Author: Lawrence Cunningham

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Warren Buffett & Charlie Munger Annotated by Experts in Wall Street Journal

WB1996Warren Buffett’s latest letter to Berkshire Hathaway shareholders is annotated in The Wall Street Journal by 30 professors, authors, and investors.  Editors Erik Holm and Anupreeta Das assigned us each two sentences in the letter, and/or Charlie Munger’s addendum, to amplify.  Here are my two, followed by the list of contributors. Mine address the role Warren’s son Howard will play in succession and what Munger believes concerning what made Berkshire succeed.

Regarding Buffett’s reference to his son Howard (p. 36):   Buffett tries again to defend the choice of Howard to succeed him as board chairman. Many remain skeptical. But critics should appreciate the plan’s savviness. It deftly carves a niche for the son of a legend, as Howard will: (1) not be asked to perform any task his father has performed (like investing or capital allocation) and (2) be asked to perform only one task, which Warren has never performed (monitoring the CEO for adherence to Berkshire culture and dismissing any who fail). This shrewdly avoids the trap many children of legendary parents face of never being able to measure up.

Notably, besides Munger, Howard is the only individual Buffett identifies by name among Berkshire personnel in his anniversary message and, besides Buffett, Munger only names Abel and Jain. In fact, while Munger and Buffett mutually credit the other for minting the Berkshire model, they never credit any other Berkshire personnel for its success. The omission contrasts with Buffett’s letters, which rightly herald specific executives who power Berkshire and animate its culture. The difference is that these messages, while in form historical, are really about the future, and all three people identified by name are referenced in discussions of succession.

Where Munger asserts (p. 39) that “The management system and policies of Berkshire . . . were fixed early”:   Munger’s statements about how Berkshire’s “system and policies” were “fixed early” is vague. In one sense, it sounds as if they were part of a master plan at the outset back in the 1960s.  But Buffett has often stressed that Berkshire never had a strategic plan nor any business plan. And through the 1980s, most of Berkshire’s “business” consisted of investments in securities for its insurance companies, not wholly owned operating subsidiaries. So it doesn’t seem likely that, in the 1970s or even as late as the 1980s, Buffett’s goal was to create “a diffuse conglomerate.”

On the other hand, Munger subsequently clarifies (p. 40) that Buffett “stumbled into some benefits [of these policies] through practice evolution” over his career. And Buffett sculpted much of Berkshire’s culture late in the company’s life as part of a process that is still ongoing and extends well beyond these policies. Therefore these passages should not obscure the fact that the “Berkshire system” looks sharper from today’s vantage point than from Buffett’s desk “early” on. That’s important to recognize lest observers commit errors associated with hindsight bias like believing that observed outcomes were predictable, a weakness of human psychology which Munger often lectures against.

Cunningham is the author of Berkshire Beyond Buffett: The Enduring Value of Values and editor and publisher, since 1997, of The Essays of Warren Buffett: Lessons for Corporate America. For more commentary on this topic, see today’s New York Times Dealbook column, here. Read More

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Fed Officials Accused of Perjury in AIG Bailout Trial

In the financial trial of the century, the most important document is missing. The document is the term sheet that the government says it gave AIG’s board right before taking the company over in Sept. 2008.  The government says the AIG board thus approved the Draconian terms that benefited Goldman Sachs and other rivals. But other evidence, including  AIG’s contemporaneous securities filings, suggests the board was agreeing only to sell the government warrants not transfer 80% of the common stock to it for a song.  The missing document would prove which side is telling the truth.

That’s one of many amazing points of contention noted by Yves Smith of Naked Capitalism in her relentless digging into what government really did during the financial crisis. Most recently, she alleges and documents perjury and obstruction of justice by top federal officials in the pending case of former AIG shareholders against the US. The case alleges that the government trampled on corporate law rights and that the Fed exceeded its authority—allegations that I document in my book, The AIG Story, written with Hank Greenberg, lead plaintiff in the case.

Smith lays out her claims in an extensive blog post at Naked Capitalism, accompanied by reams of additional documents and examples. For those looking for a skinny version, here is an abridged adaptation. Most examples concern Scott Alvarez, general counsel of the Board of Governors of the Federal Reserve; there is one with with Tom Baxter, general counsel of the New York Fed, who worked with Tim Geithner. The shareholders are represented by the noted trial lawyer, David Boies. The point about the term sheet is at the end.

Example 1

Boies: Would you agree as a general proposition that the market generally considers investment-grade debt securities safer than non-investment-grade debt securities?

Alvarez: I don’t know.

 

Example 2

Boies: [Presents a copy of the Financial Crisis Inquiry Commission report stating that the Fed had lowered the standards it applied for the quality of collateral for its loans under two programs then devised to support lending and asks] Do you see that?

Alvarez: I see that. . .

Boies: . . . [W]ould you agree that the Federal Reserve had lowered its standards regarding the quality of the collateral that investment banks and other primary dealers could use while borrowing. . . ?

Alvarez: No.

Boies: You would not agree with that?

Alvarez: Right.

 

Example 3 Read More

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Milton Hebald, RIP

The great sculptor, Milton Hebald, passed away at age 97.  May he rest in peace.  The NYT has a fine obituary here.  Accompanying this post are photos of three of his numerous sculptures gracing the grounds at Morefar, the Brewster, NY estate of the late Cornelius Vander Starr, founder of what Hank Greenberg turned into the American International Group.

Boy flying kite at Morefar (pp. 33-34)

 

 

 

 

 

 

 

 

 

 

 

 

Boy Flying Kite

Statue at Morefar (pp. 33-34)

 

 

 

 

 

 

 

 

 

Handstand

2011-09-10 10.22.03

 

 

 

 

 

 

 

 

 

Tennis Anyone?

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Buffett on Family Business: Beat the Third Generation Curse

warren buffettWarren Buffett is very good at spotting great family businesses. What does he look for? How can his filters help family businesses prosper?

For one, they can mitigate one of the greatest dangers: the third generation “curse.” This refers to how few family businesses survive beyond the third generation, let alone prosper.

An under-appreciated fact about Berkshire Hathaway, the conglomerate Buffett built: virtually all its family businesses boast second or third generation descendants who rival or outshine previous generations. That is rare among family businesses.

So while every family and business situation differs, Berkshire’s two dozen family companies are a good place to look for insight about multi-generational prosperity in the family business.

Studying Berkshire’s family businesses, I found that they are united by the following values. These values are important factors in their success, in the founding generation and subsequent ones.

Family business members, and their professional advisors, whether in law, accounting, or other fields, would do well to ponder these points.

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Million Dollar Reward Case Over

aaa millionA claim to $1 million for meeting a lawyer’s dare made on Dateline NBC is now dead. The case is over thanks to an opinion, by Judge Wilson for the 11th Circuit, that will be in the next editions of all Contracts casebooks: it  provides a comprehensive, careful and contestable treatment of unilateral contracts.

Former law student Dustin Kolodziej filed the case in 2009 against high-profile Florida defense lawyer, James Cheney Mason.  Prosecutors said Mason’s client, a wealthy businessman on trial for  murdering his business partner and others, manufactured an alibi putting him in a La Quinta hotel in Atlanta on the day of the Central Florida murders.

On Dateline NBC, Mason explained his defense, that the state could not show that the trip they imagined the defendant took was possible within the time frame.  A vital leg of the journey involved getting off a plane at Atlanta’s busy airport to the hotel five miles away, in less than 30 minutes, where the defendant was seen in security tape early and late in the day.

Mason said he’d pay $1 million if proven wrong.  Kolodziej did just that,  reenacting the full trip, capturing it on his camcorder, and making the final leg in less than 30 minutes.    Kolodziej claimed a valid contract, formed by Mason making an offer of a reward for an act and Kolodziej accepting it by performing the act.   Mason called the claim ridiculous.

The case raises a classic issue in contract law, about whether dares to be proven wrong like this are recognized as offers or mere bluffs and jests.  The 11th Circuit, affirming a grant of summary judgment, sided with Mason.  Stressing context,  not only was his bluster about the million a joke, the full text of what he said makes clear he was daring the prosecutors to prove the point, not the general public.

Dave Hoffman correctly predicted this outcome–nice job Dave (here and here)! I thought the case a closer call, as I explained  here and in my book, Contracts in the Real World: Stories of Popular Contracts and Why They Matter (Cambridge U Press 2012).

While I am persuaded by Dave and the 11th Circuit’s opinion, I remain convinced that Mason was wrong to call the claim ridiculous.  The court takes the claim more seriously, to its credit, though I wish they had engaged more with the arguments  put forth in my book (which, alas, the court does not cite).

Hat tip to Jim Gross, currently clerking for the 9th Circuit, who wrote to remind me that we discussed this case on his first day of Contracts class at GW back in 2011.  Hat tip also to David George, the lawyer for Kolodziej, who also sent me a copy.

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Free Berkshire Book Trivia Quiz

Amazon BBB Book Cover - CopyExpert on Berkshire Hathaway? Try this trivia quiz based on Berkshire Beyond Buffett: The Enduring Value of Values. Submit answers to lacunningham@law.gwu.edu.

The first 10 people to get all 20 right by December 20 at 5 pm ET win a free signed copy of the book (free shipping within US). (Hint: all answers are easily found in that book!)

1. Who founded The Pampered Chef and what job did that founder holder before doing so?

2. Who founded FlightSafety and what was that founder’s favorite charity?

3. What medical scare did John Justin Jr. face in 1968?

4. At what age did Rose Blumkin pass away?

5. What was Lubrizol’s most pivotal acquisition under CEO James Hambrick? Read More

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Berkshire and Coca-Cola: Deja Vu All Over Again

 

 

In response to the business media frenzy over what challenges at the Coca-Cola Company mean for Berkshire Hathaway, which owns a large stake in the company acquired in 1988, herewith an excerpt for perspective from Berkshire Beyond Buffett, my book released yesterday.  The book focuses on Berkshire’s 50 main wholly owned businesses, but also has brief passages on some of the companies in which Berkshire owns a minority position.  The following is the passage on The Coca-Cola Company, pages 181-182.  You might call it: Berkshire and Coca-Cola: We Have Been Here Before. 

Before presenting the passage, a related note: when activist Coke shareholders (like David Winters) agitating for change complain about their futile efforts to lure Buffett into their fight, remember that Buffett works for Berkshire and its shareholders, not for Coke or its shareholders. While activism might boost Coke’s shareholders today, Berkshire’s patient quiet approach has boosted Berkshire’s shareholders year in and year out.  For example, the model of quiet patience is precisely why Berkshire was able to reap such enormous gains from its investments during the 2008 financial crisis.

CokeWith sales in 2013 reaching $50 billion, the Coca-Cola Company is about as powerful a brand and company as can be, at home in Atlanta and around the world. Its success is due ultimately to a single product, originally a mixture created in 1886 by pharmacist John Styth Pemberton of sugar, water, caffeine, and cocaine (extracts of the coca leaf and the kola nut). In 1891, fellow pharmacist Asa G. Candler gained control of the product and initiated steps to launch the business. Among early moves was the first bottling franchise in 1899, an investment in local partnerships that became the scaffolding to build the brand: the company makes concentrate for sale to bottlers that mix it into liquid form and package it for sale to retailers. Other early milestones include the 1905 removal of cocaine from the mix and the 1916 creation of the unique contour-shaped bottles.

In 1919, Candler sold the company to Ernest Woodruff and an investor group which promptly took it public. In 1923, Ernest’s son, Robert Winship Woodruff, became president, a position he held through 1954, followed by serving as a director through the 1980s. Coke went global in the 1940s, establishing bottling plants near the fronts in World War II. With the stewardship of CEO William Robinson, in 1960, Coke acquired Minute Maid Corporation and in 1961, launched Sprite, the first of many brand expansions it would continue as it developed its product line of five hundred different drinks.

Under Paul Austin during the 1970s, despite reasonable sales, the company stumbled from one problem to another. Bottlers felt misunderstood, migrant workers in the Minute Maid groves were mistreated, environmentalists complained about its containers, and federal authorities challenged the legality of its franchise bottling system. Although Austin launched Coca-Cola into China and was responsible for other international achievements, critics say he neglected the flagship brand by diversifying into water, wine, and shrimp. With investors punishing the stock, the board finally ousted Austin in 1980, replacing him with Roberto C. Goizueta, Coca-Cola’s most famous CEO, serving from 1981 through 1997.

A legendary businessman and Wall Street darling, Goizueta returned to basics, focusing on the Coke brand and rejuvenating Coca-Cola’s traditional corporate culture of product leadership and cost management. During his tenure, Goizueta led the company to widen profit margins from 14 to 20 percent, boosted sales from $6 billion to $18 billion, drove profits from less than $1 billion to nearly $4 billion, and pushed returns on equity from 20 to 30 percent.  These measures were propelled by expanding Coke’s global network and the successful 1982 launch of Diet Coke.

There were, of course, a few errors along the way. One, the lamentable 1985 birth and death of New Coke after it flopped with consumers, simply revealed the power of the core brand. Another was Coca-Cola’s 1982 acquisition and 1987 divestiture of Columbia Pictures after it had become disillusioned with the inscrutable ways of Hollywood. But this diversion simply proved the durability of Coke’s corporate culture—and was also lucrative, as the company paid $750 million for Columbia and sold it for $3.4 billion.

In 1988 and 1989, Buffett heralded Goizueta’s achievements when Berkshire bought the large block of Coca-Cola shares it still owns today and Buffett joined the board (on which he served until 2006). After Goizueta’s sixteen years, however, the company’s CEOs came and went more like temps, four in thirteen years. But despite mistakes, none could fail so spectacularly as to ruin the Coke brand or Coca-Cola’s corporate culture. Douglas Ivester (1997–2000) swapped the contour-shaped Coke bottle for a larger unfamiliar variant, compromising a valued trademark. Douglas N. Daft (2000–2004) fired large numbers of people, a slap in the face to the employee-centric culture that prided itself on lifetime employment.

Yet changing strong corporate cultures is not easy, and at Coca-Cola, successors quickly reversed course. E. Neville Isdell, who returned from retirement to right the ship, and Muhtar A. Kent, who took over in 2009, revived a decentralized structure and the professional style that Goizueta favored. They also understood the importance of international markets, especially in southeast Asia, where growth prospects remain strong. Kent celebrates Coca-Cola’s greatest tradition, epitomized by its history of using hundreds of bottling partners: being simultaneously global and local.

Coca-Cola has been a profitable investment for Berkshire—worth today twelve times what Berkshire paid for it. And Buffett’s son Howard has been on its board since 2010. The company appears to be prospering, and the Buffetts are bullish on it. Buffett and Munger continue to give the brand free advertising by sipping it on the podium at Berkshire’s annual meetings. But skeptics wonder about the durability of its economic characteristics in a health-conscious world turning away from carbonated beverages.

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Berkshire Beyond Buffett in Print and on Shelves

BBB at barnes & NobleBook publication day always feels like a big deal, enough of a professional achievement to announce it to the world, so here goes: Berkshire Beyond Buffett: The Enduring Value of Values is now available from Barnes & Noble, Indie Stores, Target, Walmart, and other shops across Europe and North America. Thanks to my wife Stephanie for the picture at left from a B&N in New York City (bottom shelf, middle, next to the new Google book).  Of course it’s online at B&N.com (ships immediately), Amazon (ships October 21), and CEO-READ.Amazon BBB Book Cover - Copy

Visit the book’s web page for a free sample chapter and other free cool stuff, including details of the multi-campus book tour. It spans from my beloved GW, to my alma maters U. Delaware and Yeshiva U., and to universities coast-to-coast from Columbia to Stanford as well as Northwestern, Wash U and many others (thanks again, diligent patient hosts!). There’s also an Author-at-Google talk which should be very interesting, and they promise a You Tube posting afterwards.

On the tour, I’ll be joined to discuss Berkshire Beyond Buffett by several Berkshire directors, numerous Berkshire subsidiary CEOs, and a number of Berkshire’s largest shareholders (thanks Sandy Gottesman, Don Graham, Tom Russo et al!). The theory? As with the book’s portrait and thesis, we’ll hear a wide variety of diverse voices singing the same singular song of a strong and distinctive corporate culture.

The reviews have begun, including a particularly comprehensive one this morning by Kevin LaCroix, as well a recap interview by ThinkAdviser yesterday. Media appearances begin with radio next week (American Talk Radio on Monday, The Motley Fool on Wednesday, Bob Brinker at the weekend) and television the following week (Betty Liu on Bloomberg Tuesday, Liz Claman on Fox Business Wednesday, and others).

While the anticipation of all these events and dialogue is exciting, there is something simply special about grasping the physical volume in hand, inky aroma, cream-soft pages, firm bound spine, and well-edited narrative. The feeling reminds me how much I love books, which makes it extra cool to write them and to behold their physical beauty, as well as their intellectual sustenance.

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The Campus Book Tour

If you are publishing a new book–as almost all Co-Op bloggers seem to be doing, including Danielle, Frank, and me–getting the word out entails effort across mainstream media, social media, niche blogs, radio and TV, and, of course, old-fashioned book tours.  While technology and industry change have opened other media to more authors and others in the marketplace of ideas, the book tour has lost ground with the rise of ebooks and etailing and the decline of the traditional bookstore.

Into that void, however, the university is stepping. And not just for campus books like William Deresiewicz’s Educating Sheep,  in the swing of a 20-stop university based tour.  By reaching out to friends across the academy, a book tour can be fashioned to reach relevant communities. Targeting the open minds that ideally characterize university gatherings, the campus tour might even be more consequential than you could have done criss-crossing the country’s old Borders, Barnes & Noble, and Books-A-Million stores.

Thanks to the generosity of a network of professorial friends, such a book tour for Berkshire Beyond Buffett: The Enduring Value of Values, starts tomorrow at the University of Delaware. This is first in a series for a 20-stop tour, most at universities or other learned societies, as well as one in the Author at Google / You Tube series.  The banners or pennants of many of the schools appear below and a full regularly updated list can be found here. School Pennants

While what I most enjoy is preparing my lecture and then engaging in Q&A, putting the trip together also has its rewards, especially connecting with so many wonderful colleagues across so many schools.  But I know it’s a lot more work for them than me, so I want to use this blog post to shout out my deep gratitude to all those who are helping with this, listed specifically below.

For those authors now thinking about organizing a campus book tour, I should mention that it takes considerable effort, entails some frustration, and, like most everything in social life, should include a commitment to give at least as much  you hope to get in the exercise.   When I have a complete list of tips to pass on after this tour its completed, I’ll write them up in a blog post here.  For now, I can say that the wonderful people helping with this have made it thoroughly worthwhile.  Looking forward to seeing everyone on the road! Read More

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Chapter 8 of Berkshire Beyond Buffett: An Excerpt and Link

untitledThe following is an excerpt from Chapter 8, Autonomy, from Berkshire Beyond Buffett: The Enduring Value of Values; the full text of the chapter, which considers the case for Berkshire’s distinctive trust-based model of corporate governance, can be downloaded free from SSRN here.

. . . Berkshire corporate policy strikes a balance between autonomy and authority. Buffett issues written instructions every two years that reflect the balance. The missive states the mandates Berkshire places on subsidiary CEOs: (1) guard Berkshire’s reputation; (2) report bad news early; (3) confer about post-retirement benefit changes and large capital expenditures (including acquisitions, which are encouraged); (4) adopt a fifty-year time horizon; (5) refer any opportunities for a Berkshire acquisition to Omaha; and (6) submit written successor recommendations. Otherwise, Berkshire stresses that managers were chosen because of their excellence and are urged to act on that excellence.   

Berkshire defers as much as possible to subsidiary chief executives on operational matters with scarcely any central supervision. All quotidian decisions would qualify: GEICO’s advertising budget and underwriting standards; loan terms at Clayton Homes and environmental quality of Benjamin Moore paints; the product mix and pricing at Johns Manville, the furniture stores and jewelry shops. The same applies to decisions about hiring, merchandising, inventory, and receivables management, whether Acme Brick, Garan, or The Pampered Chef. Berkshire’s deference extends to subsidiary decisions on succession to senior positions, including chief executive officer, as seen in such cases as Dairy Queen and Justin Brands.

Munger has said Berkshire’s oversight is just short of abdication. In a wild example, Lou Vincenti, the chief executive at Berkshire’s Wesco Financial subsidiary since its acquisition in 1973, ran the company for several years while suffering from Alzheimer’s disease—without Buffett or Munger aware of the condition. “We loved him so much,” Munger said, “that even after we found out, we kept him in his job until the week that he went off to the Alzheimer’s home. He liked coming in, and he wasn’t doing us any harm.” The two lightened a grim situation, quipping that they wished to have more subsidiaries so earnest and reputable that they could be managed by people with such debilitating medical conditions.   

There are obvious exceptions to Berkshire’s tenet of autonomy. Large capital expenditures—or the chance of that—lead reinsurance executives to run outsize policies and risks by headquarters. Berkshire intervenes in extraordinary circumstances, for example, the costly deterioration in underwriting standards at Gen Re and threatened repudiation of a Berkshire commitment to distributors at Benjamin Moore. Mandatory or not, Berkshire was involved in R. C. Willey’s expansion outside of Utah and rightly asserts itself in costly capital allocation decisions like those concerning purchasing aviation simulators at FlightSafety or increasing the size of the core fleet at NetJets.

 Ironically, gains from Berkshire’s hands-off management are highlighted by an occasion when Buffett made an exception. Buffett persuaded GEICO managers to launch a credit card business for its policyholders. Buffett hatched the idea after puzzling for years to imagine an additional product to offer its millions of loyal car insurance customers. GEICO’s management warned Buffett against the move, expressing concern that the likely result would be to get a high volume of business from its least creditworthy customers and little from its most reliable ones. By 2009, GEICO had lost more than $6 million in the credit card business and took another $44 million hit when it sold the portfolio of receivables at a discount to face value. The costly venture would not have been pursued had Berkshire stuck to its autonomy principle.

The more important—and more difficult—question is the price of autonomy.  Buffett has explained Berkshire’s preference for autonomy and assessment of the related costs: 

We tend to let our many subsidiaries operate on their own, without our supervising and monitoring them to any degree. That means we are sometimes late in spotting management problems and that [disagreeable] operating and capital decisions are occasionally made. . . . Most of our managers, however, use the independence we grant them magnificently, rewarding our confidence by maintaining an owner-oriented attitude that is invaluable and too seldom found in huge organizations. We would rather suffer the visible costs of a few bad decisions than incur the many invisible costs that come from decisions made too slowly—or not at all—because of a stifling bureaucracy.

Berkshire’s approach is so unusual that the occasional crises that result provoke public debate about which is better in corporate culture: Berkshire’s model of autonomy-and-trust or the more common approach of command-and-control. Few episodes have been more wrenching and instructive for Berkshire culture than when David L. Sokol, an esteemed senior executive with his hand in many Berkshire subsidiaries, was suspected of insider trading in an acquisition candidate’s stock. . . .

[To read the full chapter, which can be downloaded for free, click here and hit download]