Investment Wisdom

78. Wesco 2006: Let’s Learn – Part 4 – Points 19-24

Excellent Book: Charlie Munger For All Seasons

Point 19. Money managers and stock brokers – it’s not a class where everybody’s wonderful and angels

I said at the Berkshire meeting that the money managers and stock brokers – it’s not a class where everybody’s wonderful and angels – but those who tend to come to our meetings I always feel are the class in their group. I think Berkshire and Wesco, in their meetings, attract a very good class of money managers who try to be rational and do a good job and not go crazy. I think that’s why you’re here. It’s kind of like a reaffirmation of the faith.

Well, with those preliminary remarks, I will now open the field for questions.

Point 20. [On Some Corporate Behavior] – Oscar Wilde’s definition of fox hunting: Pursuit of the Uneatable by the Unspeakable.

Part 2, Question and Answer Period

Hello Mr. Munger, I’m Whitney Tilson, a shareholder from New York.

[Mr. Munger: “I know you well.”] Thank you. My question relates to something you and Mr. Buffett said at the annual meeting last Saturday. Mr. Buffett spoke at length about the need for improved corporate governance and that large shareholders really need to step up and start behaving like owners rather than renters. I forget whether it was in the context of that question that you said something along the lines of activist hedge funds being a mixed bag. It struck me that there might be some inconsistency in those statements because in the past two or three years, virtually every case in which I can think of in which a large shareholder acted like an owner – the only exception I can think of is in the case of Hollinger and Chris Browne and the Tweedy Browne folks, but even that was an accident and they hope never to be activists again – the only people who are behaving as you are calling on shareholders to behave are, in fact, these hedge funds. I know what you think about hedge fund fees and that they’re likely to underperform as an asset class – and I wholeheartedly agree, despite running one of these creatures – but my question is: at least in the area of corporate governance, shouldn’t you and Mr. Buffett be applauding this kind of behavior (while perhaps holding your nose about the fees these funds charge) and encouraging institutional investors and mutual funds to behave in this fashion.

Munger’s reply: The reason I said it was a mixed bag is because I regard it as a mixed bag. Obviously, since Hollinger was a total kleptocracy [laughter] – I mean total; it was the most god-awful example of corporate misbehavior that you could imagine – and it was contrary to Tweedy Browne’s interests to do what it did, when they cleaned up that mess by wading in big-time, they did the rest of us a favor. So that’s the part of the mixed bag that’s weighted toward the favorable side. But if you take Carl Icahn’s assault on Time Warner – if you think Carl Icahn really gives a damn about the shareholders of Time Warner… Tweedy Browne was revolted by the behavior and so they got on a real moral crusade. And they were right, and I applaud that. But a lot of other people just want to raise hell and they don’t care if they’re raising hell with admirable people or knaves – they’re just trying to make money. That second class is I think a mixed bag that we don’t need.

I don’t think every corporation in America that could be, on a short-term basis, made to give shareholders a little jump in value…I don’t think every single instance like that ought to be seized by the management or whether shareholders ought to have the power to run around and do it, particularly if they’re the .

I think I said on a previous occasion that some of these assaults remind me of Oscar Wilde’s definition of fox hunting: he said it’s the pursuit of the uneatable by the unspeakable. [Laughter] In other words, I think some of the hedge fund types are the unspeakable and even when they’re on the right side, the other people are uneatable. But still it’s not an elegant view. The Tweedy Browne thing was a huge blessing – I’d agree with that.

Corporate Management and Governance

Governance is a very tough subject and the truth of the matter is that corporate managements, from shareholders’ point of view, run the gamut from being very valuable, so they add to the asset value of the business they supervise, to very negative, so that the asset value of the business should have a big discount. You know that perfectly well in your own life. One of our fellow value investors said the other day, considering the self-interested way that most corporate managers behave, you ought to get 30-40% more assets than you pay for to allow for the depravations of the people who are running the corporation. [Laughter] That’s a very harsh thing to say, but it’s true in many cases.

Point 21. (Of Some in Accounting) “Whose bread I eat, his song I sing.”

Compensation and Stock Option Abuse

There were lots of companies that had something like 50% of all of the outstanding stock subject to options. They couldn’t help it. They were in the high-tech game, everybody else was paying in options, and they needed people like this woman who was making $40,000 per week in options, so they paid in this currency and were just swept along by these crazy practices. Corporate compensation is a weird subject.

Stock Option Accounting: The Accountants Failed Us

Again, the accountants failed the rest of us. Never, ever should the accountants have allowed any stock option compensation not to go through the income statement, 100%, all of it. The Washington Post has a subsidiary where they created a phantom stock option plan in which somebody valued the subsidiary as a public company and the employees get options. But they account for that on a full-cost basis, not the way people are now accounting for the cost of stock options, which is to hire phony experts to come up with low values. They resented the fact that options had to be expensed, so they made very foolish assumptions so they could get the charges as low as possible. And they’re still lobbying to try to get Congress in some way to change the accounting back to its former knavish state.

Accounting Has Huge Consequences

Accounting has huge consequences because given the competitive pressures in life, you have enormous incentives to report every damn item of income they possibly can. People who are subjected to that kind of temptation need a disciplined supervisory structure, which accounting provides. I feel sorry for my individual friends in the accounting profession who haven’t produced any income for years because of the malpractice fines, but the profession as a whole richly deserves the amount of trouble that it’s had. It’s such a thankless job to want to pull the plug. How many people are volunteering for that? It reminds me of the saying, “Whose bread I eat, his song I sing.”


The Sarbanes-Oxley stuff did give us a little bit of supervision over accountants but what they’re doing mostly is running around improving internal controls, which is a gold mine for the accounting firms. Companies need bodies and the accounting firms are billing those bodies at very high rates (despite the quality of some of them), so it’s been a bonanza for the accounting profession. And I think better internal controls are ultimately good.

Point 22. Bad Accounting: A Cause Of The Enron Disaster

But some of the big stuff is being ignored. I had fun once at the Stanford Directors’ College [a program at Stanford University to train corporate directors on how to be good directors] – I asked them, “Name the time when that whole Enron thing could have easily been stopped?” People utterly failed – they should have done better. A whole bunch of experts paid thousands of dollars to come to the college, but not one person stood up with the correct answer, which is: that when Skilling got to SEC and talked them into allowing them to front-end all future profits from long-term arrangements to deliver natural gas and the income immediately went to the trading desk. This triggered a whole daisy chain, with all of its misery and terrible example. And all they had to do is make that one decision right instead of wrong. What I’ve said is totally obvious, but I don’t know how many other people realize it – and this is a smart bunch. It’s so easy to realize how all of this sin and error could be fixed by proper accounting. Yet the skilled people like Skilling and Arthur Andersen went to talk to the skilled regulators who are the accountants at the SEC and they made the exact wrong calls.

There’s a lot to be fixed in the world. To the extent that this is an educational meeting, I think the story I’ve told you is giving you a real educational lesson. It would have been so easy…yet the method they chose was so insane. I’ll give anybody with any understanding of traders and trading culture and management consulting and management consulting culture, how could anyone believe that that kind of accounting would be anything but a disaster?! There’s so much skill in exposition in this stuff. Look at Johnnie Cochran. There’s just a huge amount of skill in exposition. And part of being a wise person is resisting the other person’s expository – to know nonsense when you see it. If you’re like me, you can conceal your contempt for the person even as they speak. [Laughter]

I think we can offer a certain forgiveness. It reminds me of the [?] who was confronted

with the scandals of the Catholic church. He said, “Well, I’ve had my scandals too. It just happens because of our different doctrines. Most of mine are heterosexual.”

[Laughter] And I said, “Well, I can understand why the Catholic church got into so much trouble, because of all of the religions, they’re the one that’s most into forgiveness. A person can be redeemed. How about you?” And he said, “Oh Charlie, I forgave every single one [because of what’s it’s like to live somewhere else?].” Well, that’s the wonder of forgiveness. [Laughter]

Point 23. (On Investments) – Complex Models Can Lead To False Confidence


Comments on the Reinsurance Business

I think the reinsurance business is a very difficult business. And it’s a very tempting business, in which a guy writes you really large checks in advance. That kind of field will lead to a lot of dumb stuff and a lot of calamities. It takes exceptional skill to do well in reinsurance over the long term. Few people can do it. So you might ask, Why do we think we can do it? Well, we’re not everybody else. [Laughter] If you stop and think about it, that’s the only logical answer. The only other alternative is that we’re nuts, a possibility you’ll have to consider. [Laughter]

What is Berkshire’s Formula for Pricing Super-Cat Insurance?

The answer is, there is no formula. Ajit [Jain] and Warren are like father and son in how they interact. They’re like a couple of bridge players. Anything they want to do is okay with me. You should be so lucky to have Ajit Jain and Warren Buffett doing this for you.

What Investment Hurdle Rate Do You Use in Your Models When Deciding

Whether to Make an Investment?

We don’t do a lot of involved math with schedules of investments. Certainly we expect a decent return or we don’t do it. We use a lot of experience and do it in our heads. We distrust others’ systems [and complex models] and think it leads to false confidence. The harder you work, the more confidence you get. But you may be working hard on something you’re no good at. We’re so afraid of that process that we don’t do it.

Point 24. On Judging Managerial Talent: (Genuine) Paper Record Is Important If You Add That To Character and Intelligence

How Do You Judge Managerial Talent: the Paper Record or Your Own Judgment?

And How Did You Judge Eitan Wertheimer?

The paper record is usually a better indicator of talent . The paper record of this man is so extraordinary that it couldn’t have been created by an ordinary human being. If you add to that the man’s obvious character and intelligence – who isn’t looking for that?

You also want to get a fair price of course.

Eitan said he learned some things from us. He’s one of the smartest men I’ve met in my whole life. I can’t imagine he’d learn anything from me.

When You Bought Iscar, Did You Consider That One of Israel’s Greatest Companies Is No Longer Israeli Owned and Controlled?

You gotta understand that these people picked us. All we did was say yes. [Laughter] We think the kind of people who seek us out have such marvelous judgment that they’re the kind of people we want to be in business with.

Details on Iscar

That was a very intelligent question and I’m going to give you a very intelligent answer: I’m not going to answer. [Laughter] All I’m going to say is that we are very happy with the acquisition and the price we paid. It’s not rudeness. We want Iscar to be run like it has been in the past. They want to be private and quiet and we have a tradition of respecting this.

Notes from 2006 Wesco Financial Annual Meeting – By Whitney Tilson