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NetJets Shuffle: Costs of Deviations from the Berkshire Model

aaaaaaaWarren Buffett just oversaw an executive shuffle at Berkshire Hathaway’s NetJets. He  accepted the resignation of Jordan Hansell, CEO since 2011, and hired into the top jobs two company veterans who had resigned last month, Adam Johnson and Bill Noe. Two narratives are emerging: that the shuffle strengthens the case that Berkshire’s 1998 acquisition of NetJets was a mistake or that they illustrate flaws in Berkshire’s model of decentralization and autonomy. Here’s a third alternative: the circumstances show the strength of the Berkshire model, with pitfalls revealed by deviations from it.

As background, Richard T. Santulli, who in the 1980s pioneered the fractional aviation industry at NetJets, by 2005 had joined the short list of people widely seen as a likely successor to Buffett.  A mathematics whiz, Santulli built NetJets by selling fractional interests in planes to multiple owners. In exchange for customer fees, NetJets operates the fleet, as well an additional fleet of company-owned planes necessary to make certain that there are always enough planes to meet customer needs at any time. The business model is challenging: capital intensive and competitive with unionized pilots and a demanding clientele (the likes of David Letterman and Tiger Woods).

In the early 1990s, Sanutlli personally guaranteed NetJets’ loans to escape bankruptcy and in the mid-1990s sold 25% of the company to Goldman Sachs to obtain capital.  In 1998, he sold the company to Berkshire. Despite thin margins due to high costs, NetJets had relatively low debt, an impeccable safety record, and growth prospects as a first-mover. While NetJets produced profits in most of its first decade with Berkshire, the recession that began in 2008 throttled it. NetJets took a $700 million write-down on its fleet, erasing years of profits and tallying a large loss that year. Yet it had also had incurred considerable debt to expand its fleet.

By late 2009, Buffett decided to change course, as he conferred with David Sokol, another Berkshire executive on the short list to succeed Buffett. Sokol, who built and was then running Berkshire’s energy business, was a ruthless cost cutter, and perceived NetJets to be bloated. Taking over as CEO of NetJets, while still running the energy business, Sokol slashed expenses right down the income statement. But Sokol, who stands out as the least Berkshire-like CEO—he built the energy business by hostile takeovers and used brokers to scout for acquisitions—soon resigned after being caught front-running, shattering Buffett’s erstwhile trust in him.

At NetJets, Sokol left behind both his thrifty business model and a successor, Hansell, whom Sokol had recruited from Berkshire’s energy business. NetJets’ pilots love Santulli and have always lamented his departure. They detest both Sokol and Hansell, and especially their low-cost strategy. After Santulli left, management-labor relations deteriorated steadily, and lately the union hurled invective at Hansell in aggressive campaigns from the internet to the Wall Street Journal and Omaha World Herald. Pilots picketed by the hundreds outside Berkshire’s annual meeting in 2014 and 2015.

Amid mounting turmoil, in early 2015, two Santulli-era senior executives resigned from NetJets and those are the two now returning to lead NetJets. Johnson has stated that their goal is to reengage NetJets’ employees in the business and return the company to greatness. In other words, they appear poised to abandon the Sokol business model in favor of Santuilli’s original concept.

From these circumstances, it is tempting to infer that Berkshire’s acquisition of NetJets was a mistake. Apart from first-mover advantage, its business moat was insubstantial and Buffett’s usual rationality may have been colored by his devotion to NetJets as a customer. Yet NetJets was profitable during most of its first decade with Berkshire and continues to show strengths. NetJets may well belong on the short list of costly acquisitions that are due to Buffett being Berkshire’s sole decision maker, with limited input from one or two trusted insiders. But I think there is another lesson to discern, also about Berkshire’s managerial model.

Today’s shuffle seems to recognize and correct two mistakes that involved deviations from the Berkshire model: replacing Santulli and installing Sokol. After all, Buffett does not usually second-guess subsidiary CEOs, especially not company founders, so intervening against Santuli violated the Berkshire model. Nor does Berkshire usually move executives from one subsidiary to another, especially not assigning two companies to a single CEO, so installing Sokol at NetJets also deviated from the Berkshire model. The pair of highly unusual moves amounts to the sharpest instance of exceptions to the Berkshire model in its history.  They are also costly, given Santulli’s departure and Sokol’s fate, but measurement is elusive. It would also be useful to know more inside information about how Santulli’s ouster and Sokol’s ascension came to be.

Lawrence A. Cunningham, a professor at George Washington University,  has written numerous books, including “Berkshire Beyond Buffett,” through which he interviewed Santulli, became acquainted with Hansell, and spoke with numerous NetJets pilots and union officials.  

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FAN 61.2 (First Amendment News) Cato’s Ilya Shapiro weighs in on Elonis

Ilya Shapiro

Ilya Shapiro

True to form, in Elonis v. United States the Supreme Court continued its unparalleled defense of free speech — this time in the social-media context. Also true to form, however, Chief Justice John Roberts put together a near-unanimous majority by shying away from hard questions and thus leaving little guidance to lower courts.

The case involved a statute that made it a federal crime to transmit in interstate commerce — the Internet counts — “any communication containing any threat . . . to injure the person of another.” Based on a bizarre series of Facebook posts styled largely on the lurid lyrical stylings of Eminem, Anthony Elonis was convicted under that law of threatening his wife, the police, an FBI agent, and a kindergarten class. Yet prosecutors didn’t prove that Elonis intended to threaten anyone or even understood his words as being threatening. All they showed was that the individuals in question felt threatened by the posts.

The Supreme Court correctly ruled that that’s not enough, that negligently throwing around violent rap lyrics shouldn’t get someone thrown in prison. As Roberts noted, the general rule is that a “guilty mind” — what lawyers call mens rea — is a necessary element of any crime.

But alas that’s as far as Roberts went: since the statute in question doesn’t specify the requisite state of mind, mere negligence isn’t enough. He did not say — the Court did not rule at all — whether an amended statute criminalizing negligent speech would pass First Amendment muster. This issue was the focus of Cato’s amicus brief, which was also signed onto by the ACLU, the Abrams Institute, the Center for Democracy & Technology, and the National Coalition Against Censorship. Indeed, as Justice Samuel Alito points out in partial dissent, the majority opinion doesn’t even say whether “reckless” Facebook posts come under the statute’s purvey (or whether that reading would in turn satisfy the First Amendment.

In short, I’m glad that amateur poet “Tone Dougie” (Elonis’s nom de rap) won’t be practicing his art in the hoosegow, but the Supreme Court’s minimalism has guaranteed this type of case — and maybe even this defendant — an encore. Particularly as social media and other new means of expression evolve, the Hustices need to do more than narrowly slice speech-chilling criminal laws.

Ilya Shapiro
Senior Fellow in Constitutional Studies
Cato Institute

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FAN 61.1 (First Amendment News) Court Decides Facebook “Threats” Case on Statutory Grounds

Anthony Elonis

Anthony Elonis

The Court just handed down in decision in Elonis v. United States, which had been argued on December 1, 2014. The Court ruled in favor of the Petitioner Elonis. The opinion is here.

The Vote: 8-1

Author of Majority opinion: Chief Justice Roberts

The Holding: The Court holds that the Third Circuit’s instruction requiring only negligence with respect to the communication of a threat is not sufficient to support a conviction under the federal law at issue in this case.” [Amy Howe, SCOTUSblog]

“The judgment of the United States Court of Appeals for the Third Circuit is reversed, and the case is remanded for further proceedings consistent with this opinion.” [From majority opinion]

Case decided on statutory grounds; First Amendment question not reached.

Dissenting Opinions: Justice Thomas dissents, and Justice Alito concurs in part and dissents in part.

Justice Alito: “The Court holds that the jury instructions in this case were defective because they required only negligence in conveying a threat. But the Court refuses to explain what type of intent was necessary. Did the jury need to find that Elonis had the purpose of conveying a true threat? Was it enough if he knew that his words conveyed such a threat? Would reckless- ness suffice? The Court declines to say. Attorneys and judges are left to guess.”

Justice Thomas: “Because the Court of Appeals properly applied the general-intent standard, and because the communications transmitted by Elonis were “true threats” unprotected by the First Amendment, I would affirm the judgment below.”

The Facts: Anthony Elonis was convicted of making threats against his estranged wife, and later against an FBI agent. In response to his wife leaving him and taking their two children, Elonis posted several things referring to her on his Facebook page. On it he wrote: “Revenge is a dish that is best served cold with a delicious side of psychological torture.” Consistent with that statement, he also wrote: “There’s one way to love ya, but a thousand ways to kill ya,/ And I’m not going to rest until your body is a mess,/ Soaked in blood and dying from all the little cuts./ Hurry up and die bitch.” (See here for additional statements.)

A jury found Elonis guilty and he was sentenced to 44 months in prison. In an opinion authored by Judge AnthonyScirica , the Third Circuit upheld his conviction.

The Issues: The two issues before the Supreme Court were:

  1. Whether, consistent with the First Amendment and Virginia v. Black, conviction of threatening another person under 18 U.S.C. § 875(c) requires proof of the defendant’s subjective intent to threaten, as required by the Ninth Circuit and the supreme courts of Massachusetts, Rhode Island, and Vermont; or whether it is enough to show that a “reasonable person” would regard the statement as threatening, as held by other federal courts of appeals and state courts of last resort; and
  2. whether, as a matter of statutory interpretation, conviction of threatening another person under 18 U.S.C. § 875(c) requires proof of the defendant’s subjective intent to threaten.

The Lawyers

 John P. Elwood argued the case on behalf of the Petitioner Anthony Elonis.

 Michael R. Dreeben, Deputy Solicitor General, Department of Justice, argued on behalf of the government.

Amici Briefs

Fourteen amicus briefs were filed in the case.

 Amicus briefs in support of the Petitioner were filed by: the  American Civil Liberties Union, the Abrams Institute for Freedom of Expression, the Cato Institute, the Center for Democracy & Technology, and the National Coalition Against Censorship Reporters Committee for Freedom of the Press and Nine Media Organizations, the Thomas Jefferson Center for the Protection of Free Expression, and the Rutherford Institute, among others.

Amicus briefs in support of the Respondent were filed by the Anti-defamation League, Wisconsin and Seventeen Other States, the District Of Columbia, Guam, and the National District Attorneys Association, and the National Center for Victims of Crime, among others.

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LSA Retro-Recap Day 0: I Miss My Friend

Hello from Seattle! Over the next few days, I will describe some of the best things I saw at the 2015 annual meeting of the Law and Society Association (which was held from May 28-31). As I did back in 2013, my plan is to discuss one or two papers with high VOSFOTWOAS— Value Over Season Four Of The Wire Or A Separation.

Before getting to the recap, though, I want to remember Dan Markel. I did not know Dan very well, nowhere near as well as many other law professors or most of the folks who blog here. I met Dan in person exactly 5 LSA’s ago, in Chicago. I can remember the moment when I first saw him. He walked into a conference room with what I instantly recognized as the sleep deprivation that affects all new parents (and the glow that demarks the good ones). His hand was the first in the air during the questioning period then, as it was in nearly every other session I saw him at. I made a game to myself of trying to beat him to the punch in asking a question; I always lost.

I once read a piece in the New Yorker that, to my memory, said something like: people worry that caffeine will interfere with the real you, but after a while the person you are on caffeine is the real you.* I like to imagine (perhaps without warrant) that the person Dan was at conferences, Conference Dan, was the real Dan. Intense. Reveling in the attention of friends. Generous in facilitating connections. Enthusiastic about your ideas to the point of disregarding the rules of social comportment.

As the yahrzeit of his death approaches and I sit in a bustling hotel lobby, I miss Conference Dan, although this sense loss is infinitesimal compared to the ache that I feel for his family. I wish I had been able to better know Dan outside of these conferences. I still flip through the conference program to see what he is presenting. I schedule time for a Prawsblog happy hour that will not happen. I rush to raise my hand after the chair asks for questions, only to realize that it is alone in the air.

 

*A quick Googling suggests that the line closest line to the one I (mis-)remembered is this one by Malcolm Gladwell: “Part of what it means to be human in the modern age is that we have come to construct our emotional and cognitive states not merely from the inside out–with thought and intention–but from the outside in, with chemical additives. The modern personality is, in this sense, a synthetic creation: skillfully regulated and medicated and dosed with caffeine so that we can always be awake and alert and focused when we need to be.”

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Introducing Guest Blogger Stephen Galoob

I’m pleased to introduce guest blogger Stephen Galoob, who lasted visited with us in 2013. Stephen is an assistant professor at the University of Tulsa College of Law. He is a graduate of UVA law school and received his Ph.D. at U.C. Berkeley’s Jurisprudence and Social Policy program.  Stephen teaches criminal law, criminal procedure, legal ethics, and an undergraduate course on moral and legal responsibility.

Stephen’s recent work includes:

Norms, Attitudes, and Compliance, 50 Tulsa Law Review 613 (2015) (with Adam Hill)

Intentions, Compliance, and Fiduciary Obligations, 20 Legal Theory 106 (2014) (with Ethan Leib)

Are Legal Ethics Ethical? A Survey Experiment, 26 Geo. J. Legal Ethics 481 (2013) (with Su Li).

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5 Great Novels About Privacy and Security

I am a lover of literature (I teach a class in law and literature), and I also love privacy and security, so I thought I’d list some of my favorite novels about privacy and security.

I’m also trying to compile a more comprehensive list of literary works about privacy and security, and I welcome your suggestions.

Without further ado, my list:

Franz Kafka, The Trial

Kafka’s The Trial begins with a man being arrested but not told why. In typical Kafka fashion, the novel begins badly for the protagonist . . . and then it gets worse! A clandestine court system has compiled a dossier about him and officials are making decisions about him, but he is left in the dark. This is akin to how Big Data can operate today. The Trial captures the sense of helplessness, frustration, and powerlessness when large institutions with inscrutable purposes use personal data and deny people the right to participate. I wrote more extensively about how Kafka is an apt metaphor for privacy in our times in a book called The Digital Person about 10 years ago.

Franz Kafka The Trial

 

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The Integrity of Clayton Homes and the Politics of “Investigative Journalism”

The following is adapted from “Berkshire’s Blemishes,” a working paper delineating the costs, rather than the vaunted benefits, of Warren Buffett’s Berkshire Hathaway as a management model, including its commitment to integrity and its elements of subsidiary autonomy and corporate decentralization.   

aaaaaOn April 3, 2015, two purported journalists, Daniel Wagner and Mike Baker, reported an investigative piece challenging Clayton Homes, Berkshire Hathaway’s vertically integrated manufacturer and financier of manufactured housing. Writing in the Seattle Times a piece sponsored by the Center for Public Integrity, the writers alleged that Clayton’s  sales team channeled buyers into Clayton mortgages, that they were offered few or no alternative financing options, that terms were seductive (including low down payment requirements), that defaults and foreclosures were high and that collection practices were aggressive. One assertion the piece specifically highlighted: a significant portion of Clayton loans carried interest rates exceeding fifteen percent. The writers reported that “more than a dozen” customers offered complaints along with two former dealers who confirmed their legitimacy—notable numbers considering that Clayton sells and finances some 30,000 homes per year.

Clayton promptly issued a response disagreeing with every negative assertion in the piece. It stressed its policies of customer protection while acknowledging that, in a minority of cases such as the writers portrayed, customers facing periodic life challenges have difficulty repaying loans and may face foreclosure. The authors responded with a point-by-point rebuttal. At the Berkshire annual meeting five weeks later, Mr. Buffett also repudiated the piece and, again, one of the writers responded with continued skepticism.  Yet all the claims contradict everything Clayton Homes stands for, as I explained in both my book, Berkshire Beyond Buffett, and in a New York Times column ninety days before this piece—a column, incidentally, which the company cited in its response and which the writers dismissed in rebuttal because written by me, whom they called “a longtime Buffett acolyte.” (Notably, it also came out that one of the writers, Mr. Wagner, had an undisclosed conflict of interest: his sister is a lawyer representing plaintiffs in lawsuits against Clayton Homes.)

The real reasons behind the piece now seem to be more political than at first appears. At the time of the report, Congress had begun debating regulations applicable to manufactured housing loans. After the financial crisis of 2008, the Dodd-Frank Act added disclosure and timing requirements to such loans bearing high interest rates, which Congress has been considering repealing as onerous and costly—a House vote was set for mid-April.  Clayton and other industry leaders support repeal while some homeowner and consumer groups are opposed.  Although the original report did not mention these points, the writers added the theme in a story last week—linking their original assertions to Clayton’s incentives in the political debate and making it clear that they are on the other side of that debate, opposing repeal.   Thus it now appears as if the authors wrote a piece of political advocacy, not investigative journalism, and targeted Clayton for ulterior motives, not as neutral reporters of facts.   (Notably, once Mr. Wagner’s conflict of interest was revealed, bylines in the two subsequent pieces credit only Mr. Baker, with Mr. Wagner demoted from the byline to credit for additional reporting.)

While wrongful activity within a subsidiary of a decentralized corporation would reveal costs of such a model, given the political context of the purported exposé, that does not appear to be an implication in this case.   On the contrary, the political benefits of a piece attacking Clayton would be proportional to Clayton’s reputation for integrity—if even those reputable entrepreneurs sell or finance manufactured homes to troubled buyers, imagine what the rest of the industry looks like!  Had there been a real problem—whether dealers wrongly steering customers toward inferior loans or loan officers deceiving customers—there would be reason to consider the efficacy of Clayton’s vertically integrated structure—making, selling, financing and insuring manufactured homes operating as walled-off business silos.  Likewise, if Clayton’s formal response and Mr. Buffett’s oral comments had missed their mark, consideration should be given to changing Berkshire’s lean anti-bureaucratic model to add departments of political or public affairs at both the subsidiary and parent levels.  But no such costs appear to warrant such a revision.  (Indeed, it was Mr. Buffett who called out Mr. Wagner’s undisclosed conflict of interest, in an interview with the writers at the annual meeting—not a fact he likely dug out himself.)

Lawrence A. Cunningham, a professor at George Washington University,  has written numerous books on a wide range of subjects relating to business and law. 

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Berkshire Trivia Contest: Win $100 in Books

Berkshire-Beyond-Buffett-Flyer-2Ace the following quiz and win a $100 Amazon gift certificate (or, if you prefer, take $100 worth of my own books directly from me).  All answers may be found in Berkshire Beyond Buffett:  The Enduring Value of Values.  Feel free to share with friends.  Email your answers to me.  Offer limited to the first person to submit all answers correctly by Friday May 29, 2015  at midnight EDT.

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?
6. What was the original name at its creation of the company today called Berkshire Hathaway Energy?
7. Who christened the company now called MiTek and what was it called before that?
8. What company most assisted McLane as it expanded in the 1960s and 1970s?
9. What CEO and company minted the “I Am Loved” campaign?
10. Identify the origins of the name Marmon, stating year, deal and source of name.
11. What company provided the inspiration for the founding of GEICO?
12. Name the Berkshire executive listed as the largest donor by the Chronicle of Philanthropy from 2000 to 2009.
13. Berkshire is to Fruit of the Loom as Philadelphia & Reading is to what company?
14. Name the bidder that Berkshire outbid to acquire Clayton Homes.
15. Name three Berkshire CEOs who have won the Horatio Alger Award.
16. Name four minority positions Berkshire has swapped for entire businesses.
17. Name four Berkshire subsidiaries that have been through bankruptcy.
18. Name the individual who introduced the deal for Berkshire to acquire Star Furniture.
19. Name all Buffett family members who have served on Berkshire’s board.
20. Who wrote the foreword to Berkshire Beyond Buffett and what is that author’s role at Berkshire?

Lawrence A. Cunningham, a professor at George Washington University,  has written numerous books on a wide range of subjects relating to business and law. 

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Are Robots and Algorithms Taking Over?

The past half-decade has seen an uptick in thoughtful and influential scholarship on the potential risks — particularly to privacy and civil liberties — of emerging technologies. Regular readers of this blog will not be surprised to find works by several Concurring Opinions bloggers on any list of must-read commentary on the legal, ethical, and political dimensions of new data-driven technologies. Technological progress (or regress, depending on your point of view) has become one of the dominant narratives of our time, and it’s good that critiques of its darker implications have slowly but inexorably entered our political discourse.  

Still, there’s a smallish subset of tech commentary and criticism that is, in my view, overwrought. These are critiques that, on their face, seem to have no particular target other than technology tout court. They often include alarmist headlines which are not supported in substance. They cite the marketing claims of technology vendors as statistics. Their true targets are generally people, or political ideologies, rather than technology — a critical fact which often remains buried in the work. Sue Halpern isn’t usually guilty of being a part of this subset (for example, Halpern’s work on the surveillance disclosures has been thoughtful and important) but her latest effort, on the pages of the Review, comes close. (Though, as I’ll explain, she gets a lot right as well).

The headline: How Robots and Algorithms Are Taking Over.

Screen Shot 2015-03-31 at 7.52.43 PM

Are robots and algorithms really taking over?  Will technological unemployment beget a new era of economic and social disorder? I’m skeptical.

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A Berkshire Opportunity Cost: Listed Family Firms

aaaaaThe following is adapted from “Berkshire’s Blemishes,” a working paper delineating the costs, rather than the vaunted benefits, of Warren Buffett’s Berkshire Hathaway as a management model.  

Warren Buffett loves family businesses whose owner-managers care more about their constituents than about profits, recognizing instead that customer care tends to translate into economic gain. Those entrepreneurs, in turn, love Berkshire Hathaway, Buffett’s company, because it offers intangible benefits such as managerial autonomy and a permanent home. When family businesses sell to Berkshire, they know they can still run them as they see fit and will not be sold if prospects falter: Berkshire has not sold a subsidiary in forty years and promises not to.

Buffett hates using Berkshire stock to pay for acquisitions, however, since few companies can match the time-tested premium currency Berkshire has come to represent. In fact, Berkshire’s worst acquisition was paid for in stock and Buffett still translates the cost into current values: $443 million paid in 1993, equivalent to more than $5 billion in Berkshire stock now. Preferring to pay cash, Berkshire is often able to acquire family businesses at a discount because selling shareholders value Berkshire culture. Buffett also hates auctions, plagued by frightful dangers like the winner’s curse, which can push bids well above value, rationally calculated.

Sensible as these tenets are, there is always an opportunity cost, in this case forsaking listed family firms–publicly traded companies controlled by a family. Unlike those owned solely by close-knit groups who all wish to sell to Berkshire, directors of listed family businesses owe duties to non-family shareholders when selling control. In most states, led by Delaware, they are duty-bound to get the best value for shareholders.  (The doctrine is known by famous cases illustrating it, including Revlon and Paramount v. QVC.)

In a stock deal where all holders share gains in future business value, directors could consider Berkshire’s special culture in valuing the transaction. But with cash, all such future value goes to Berkshire’s shareholders, not selling public stockholders, who would also gain nothing from the autonomy or permanence that family members prize in a sale to Berkshire. So directors resist an all cash sale at a discount and seek rival suitors at higher prices, even stimulating an auction to drive price up—repelling Berkshire’s interest.

An example can be drawn from Berkshire’s 2003 acquisition of Clayton Homes, a publicly traded family business bought for a modest (seven percent) premium to market. Many Clayton shareholders objected; one, Cerberus Capital Management, told Clayton it wanted the chance to make a competing bid; another sued. The result was a six-month delay in getting to a shareholder vote, which narrowly approved the Berkshire deal. Many Clayton shareholders were disappointed, but Cerberus opted not to outbid Berkshire, and the court dismissed the lawsuit.

The scenario remains unattractive to Berkshire, however, given the risk of litigation, delay and rival bids. After all, courts might require directors to take affirmative steps, presenting the risk of an auction, which in itself suffices to deter Berkshire from bidding in the first place. The upshot: the publicly traded family business is outside Berkshire’s acquisition model, amounting to an opportunity cost for what would otherwise be a sweet spot. On balance, it is probably a price worth paying, but it’s useful to know the price.

Lawrence A. Cunningham, a professor at George Washington University,  has written numerous books on a wide range of subjects relating to business and law.