Category: Corporate Governance


Berkshire’s Prosperous Simplicity: Try It!

Berkshire Hathaway is simple. Though among America’s largest public companies, it is almost entirely self sufficient. It rarely uses intermediaries — brokers, lenders, advisers, consultants and other staples of today’s corporate bureaucracies. It’s interesting to ponder how and why, but as important to ask why is it so unusual — and what people are doing about it.

While American companies borrow heavily, Berkshire shuns debt as costly and constraining, preferring to rely on itself and to use its own money. It generates abundant earnings and retains 100 percent, having not paid a dividend in more than 50 years. Berkshire earns some $30 billion annually — all available for reinvestment. In addition, thanks to its longtime horizon, Berkshire holds many assets acquired decades ago, resulting in deferred taxes now nearing $100 billion. These amount to interest-free government loans without conditions.

The principal leverage at Berkshire is insurance float. This refers to funds that arise because Berkshire receives premiums up front but need not pay claims until later, if it all. Provided insurance is underwritten with discipline, float is akin to borrowed money but cheaper. At Berkshire, float now runs another $100 billion, which it uses to buy businesses that continue to multiply Berkshire’s value.

American corporations tend to design acquisition programs using strategic plans administrated by an acquisitions department. They rely heavily on intermediaries such as business brokers and investment bankers, who charge fees and have incentives to get deals done; firms also use consultants, accountants and lawyers to conduct due diligence before closing. Read More


What’s Buffett’s Secret to Great Writing?

symposium-coverWe all write more than ever today, but do we communicate well?  As one group, corporate directors, pondered how to communicate effectively to shareholders, they  turned to the gold standard.  They wondered, what most distinguishes Warren Buffett’s annual missive to Berkshire Hathaway shareholders, and asked me, as a student of these writings for two decades, for the answer.

Clarity, wit and rationality are hallmarks to emulate, I said, along with how Buffett personally pens lengthy sections to read more as literary essays than corporate communications.

But, far more important, these attractive qualities are products of a deeper distinction with greatest value. Every Buffett communiqué has a particular motivation: to attract shareholders and colleagues—including sellers of businesses—who endorse his unique philosophy. Tenets include fundamental business analysis, old-fashioned valuation methods, and a long time horizon.

A recurring motif of Buffett’s writing is the classic rhetorical practice of disagreement. Buffett recites conventional wisdom along with multiple reasons why it is inaccurate or incomplete. He then differentiates Berkshire with themes like autonomy, permanence, and trust.

In a new article I wrote at the request of the National Association of Corporate Directors (available free here), I parse recent examples to show that Buffett’s dispatches often work on several levels simultaneously. Think of circles on a dartboard, with the bull’s-eye as Berkshire’s distinctive practices, which Buffett relentlessly explains. Surrounding that core explication, in concentric circles, Buffett lauds specific Berkshire businesses or personnel, contrasts their industry or competitors, and opines on related public policy debates.

By arguing in this artful manner, Buffett hones Berkshire’s corporate culture while answering rivals and critics alike. Leaving an unmistakable effect on the conglomerate’s millions of owners, managers, and employees, Buffett’s essays are a model of tone-at-the-top governance.

Buffett’s essays are rich with history, putting current debates in broad context, and steeped in statistics, anchoring argument in data. Buffett contrasts and compares; jokes and quips; and prefers to praise by name but criticize by category. Even when confronting critics, Buffett’s essays avoid sounding defensive.

Above all, the work expresses who Warren is—a confident, astute and joyous capitalist. Yale University writing professor William Zinsser says that “Motivation is at the heart of writing.” Buffett loves Berkshire, his curated life’s work defined by unusual shareholders, adroit managers, and idiosyncratic principles. Munger has commented: “Warren’s whole ego is poured into Berkshire.”

More than the elements of style, such motivation is a gold standard worth aspiring to.

Download the full article free here.

* * * * *

In 1996, based on a law review symposium they led together, Warren Buffett chose Lawrence Cunningham to compile his famous shareholder letters into the book, The Essays of Warren Buffett: Lessons for Corporate America, now in its 4th edition and sold worldwide in a dozen languages.


Berkshire’s Blemishes: Lessons for Buffett’s Successors, Peers, and Policy

Columbia University has published my most recent research paper, available free on SSRN (registration required): “Berkshire’s Blemishes: Lessons for Buffett’s Successors, Peers, and Policy.” Here is the abstract.

* * * * * * * * * *

Berkshire Hathaway’s unique managerial model is lauded for its great value; this article highlights its costs. Most costs stem from the same features that yield such great value, which boil down, ironically, to Berkshire trying to be something it isn’t: it is a massive industrial conglomerate run as an old-fashioned investment partnership. An advisory board gives unchecked power to a single manager (Warren Buffett); Buffett makes huge capital allocations and pivotal executive hiring-and-firing decisions with modest investigation and scant oversight; Berkshire’s autonomous and decentralized structure grants operating managers enormous discretion with limited second-guessing; its trust-based culture relies on a cultivated vision of integrity more than internal controls; and its thrifty anti-bureaucracy means no central departments, such as public relations or general counsel.

Delineating the visible costs of Berkshire’s model confirms the desirability of tolerating many of them, given the value concurrently generated, but also reveals ways to improve the model—a few while Buffett is at the helm but mostly for successors. Current reform suggestions include hiring a full-time public relations professional at headquarters and more systematically developing senior executives; suggestions for future reform include enhanced subsidiary compliance resources and separating the identity and personal opinions of top executives from the corporation and its official policy.

Besides helping Berkshire, the review and suggestions will help managers of other companies inspired by Buffett’s unique managerial model and policymakers who should study it. Implications for peers and policymakers include highlighting flexibility in corporate governance, the efficacy of the conglomerate form, and especially the value of strategies that produce long-term thinking among shareholders and managers alike.


Better Bankers Symposium, June Carbone

Thanks to everyone who participated in the Better Bankers Symposium.

My two cents worth it that the current system does not just reward “greed,” it create a Gresham’s dynamic where those most motivated not just by self-interest, but a preference for short term financial rewards, drive out others who see their self-interest defined in other ways.  Market discipline may produce boom and bust cycles that put firms like Lehman Brothers out of existence, but the corrections of the market often either overcorrect (Akerlof’s references to lemons’ markets) or do so at very high cost (the financial crisis).  This is because greedy individuals (those motivated by short term gains) have managed to create an opaque system in which market responses kick in only after individuals have a chance to leave the companies they undermined, with their outsized individual bonuses intact.

Better Bankers thinks more creatively about how self-interest can be marshalled to police such activities before they get out of control.  It seeks to restore the identity of interests between bankers and banks.  It thus seeks to create a system in which self-interest includes interests broader than short term financial incentives, and in which private market mechanisms can become more effective.  The old joke is “how many economists does it take to change a lightbulb?  None, the market will do it if it needs to be done.”  Hill and Painter’s answer is that it requires a design and it requires the will to create the conditions where the more intelligent design is likely to be adopted because it advances the common good at the expense of individuals who would like to be able to continue to game the system.  Let’s hope their proposal finds fertile ground.

Better Bankers Book Symposium – Is the Problem Bankers, Rather Than Banks?  BY David Zaring

better bankers

I’d like to put Claire Hill’s and Richard Painter’s fine proposal in the context of how we think about the purpose of financial regulation more generally.  Specifically, how should we think about reforming the financial system to avoid the problem the financial crises? The question is one of the most central to regulation in general, and has been a preoccupation of policymakers ever since the last such crisis. Many look to forestall financial crises with institutional reform.  In the case of banking safety and soundness, that dictates regulation designed to strengthen the balance sheets of banks. Since 2010, American banks have been required to hold more money on hand so that they are ready for shocks, to limit their proprietary trading, to hive off their derivatives arms, and so on. Each of these requirements, of course, have been the subject of regulatory battles and industry pushback.  But all of them are about banks as institutions.

But what if the solution is not to change what banks do, but rather to change what bankers do?

Regulators have taken some steps in this direction recently. They are emphasizing the importance of ethical behavior in banks, set by a “tone at the top”, or unimpeachable conduct in the boardroom.  Regulators haven’t really defined what the tone is, or listed the ethical requirements they find to be important, but there has a been a change in perspective.  Banks are being scrutinized not merely as institutions with balance sheets, but as ones with cultures, and cultures but need improving.


Hill and Painter are interested in boardrooms too.  They have condemned the lack of ethics among bankers, but their solution is much less diffuse than the idea of imposing ethical standards and hoping for the best.  Hill and Painter argue that bankers should “be personally liable from their own assets for some of their banks’ debts” and “personally liable from several years of their past, present, and future compensation for some portion of fines and fraud-based judgments (including settlements) against the bank.”

The book is great, and the solutions are intriguing ones. As Hill and Painter observe, current compensation and contractual arrangements within banks lead those bankers to take lots and lots of risks. To change the culture in any bank, the incentives must change as well. Hill and Painter’s elegant solutions looks to incentives to instill a culture that would discourage excessive risk taking and illegal behavior and embrace the sort of behavior that we want to see from our bankers.

Will that lead to safer banks?  I worry about the instability inherent in financial intermediation – many financial crises have macroeconomic causes, rather than causes rooted in financial misconduct.  But there is financial misconduct as well, and if instability inheres in anything, you’d like to promote caution.  Hill and Painter’s solutions would certainly be a step in that direction.




Better Bankers Book Symposium – a Perspective from Across the Pond

“Better Bankers, Better Banks” is an intriguing account of all the scandals and problems in banking that we appear to have become accustomed to. Professors Hill and Painter offer a fascinating new proposal on how to address these problems, which is as topical in the US as it is in Europe. In short, what their proposal amounts to is to rebalance the upside and the downside participation of bank managers in the profits and losses of their bank. Whereas before the crisis, regulatory efforts have long sought to align bankers’ incentives with the upside (by offering variable pay, bonuses, etc), there was very little attention on how to account for the downside risk. The idea of “covenant banking”, i.e. a form of self-commitment in the firm’s losses, is an important contribution to the current debate on how to improve banking culture post-crisis.

Inevitably, as soon as a proposal is on the table, market participants will want to know how it works in practice. In the following, I offer a few thoughts and questions that may broaden the debate towards its effects and implications.

First, how strongly would we encourage banks (or bankers) to make use of covenant banking. I am a little sceptical on whether they might adopt covenants deliberately. Some form of a government nudge would certainly be required. Different nuances in the regulatory toolkit are available. It seems to me that offering a best practice recommendation or a legislative menu with different options could be a sensible step to take. Findings from behavioural science support the effectiveness of such soft law standards.

Secondly, how will the market respond? Will clients and customers appreciate the stronger commitment that an individual banker’s “covenant” involves? Will they be able to digest the additional information appropriately? I would argue that a certain standardization of the covenant might help. If a small number of different covenants were “on offer”, endorsed by legislature or best practice code, the public would be much better placed to appreciate them. By contrast, if you leave firms to develop a million different tailor-made types – with exceptions, limitations and exclusions – creditors will not be able to price in their value correctly. This even more when you add an international perspective – jurisdictions will differ in their prescriptions and make it difficult to appreciate them in cross-border cases.

My final point is a little provocative: do we really get “better” bankers by making them liable for the firm’s debts? My pessimistic view of human nature is that bankers will still have strong incentives to work around their covenants – and possibly even use them as a commitment signal but do the opposite. Monitoring by creditors is therefore essential. This is another reason for why the rules should be clear, transparent, and somewhat standardized.

Hill and Painter have started a captivating journey, and I congratulate them on designing a stimulating new conceptual framework to address evil banking behaviour. I am convinced that their book will be the starting point for a long and fruitful discussion.




better bankers

We are delighted to introduce Professors Claire Hill and Richard Painter, along with the participants of our online symposium on Better Bankers, Better Banks:  Promoting Good Business Through Contractual Commitment (University of Chicago Press, 2015).  In the book Professors Hill and Painter trace the history of American banking to explain how we have arrived at what they term the “irresponsible banking” of today.  They argue that it is the failures of bankers themselves that causes banks to fail.  Their provocative solution is to hold bankers personally liable for bank failure.  As Larry Cunningham wrote on Concurring Opinions last year, Better Bankers, Better Banks offers a “fresh and compelling assessment of global financial stability.”

For roughly a half century after the Wall Street crash of 1929, the financial boom and bust cycle seemed to come to an end. Part of the reason was a change in the structure of banking; organizations that benefitted from federal deposit insurance had strict limits on the type of transactions in which they could engage and less regulated entities, such as investment banks, had to be owned as partnerships.   Another part of the reason is that the memory of the Great Depression restrained banking practices for decades after it occurred.   By the 1980s, however, those memories had faded, and a new era of high interest rates, greater international competition, and free market ideology encouraged deregulation of the financial section. The result contributed to the housing bubble and a series of scandals resulting in a new financial crisis from which we have yet to recover.   Few believe either that the government responses to date or the changes in banking culture the large banks have promised will eliminate the risk of another crisis. Yet, there is little agreement on the best ways to approach the risk.


Hill and Painter offer a straightforward solution: bring back an easily administered idea that worked. Require that those engaged in banking remain personally liable for their decisions. During the era in which investment banks could only be held in partnership form, partners could not easily buy and sell their interests. They had to be concerned about the long haul, and they jealously safeguarded their reputations and those of the companies they oversaw.   Once again making bankers personally liable for their actions will change the incentives that underlie banking, in an era in which transactions have become so complex that trying to anticipate each new abuse has become practically impossible.

To consider these and many other fascinating questions, we have invited a group of leading banking and corporate law scholars,  and of course, Professors Hill and Painter.

We look forward to a discussion on how to better our banks – and bankers.



Delaware’s Latest Show of Corporate Savvy

corp_logo_180x175Delaware continues to be the savviest seller in the world of corporate charters and related services, thanks to a combination of judicial vision and legislative elegance supported by all the state’s leadership and citizens alike.  The most recent example appears in the intersection of two technical corners–strike suit merger litigation and forum selection bylaws.

As detailed in this Wall Street Journal article of Wednesday, Delaware’s Chancery Court, led by Vice Chancellor Travis Laster, has been cracking down on frivolous shareholder suits challenging mergers.  The cases tend to be settled quickly based on corporate governance promises. Most of the cash that changes hands goes to plaintiffs’ lawyers while defense lawyers and boards seem to accept paying this “merger tax” as an investment in the certainty that that there will be no future litigation.

The WSJ piece suggests that the Chancellors’ crackdown may simply lead plaintiffs’ lawyers to file such suits in other forums.  But this overlooks one of the most important developments in recent Delaware corporate law, with which the savvy Delaware judges are keenly attuned.  If plaintiffs’ lawyers start filing increasing numbers of suits outside the Chancery Court,  more and more boards would unilaterally adopt bylaws barring such cases from any forum but Delaware.

The Delaware legislature recently authorized boards to do just that and courts elsewhere are bound to respect such arrangements and transfer any filed cases over to Delaware (as the Oregon Supreme Court did at year end in Roberts v. Triquint Semiconductor, Inc.).

True, in the past, Delaware boards and defense lawyers settle the frivolous cases and may find value in the finality. To that extent, the Chancellors’ crackdown on settlements may lead them to prefer litigating in courts more willing to give a rubber stamp, perhaps states eager to compete with Delaware in the corporate chartering and services business.

Except the Delaware judges are signaling a new world where boards need not fear these suits and crave their settlement as much as in the past.  If so, that makes Delaware more attractive and favors its selection for forum.  That increases board incentives to adopt Delaware forum bylaws.

A clearly virtuous effect of this combination of legislative, judicial, and directorial innovation is to make the merits matter more.  For Delaware, it is yet another way to cement the state’s deserved reputation as an attractive place to be incorporated.  And it does so primarily in the name of quality corporate law administration, rather than being either pro-management or pro-shareholder.


Five Reasons to Cheer for Starr v. United States (AIG Nationalization Case)

AIG coverYesterday, the US Federal Court of Claims ruled that the US government and its leaders acted illegally in nationalizing AIG during the 2008 financial crisis, in a shareholder suit led by Hank Greenberg, the man who built AIG until his departure in 2005. But the judge (Wheeler) also ruled against awarding any damages, saying AIG shareholders were not harmed.

A top journalist at a major financial magazine asked me the following five questions, and I gave the answers indicated–being five reasons you should celebrate the ruling. Please note that I wrote the book, The AIG Story (Wiley 2013), with Greenberg, where we laid out the legal basis for Wheeler’s ruling on illegality.

1) Is this a moral victory for Hank Greenberg? Do you think he sees it that way? 
Yes, it is a moral victory for Greenberg and for everyone else who cares about the rule of law.  I can’t speak for Hank other than to say he cares deeply about the rule of law.

2) Andrew Ross Sorkin calls this a split decision in today’s New York Times. Is that true and if not who won?
It is a Solomonic split decision but designed to invite an appeal by Greenberg and not by the government, so Hank gets a second bite at the apple on appeal.

3) Given the collateral calls that were pending and the certainty of an AIG bankruptcy, did Greenberg ever have a real chance to recover $40 billion?
No, but given the possibility of hiving off the insurance companies outside of bankruptcy, Judge Wheeler’s conclusion on no damages is vulnerable to reversal on appeal.

4) What will this ruling mean for government intervention in future financial crises? Is that good or bad?
No more violating the law or the rule of law by government officials, whatever they may think at the time. Very good–a win for justice and true American legal values.

5) The judge says that government broke the law in taking over AIG. Do you agree with that assessment?
Yes. Virtually every major figure in the takeover violated the law, certainly fiscal authorities such as Bernanke and Geithner, and maybe cabinet secretaries such as Paulson, and many of their bankers and lawyers, including those from Davis Polk, Goldman Sachs and Sullivan & Cromwell. They should all feel disgraced.


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.