Investment Wisdom

68. Wesco Financial Annual Meeting 2005: Lessons Learned – Part 1 – Points 1 – 6

Excellent Book: Charlie Munger For All Seasons

1. High Quality Individuals Joined The Berkshire Hathaway Board For Very Little Money. Why? Lollapalooza of Integrity, Trust and Ability.


I feel a duty in these later years to talk a little bit because so many of you have come so far and therefore I’m going to talk a little about current change conditions in corporate governance, the investment world, how we’re adapting at Berkshire Hathaway and Wesco, and how you might face these challenges.

First, corporate governance. We’re having a mild revolution in corporate governance. Congress passed rules requiring that a majority of directors be independent, which has affected all kinds of companies, including Berkshire Hathaway and Wesco. At Costco, we added Bill Gates Sr. [actually, Bill Gates’s father is Jr. and Bill Gates, the head of Microsoft, is Bill Gates III (hence the nickname “Trey”), but everyone calls them Sr. and Jr.] and Daniel Evans – I like to see young people joining the board. [Laughter. Gates and Evans are both 79 years old.]

I think it’s a plus at Berkshire Hathaway. We have a very able, brilliant group of shareholders. We pay a pittance but everyone we asked [to join our board] agreed to come aboard: Bill Gates, Sandy Gottesman, Tom Murphy, Don Keough, Charlotte Guyman – there’s a couple of billion dollars of Berkshire Hathaway stock in the Gottesman family.

2. Sarbanes-Oxley creates all kinds of oaths and compliance procedures. One thing it caused was an enormous increase in costs. Overall, there needs to be deserved trust.

Then they passed Sarbanes-Oxley, which creates all kinds of oaths and compliance procedures. One thing it caused was an enormous increase in costs. The auditors must certify the internal controls. At Berkshire Hathaway, including Wesco, this used to cost $200,000 but now it’s in the multiple millions. It’s not all wasted though – only about 80% is wasted. (Laughter)

There are some results to the good. But the cost of being a publicly traded stock has gone way, way up. It doesn’t make sense for a little company to be public anymore. A lot of little companies are going private to be rid of these burdensome requirements.

The problem is that you can require people to solemnly swear that their financials are accurate, but the only way to do it is to trust a lot of other people. That’s what they did before and that’s what they do now. I think someone in Congress thought that the President of Exxon would run around and count the barrels of oil. Well, it’s not going to happen. There needs to be deserved trust.

I think the current requirements are good. It makes it easier to prosecute crooks. But for the organization and for ordinary people, I don’t think Sarbanes-Oxley will create a lot of control.

3. Press Coverage On Scandals Can Have Good Effect On Corporate Bevaior


But another change is having a dramatic effect on corporate governance and behavior – that’s the widespread scandal and press coverage which has caused shame, disgrace, personal legal costs, and ruined many lives. That has changed behavior – even more so than in the past, during the price-fixing scandal when they carted executives off to jail. That had an effect [but the current scandals are having more of an effect].

This wave of scandal and widespread press coverage has had an unbelievably strong impact on corporation behavior – it’s overdue. Think of the publicity of Enron, WorldCom and Tyco. And the mutual fund industry – many firms had some whiff of scandal. Personally, I think what happened to the Strong funds was an outrage. The independent directors found him stealing, but instead of firing him and finding another manager for the funds, they instead allowed him to sell the firm. This shows how permissive and evil a culture can become.

Kudos to Spitzer

Prosecutors have used the press instead of relying on quiet lawyerly procedures. Personally, I’m in favor of this approach. While some have claimed that this is abusive, 99% of the time it’s not. As far I’m concerned Eliot Spitzer has behaved very well and has done a lot of good. He’s caused a lot of reforms the SEC wouldn’t have caused.

4. Lawyers Are Paid By The Hours Like Due Process. Story: Lawyer who goes to hell and all he gets is endless due process and no decision.

Some claim that those targeted by Spitzer are not getting due process, but only lawyers like endless due process – they get paid by the hour. It reminds me of the story about the lawyer who goes to hell and all he gets is endless due process and no decision. There’s been a tremendous change in behavior. In the insurance business, I’d say it’s changed virtually overnight. All kinds of gamey insurance products which fall under financial reinsurance – a meaningless term, by the way – you couldn’t get written today.

5. Short-Termism: Too Much Focus On Quarterly Earnings Is Not Necessarily A Good Thing


In many corporations, there’s an obsession with meeting quarterly earnings targets. To do so, they’d fudge a little, sell stock at a capital gain, sell a building or two… Then, if that wasn’t enough, they’d engage in channel stuffing – if you were selling through a middleman, you could unload your product at the end of the quarter and make the current quarter look better, but of course the next quarter would be worse. It went on a lot and the penalties were pretty light. For many major pharmaceutical, consumer products and software companies, at the end of quarter, this was very common. That’s pretty well over. A few public hangings will really change behavior.

One of our Presidents said if he could execute three people each year for no cause, it would make it a lot easier to govern. When someone said that’s not enough, he said, “Oh yes it is, because I’d publish the list of people under consideration.” (Laughter) So this is all to the good and the cost of doing it has been really low. The public hanging aspect has really worked. People now go to seminars to learn how to avoid this.

Sentencing shows that if you try to avoid this [companies trying to avoid reporting false or misleading earnings], you’ll get lower penalties, so corporations are putting in policies to prevent this.

6. Pay based on commission is good for some jobs but bad for others.


This has worked in the insurance and reinsurance industries. It has worked less well where you have direct commissions because you have a sales force relying on commissions. You’ll always have brokers, annuity salesman and the like who go astray. You’ll never be able to stamp it out in these areas. It’s human nature – people will rationalize all sorts of things to get paid. If you want good behavior, don’t pay on a commission basis. Our judges aren’t paid so much a case. We keep them pretty well isolated with a fixed salary. Judges in this whole thing have come out pretty well – there have been relatively few scandals. So not everything has gone to hell in a bucket in our civilization. (Laugher)


Notes from 2005 Wesco Financial Annual Meeting – May 4, 2005 – By Whitney Tilson

Note: This is not a transcript. No recording devices were allowed at the meeting, so this is based on many hours of rapid typing, combined with my memory. I have reorganized comments by subject matter. Words in [brackets] are my comments or edits.