4 million of Berkshire stock. Moreover, all have held major stakes in Berkshire for many years. In the case of six of the eleven, family ownership amounts to at least hundreds of millions and dates back at least three decades. All eleven directors purchased their holdings in the market just as you did; we’ve never passed out options or restricted shares. Charlie and I love such honest-to-God ownership. After all, who ever washes a rental car? In addition, director fees at Berkshire are nominal (as my son, Howard, periodically reminds me). Thus, the upside from Berkshire for all eleven is proportionately the same as the upside for any Berkshire shareholder. And it always will be.

The downside for Berkshire directors is actually worse than yours because we carry no directors and officers liability insurance. Therefore, if something really catastrophic happens on our directors’ watch, they are exposed to losses that will far exceed yours.

The bottom line for our directors: You win, they win big; you lose, they lose big. Our approach might be called owner-capitalism. We know of no better way to engender true independence. (This structure does not guarantee perfect behavior, however: I’ve sat on boards of companies in which Berkshire had huge stakes and remained silent as questionable proposals were rubber-stamped.)

In addition to being independent, directors should have business savvy, a shareholder orientation and a genuine interest in the company. The rarest of these qualities is business savvy—and if it is lacking, the other two are of little help. Many people who are smart, articulate and admired have no real understanding of business. That’s no sin; they may shine elsewhere. But they don’t belong on corporate boards. Similarly, I would be useless on a medical or scientific board (though I would likely be welcomed by a chairman who wanted to run things his way). My name would dress up the list of directors, but I wouldn’t know enough to critically evaluate proposals. Moreover, to cloak my ignorance, I would keep my mouth shut (if you can imagine that). In effect, I could be replaced, without loss, by a potted plant.

Last year, as we moved to change our board, I asked for self-nominations from shareholders who believed they had the requisite qualities to be a Berkshire director. Despite the lack of either liability insurance or meaningful compensation, we received more than twenty applications. Most were good, coming from owner-oriented individuals having family holdings of Berkshire worth well over $1 million. After considering them, Charlie and I—with the concurrence of our incumbent directors—asked four shareholders who did not nominate themselves to join the board: David Gottesman, Charlotte Guyman, Don Keough and Tom Murphy. These four people are all friends of mine, and I know their strengths well. They bring an extraordinary amount of business talent to Berkshire’s board.2

Both the ability and fidelity of managers have long needed monitoring. Indeed, nearly 2,000 years ago, Jesus Christ addressed this subject, speaking (Luke 16:2) approvingly of “a certain rich man” who told his manager, “Give an account of thy stewardship; for thou mayest no longer be steward.”

Accountability and stewardship withered in the last decade, becoming qualities deemed of little importance by those caught up in the Great Bubble. As stock prices went up, the behavioral norms of managers went down. By the late ’90s, as a result, CEOs who traveled the high road did not encounter heavy traffic.

Most CEOs, it should be noted, are men and women you would be happy to have as trustees for our children’s assets or as next-door neighbors. Too many of these people, however, have in recent years behaved badly at the office, fudging numbers and drawing obscene pay for mediocre business achievements. These otherwise decent people simply followed the career path of Mae West: “I was Snow White but I drifted.”

In theory, corporate boards should have prevented this deterioration of conduct. I last wrote about the responsibilities of directors in the 1993 annual report. (We will send you a copy of this discussion on request, or you may read it on the Internet in the Corporate Governance section of the 1993 letter.) There, I said that directors “should behave as if there was a single absentee owner, whose long-term interest they should try to further in all proper ways.”This means that directors must get rid of a manager who is mediocre or worse, no matter how likable he may be. Directors must react as did the chorus - girl bride of an 85-year-old multimillionaire when he asked whether she would love him if he lost his money. “Of course,” the young beauty replied, “I would miss you, but I would still love you.”

In the 1993 annual report, I also said directors had another job: “If able but greedy managers overreach and try to dip too deeply into the shareholders’ pockets, directors must slap their hands.” Since I wrote that, over-reaching has become common but few hands have been slapped.

Why have intelligent and decent directors failed so miserably? The answer lies not in inadequate laws—it’s always been clear that directors are obligated to represent the interests of shareholders—but rather in what I’d call “boardroom atmosphere.”3

It’s almost impossible, for example, in a boardroom populated by well - mannered people, to raise the question of whether the CEO should be replaced. It’s equally awkward to question a proposed acquisition that has been endorsed by the CEO, particularly when his inside staff and outside advisors are present and unanimously support his decision. (They wouldn’t be in the room if they didn’t.) Finally, when the compensation committee—armed, as always, with support from a high-paid consultant—reports on a megagrant of options to the CEO, it would be like belching at the dinner table for a director to suggest that the committee reconsider.

These “social” difficulties argue for outside directors regularly meeting without the CEO—a reform that is being instituted and that I enthusiastically endorse. I doubt, however, that most of the other new governance rules and recommendations will provide benefits commensurate with the monetary and other costs they impose.

The current cry is for “independent” directors. It is certainly true that it is desirable to have directors who think and speak independently—but they must also be business-savvy, interested and shareholder oriented.

In my 1993 commentary, those are the three qualities I described as essential. Over a span of 40 years, I have been on 19 public-company boards (excluding Berkshire’s) and have interacted with perhaps 250 directors. Most of them were “independent” as defined by today’s rules. But the great majority of these directors lacked at least one of the three qualities I value. As a result, their contribution to shareholder well-being was minimal at best and, too often, negative. These people, decent and intelligent though they were, simply did not know enough about business and/or care enough about shareholders to question foolish acquisitions or egregious compensation. My own behavior, I must ruefully add, frequently fell short as well: Too often I was silent when management made proposals that I judged to be counter to the interests of shareholders. In those cases, collegiality trumped independence.4

Rules that have been proposed and that are almost certain to go into effect will require changes in Berkshire’s board, obliging us to add directors who meet the codified requirements for “independence.”

Doing so, we will add a test that we believe is important, but far from determinative, in fostering independence: We will select directors who have huge and true ownership interests (that is, stock that they or their family have purchased, not been given by Berkshire or received via options), expecting those interests to influence their actions to a degree that dwarfs other considerations such as prestige and board fees.

That gets to an often-overlooked point about directors’ compensation, which at public companies averages perhaps $50,000 annually. It baffles me how the many directors who look to these dollars for perhaps 20% or more of their annual income can be considered independent when Ron Olson, for example, who is on our board, may be deemed not independent because he receives a tiny percentage of his very large income from Berkshire legal fees. As the investment company saga suggests, a director whose moderate income is heavily dependent on directors’ fees—and who hopes mightily to be invited to join other boards in order to earn more fees—is highly unlikely to offend a CEO or fellow directors, who in a major way will determine his reputation in corporate circles. If regulators believe that “significant ” money taints independence (and it certainly can), they have overlooked a massive class of possible offenders.

At Berkshire, wanting our fees to be meaningless to our directors, we pay them only a pittance. Additionally, not wanting to insulate our directors from any corporate disaster we might have, we don’t provide them with officers’ and directors’ liability insurance (an unorthodoxy that, not so incidentally, has saved our shareholders many millions of dollars over the years). Basically, we want the behavior of our directors to be driven by the effect their decisions will have on their family’s net worth, not by their compensation. That’s the equation for Charlie and me as managers, and we think it’s the right one for Berkshire directors as well.

To find new directors, we will look through our shareholders list for people who directly, or in their family, have had large Berkshire holdings—in the millions of dollars—for a long time. Individuals making that cut should automatically meet two of our tests, namely that they be interested in Berkshire and shareholder-oriented. In our third test, we will look for business savvy, a competence that is far from commonplace.

Finally, we will continue to have members of the Buffett family on the board. They are not there to run the business after I die, nor will they then receive compensation of any kind. Their purpose is to ensure, for both our shareholders and managers, that Berkshire’s special culture will be nurtured when I’ m succeeded by other CEOs.

Any change we make in the composition of our board will not alter the way Charlie and I run Berkshire. We will continue to emphasize substance over form in our work and waste as little time as possible during board meetings in show -and-tell and perfunctory activities. The most important job of our board is likely to be the selection of successors to Charlie and me, and that is a matter upon which it will focus.

The board we have had up to now has overseen a shareholder - oriented business, consistently run in accord with the economic principles set forth on pages 68-74 of the Owner’s Manual (which I urge all new shareholders to read).

Our goal is to obtain new directors who are equally devoted to those principles.5

I can’t resist mentioning that Jesus understood the calibration of independence far more clearly than do the protesting institutions. In Matthew 6:21, he observed: “For where your treasure is, there will your heart be also.” Even to an institutional investor, $8 billion should qualify as “treasure” that dwarfs any profits Berkshire might earn on its routine transactions with Coke.

Measured by the biblical standard, the Berkshire board is a model: (a) every director is a member of a family owning at least $4 million of stock; (b) none of these shares were acquired from Berkshire via options or grants; (c) no directors receive committee, consulting or board fees from the company that are more than a tiny portion of their annual income; and (d) although we have a standard corporate indemnity arrangement, we carry no liability insurance for directors.

At Berkshire, board members travel the same road as shareholders.6