22: The Power of Shareholder Letters: Insights into Corporate Governance with Lawrence Cunningham

Books authored by Lawrence Cunningham can be found here:
https://www.goodreads.com/author/list/742.Lawrence_A_Cunningham

Lawrence Cunningham's full bio:
Lawrence A. Cunningham is an authority on value investing, corporate governance, corporate culture, and corporate law and advises public companies and boards of directors in those areas as Special Counsel at Mayer Brown in New York and advises managers and shareholders on investor relations as Managing Partner of the Quality Shareholders Group.
 
Professor Cunningham has written dozens of books and scores of articles on a wide range of subjects in law and business. These include best-selling books such as The Essays of Warren Buffett (in collaboration with Warren Buffett) and The AIG Story (written with Hank Greenberg) and influential research articles on accounting and corporate governance. Before retiring from GW in 2022 at age 60, Cunningham founded and for many years directed GWNY, GW Law's innovative boot camp for aspiring Wall Street lawyers.
 
Professor Cunningham has served on several public company boards, including currently Markel Group (New York Stock Exchange), a global insurance and investment company, as vice chairman of Constellation Software Inc. (Toronto Stock Exchange), owner and operator of nearly one-thousand vertical market software businesses, and Kelly Partners Group (Australian Stock Exchange), owner and operator of nearly one hundred independent accountancy firms.
 
Before becoming a professor, Cunningham practiced corporate law with Cravath, Swaine & Moore in New York from 1988 to 1994, where his practice areas included corporate governance, M&A, finance, and international. In 2018, Professor Cunningham received the B. Kenneth West Lifetime Achievement Award from the National Association of Corporate Directors (NACD).

TRANSCRIPT BELOW:
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Welcome to investing the Templeton Way podcast. I'm your host Lauren Templeton.

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And I'm your co-host Scott Phillips. Today we have the pleasure of hosting a truly remarkable guest,

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Lawrence Cunningham, a leading authority on corporate finance, corporate governance, finance,

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and investing. Mr. Cunningham is an exceptional scholar, author, and professor who has left an

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indelible mark on the world of business in academia. With a career spanning decades, Lawrence

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Cunningham has garnered widespread acclaim for his invaluable contributions to the field of

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corporate governance. As a professor emeritus at George Washington University Law School,

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and a former faculty member at esteemed institutions like Boston College and Cardozo Law School,

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he has had a profound impact on shaping the minds of future business leaders.

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Lawrence Cunningham is author of nerous critically acclaimed books, including the Essays of

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Warren Buffett, Lessons for Corporate America, Dear Shareholder, Berkshire Beyond Buffett,

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Margin of Trust, which he co-authored with his wife, and Quality Investing, Owning the Best

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Companies for the Long Term. His writings have become essential reading for anyone seeking to gain

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a deep understanding of these intricate subjects. Welcome, Larry, to the podcast.

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Thank you very much, Lauren and Scott. That was an extremely generous introduction. I appreciate that.

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Well, I had a longer one penned, actually, but your bio is so long and you have had so many

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accomplishments. It's hard to fit them all in, but we'll make sure the complete bio is posted

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to the website and show notes for readers who are interested.

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So we met you in person, or Scott did, many years back. You thought it was in what year, Scott?

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Probably around 2013. At the Berkshire Hathaway annual meeting, where we recorded an interview with you.

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So it's wonderful to have you back and a new interview. Can you start by telling our audience a

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little bit about how you got started? Your background is in law. What brought you into the Berkshire

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Hathaway world? Were you focusing on corporate governance? Tell me a little bit about your past.

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Thanks. It was really the intersection of corporate governance and investing, where

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Warren spends a lot of his brain power, and his writings highlight that intersection. Both as an investor,

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he cares a great deal about stewardship and only invests with people he likes, trusts, and

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admires, and that gets into the boardroom. That's really the essence of corporate governance.

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As a manager, as he began acquiring companies and grew and grew, his own imperative was to design

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a corporate governance system that would enable administration of that sprawling conglomerate

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that has continued to grow. He emphasizes the importance of trust in his decentralized autonomous

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structure. Corporate governance and investing overlap in that way. I came onto it as a young

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professor of corporate governance. My teacher knew Warren, worked together on a plain English

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for companies project. Many disclosure docents, prospectuses, and annual reports were written

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in terrible legalese. People didn't understand it and wouldn't find it interesting. Warren was on

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a panel that tried to improve the quality of disclosure in corporate America. My professor was

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on that with him. My professor introduced me to Warren and his letters and they just blew me away.

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The clarity, the candor, and the articulated link between corporate governance and investing.

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I fell in love with the letters and had been a big fan, a big student of them ever since.

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Yeah, it's amazing. There is so much clarity in his letters. I think that helps him attract

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that quality shareholder base. We all respond to that. Often feel like, well, actually this year,

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I took both of my girls to the AGM. On the airplane going out there, I pulled out the annual report

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and handed it to my oldest daughter and she sat there on the plane and read the letter at the

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beginning of the report. She's 14. She was able to read it and understand a lot of it. He does write

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in a very clear and simple, easy to understand format. What other CEOs do you find

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are accomplished in this area and skilled at writing investor letters?

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Thanks for the question, Lauren. I actually did a lot of research on exactly that question. I read

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hundreds or maybe nearly a thousand different authors, different CEOs' letters to shareholders

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over a long period of time and analyzed their clarity, their candor, both using some of my own

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tests as well as the tests of linguistic analysts who are experts in identifying clear prose and

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understandable language. I boiled it down to about a hundred and then dug a little deeper and came

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up with 20 and then published a book called Dear Shareholder, The Best CEO Letters and the subtitle is

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going to answer your question. I think it said,  ‘From Prem Watsa to Warren Buffett’. Prem Watsa is

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the chairman and CEO of Fairfax Financial, which I know that you know well, a terrific Toronto-based

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international insurance company and a merchant investment vehicle, that has a lot in common with

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Berkshire, including that Prem Watsa is a skillful communicator, witty, clear, honest, just, and educational.

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His letters also inform. So that book has 15 or 20 CEOs in there, Jeff Bezos is in there,

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the CEO of Amazon, former CEO I guess, but for many years he wrote clear, crisp, inspiring letters,

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talking about the business principles that Amazon was based on, especially customer centricity,

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the sense of a very long-term horizon. ‘Day one’ is his sort of mantra about always thinking

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you're starting something new and you're going for a marathon. But Warren's letters take the cake

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and it's hard to emulate him, but there are those 20 or so and I do commend those too. Because I

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think the other thing, the other test that we applied when selecting those 20 was sort of an authenticity

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test. There are a lot of ghost-written letters that look and sound good, but are not genuine and you

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can see it either in the tenure of the leader, the performance of the underlying business. So, what's

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true about this collection of letters is they're written by people who really mean it, mean what they say

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and live it. They are in the saddle for a long time, not every year is great, but over a long

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period is the time that tend to do very well for their shareholders. What is your favorite investor letter

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you've ever read? Well, it's probably Warren Buffett's 1978 letter. It’s relatively short.

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And this was early days for Berkshire as a public company. Warren had been writing letters to the

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partners of the Buffett partnership for 15 or so years, but this is the first time he's really addressing

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a public shareholder constituency. And in that letter, he described the kinds of shareholders he

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wanted to attract to Berkshire Hathaway. He called them, ‘Quality Shareholders’ and he went on to explain

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what that meant. The short version of what it meant was he wanted people who really cared about Berkshire

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Hathaway, understood the businesss, wanted to take the time to learn about its philosophy, its methods,

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its investment strategy and who would then want to own the company, own shares in the company

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indefinitely forever, essentially. And so he elaborated this framework at, you know, you were,

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I'd like to see more CEOs want that kind of shareholder and there are shareholders, there are CEOs who do.

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I'd also like to see more shareholders who are like that, who study and hold. But that's the kind

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of shareholder he said he wanted in the beginning. And that letter, a reason I value it so highly out of all

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the encyclopedias of letters out there is, you know, it was a direct appeal, a very specific

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advertisement to a very particular kind of person who was invited to join this very unusual business

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organization. And it's worked. So it's an invitation that was accepted by those to whom it was issued

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mostly and has generally worked. Yeah, it's such a fascinating case study, Berkshire Hathaway and

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the qualities of the shareholders. I mean, you can feel it at the meeting when you're standing there

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with 40,000 people, they're, you know, mostly shareholders, we hope. And they all seem very similar.

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They're all very humble and I think very educated. It's an interesting group of people, but I've heard

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you describe shareholders, you have four categories that you put shareholders in. Could you expand

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a little bit on that and how many quality shareholders are out there? I'm happy to. And the four categories

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that you mentioned that I guess I came up with them. I came up with them in certain ways, but in some

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ways, I just drew upon a fairly rich academic literature that tries to segment the shareholder universe

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as well as a more popular conception or delineation written by a number of different investors

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over a fairly long period of time, starting with Phil Fisher in his 1958 book called

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Common Stocks and Uncommon Profits. And so this, its a pretty vast literature both in the academic side

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and the sort of popular side. And basically, and there are a lot of different ways we could cut the

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shareholder universe. But what this literature, this framework stresses is a shareholders time horizon

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and degree of concentration or diversification. And so you could picture those two dimensions

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as the sort of X and Y axis on a graph, time horizon, short to forever, short to short, nanoseconds

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to infinity, and concentration to diversification, you know, running from, you know, a single stock,

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let's say, to the entire Russell 3000 or some larger index. And if you just divide that

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graph into four, you'll get basically the four types that we're talking about. So you have a

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an index fund, for example, which is basically forever, basically as long term as you can be,

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certainly they don't try to time the market and buy and sell really quickly. They basically intend to

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hold forever subject only to having to buy and sell in order to maintain the proportional interest in

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the index. So they're very long term and also extremely diversified by definition,

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a person running an index fund is as diversified as you can be in that index, whether it's the S&P

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500 or the Russell something. And so you've got that cohort, very long term, very diversified.

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And you've got the flip of that is a very arbitrage or short-term opportunistic

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trader could be using artificial intelligence and doing nanosecond trading, very in and out,

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or day trading at your, at your desk at home. But it's the opposite of long term. No interest really in

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the underlying business. You're only trying to exploit the scorecard, exploit the trading.

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And that cohort may or may not have very concentrated positions and probably does,

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buying a large position, but not holding it for very long at all. And there are different nicknames

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for that cohort. Some people just call them traders, others, transients or arbitrageurs or

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or something like that. But I call them transients in my work. So those two

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cohorts are a pretty big portion of trading or investing today. The index community probably commands

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40, at least 40% of the total market equity, certainly the big three, you know,

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own 20 together own 20 or more percent of most public companies in North America,

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more in the United States than in Canada, but still a huge portion. And then a lot of

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additional smaller index funds are out there. So it's a huge, powerful block. And again,

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they may be long term. They're certainly not trying to do short term stuff. But they're so

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diversified. They can't really pay attention to particular businesses like, say, a Berkshire

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Hathaway. And the other cohort of transients, it's a little harder to measure exactly the

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total capital that they command. But if you look at average trading, average holding periods and

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in different funds, they're also a very substantial, a very large portion of stock is held

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and traded by people or institutions with relatively short time horizon, certainly less than a year.

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And a lot of it's, you know, six months or or less. So maybe it's 30 or 40%.

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The third category are a kind of a hybrid, I guess, call them activist investors, activist

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shareholders. And they're a little different because they can't, and the population is diverse.

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Some of them are quite long term, but some of them are more of a drive-by operation where they

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just seize an opportunity to try to drive the price, stock price up and split. So it's a little

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different category. They're certainly not indexing, and they're probably not nano trading. But,

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and they're, you know, using their position to try to exert influence. And so in a certain way,

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they are concentrated and focused on the, on the business. And the fourth category, this is the quality

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shareholder category that Buffett in 1978 said he wanted to attract at Berkshire Hathaway.

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They're unlike the indexers or the transients, so basically the opposite of, of both of them, unlike

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the transients, this cohort buys and holds or intends to hold forever. For a, it has a very, very long time horizon.

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And it's in Berkshire's case, it's infinite. It's forever, you know, 20, 30 years. We're talking about

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generational wealth. But, but even funds or investors that are thinking three, five, 10 years would count

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as long term in this model. So if their average holding period is multiple years, we put them in the

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box of long term. And the other feature of the quality shareholders, unlike the indexes, that they

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tend to concentrate their portfolio in a relatively smaller number of, of investments instead of

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owning all 500 companies in the S&P, they might own as you as 20 or 30 or 40, but it's a focused

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portfolio selected based on the economic and cultural characteristics of particular companies.

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So that's the quality shareholder cohort. That's the group Warren has always wanted to attract

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since 1978. It's certainly a good description of Berkshire Hathaway. They have a very concentrated

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portfolio and their favorite holding period is forever. And so what portion of the total universe

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is represented by these two cohorts? The activist cohort can vary from three to seven or nine percent,

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depending on activity levels and so on. But so, it's relatively small as an overall, but they have,

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they have a lot of weight and so exert a lot of influence. And the quality shareholder cohort

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picks up the rest. It may be as few as 10 percent, maybe 20 percent depending on how you count,

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but it's no greater than that. So it's a minority for sure, but the thing about them is that because of

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their focus, because they do their homework and they study companies very carefully, they actually have,

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they contribute more value to the process of capital allocation, market pricing and so on,

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than the other cohorts do. So it's a small but critical cohort for the overall system.

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And then for companies like Berkshire, just the, why does Warren want that cohort? He wants people

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who are interested in Berkshire and want to hold it forever. That's the 40,000 people who,

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hopefully your daughter, who are coming to the meeting, people who know.

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And are prepared to hold it through thick and thin.

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Well, I can imagine that cohort is shrinking and has been shrinking over time. So what are the

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implications? Corporate governance implications? I mean, what should we expect?

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I think they're profound. You're exactly right. The quality shareholder cohort has been shrinking.

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And strikingly, in 1978, when Warren wrote that letter, the transient cohort was robust.

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It always has been. There are lots of people who are very excited to play the stock market.

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And that typically means thinking of stocks as pieces of paper or dollars that simply trade and are

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fun, you know, is just fun. And they're not really thinking about, you know, what's the long term

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approach to this manufacturing business or this service or this product? They're just trying to

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make a buck. And so, they're always prowling the markets. And they were probably as nerous in

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‘78 as they are today. I mean, there's some evidence that average holding periods have been shortening.

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But there's also some evidence that it's not so bad. So, I'm not as

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exercised about that short-termism. It's real, but I don't think any worse.

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But in 1978, there were very few index funds. Those things were invented early 70s. They began to

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take root. Jack Bogle famously originated the idea. He's the fellow eventually founded Vanguard.

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He wrote the idea that he articulated in his graduate thesis at Princeton University

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and where he outlined kind of why this would be attractive to an investor or manager to own the index.

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And he explained that it's because you don't have to do any homework. You don't have to incur any cost

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to learn about particular businesses. You don't even really face any meaningful risk of particular

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businesses. You're simply acquiring the market return at no or low cost and whatever risk

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that presents, high or low. And so he explained it's a wonderful device for millions of ordinary people

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who don't have to think and don't have to pay much. And yeah, you'll have a bad year once,

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a while, last year was, you know, negative 18%. Most of the time you're, yeah, 6, 8, 9, 11.

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So Jack and others in the 70s incubated this industry. And by 78, it was probably too soon

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to see that this would now become 40% of the market. But even at that time, I think it was worried.

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But the reason the quality cohort is shrinking is because of the allure of the index. It's just a lot

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easier and safer, not only for the avowed indexers like Vanguard, but for money managers who are scared

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of underperforming, who will be punished if they make the wrong picks on their concentrated stock. Career Risk. 

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So your best is pressure to pretend like you're doing real investing, but actually delivering

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the market, you know, it's called closet indexing. And it just, it accretes, you know, more and more

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people migrate in that direction. And I, savers, ordinary people preparing for retirement,

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find that very attractive proposition is a very low cost. You know, you get the market.

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Yes, Warren Buffett even advocates for it. He said, he said that, yeah, exactly, that he calls it the

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rocking chair investor or more, more, more negatively than no nothing investor, someone who doesn't

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have the time, energy, ability to evaluate a Fairfax or a Berkshire, or Amazon, just buy man, you know,

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by the S&P 500 from Vanguard. So yeah, he said that. So it's extremely

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valuable. It's extremely powerful, valuable. The, the downside is that because the

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investing model entails doing no homework and not really knowing anything, that same group,

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then gets to vote on very important consequential decisions that companies have to make,

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including electing the directors annually and setting a lot of the governance guidelines,

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like whether the CEO and the chair should be the same or different people, whether diversity

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should be a priority and what, what that would mean, whether certain kinds of lines of business

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should be off limits or embraced. And so what's been happening, over the past 20 years is

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these important decisions like that in corporate America are increasingly made by people who really

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don't have the time, energy or attention to study them. And so what the consequences that we

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have guidelines, all of the large index funds and they're, the external advisors, because they

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can examine every company, company by company, do what Warren wanted people to do for Berkshire.

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They just have general lists of rules that every company is expected to follow, such as the chair

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and the CEO should be split. A majority of the board should be independent. Every person on certain

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committees should be independent. , there shouldn't be any blank check preferred stock. There shouldn't

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be any culative voted. There shouldn't be a dual class capital structure. Just on & on, just a list of rules,

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cookie cutter corporate governance. Yeah, it's, cookie cutter corporate governance. And,

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you know, in 1978, this was not a serious problem because of Vanguard might have had a vote, you know,

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1% or 2% if that,you know, the collection of index funds of very tiny say in the matter. These

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days, you know, at 20, 30 or 40%,  this, this cohort, the indexing cohort of shareholders has

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enormous, and I would, power, and I'd call it inordinate power because the entire business model

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is premised on being, you know, homework free, you know, right passive. And they simply don't,

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you know, the economics don't support the, the necessary resources to do the fundamental analysis.

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Yeah, to be fair, they, they do attempt to deploy a staff of, engagement managers.

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They call them stewardship staff, but it's really trying, trying to identify relevant facts at

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particular companies that would warrant, , deviation from the rule book,

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 which is a nice gesture, but it's not the same. You, you still have a lot of very reflexive,

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voting on, on extremely important matters that the quality shareholders

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take a totally different approach. They do thorough examinations of the

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governance structure, who the directors are, what the strategy is, they listen carefully,

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and they don't know what, they don't always go along. Sometimes they'll say, this ship is going

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in the wrong direction, and they will sell, but they're doing their homework. And, and so those,

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are, those are the categories, and I do think, I'll just finish with one caution, you know,

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cautionary note, that Jack Bogle, the fellow basically invented the index fund,

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passed away about two years ago,and he was a very public spirited figure. He wrote a lot of books,

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and gave a lot of speeches, I commend his work to you all. And he wrote op-eds,

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and newspapers, and, and a lot of what he did was advocate for, index funds, and

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Warren Buffett loved Jack. I don't think there were super close friends,

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but Warren thought Jack Bogle was a hero to ordinary investors for having invented the index fund.

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So Jack loved the index fund, but nevertheless his last op-ed, the last editorial public spirited

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contribution that he made about eight months before he died, warned about the excessive

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concentration of power in the indexing industry. He observed that Vanguard, State Street, and Black Rock,

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they called it big three in the indexing industry, command the voting power of 20 to 25%

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of every large company in America, and, and many elsewhere in the world. And what does that mean?

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Why is it scary? Well, because the decision makers at those three firms, it's just a handful of people,

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three or four individuals at each of those places are deciding, all directors should be independent,

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no CEO can be a chair, no one can have, or blank check preferred. I mean, all these other,

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it's just a handful of people. And Jack's warning was that even the most, the wisest,

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best intentioned group of 12 people should probably not be trusted with

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the most consequential decisions in the civilization. So that was Jack's warning.

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And, and I take it seriously, and I think some of the leaders of the index funds

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appreciate that too. And they're trying to take steps to reallocate some of that concentrated

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voting power back to the actual investors, but it's, it's a huge, I think, shortcoming in the,

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in the prevailing, , governance system. Yeah. I mean, I think it's very concerning,

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the proxy voting firms and the consolidation of power there, and some of the recommendations

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that you see coming out of the proxy voting firms that don't seem to be very well informed about

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the particular circumstances giving a company,you know, impacting a certain company. I think

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it's very concerning. Yeah. And your readers might be interested in a report that was

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prepared by a group called the Society for Corporate Governance. It's a professional association.

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It's about 80 years old. It, of the general councils and corporate secretaries of, the

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largest, you know, say, the Fortune 500 in America. So these are people on the front lines of

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engaging on corporate governance, including with those proxy advisor firms and, and the institutional

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investors and, they they do a lot of reports and and studies and research about practices,

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trends, problems. And, and one exercise they produced last year catalog the errors that the proxy

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advisor firms had based the recommendations upon. Errors about the, the background of a director,

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or whether director had X number of other board seats, how long the director had been in the office,

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how old the director was, whether the director had done any consulting for the companies,

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reams and reams and reams of mistakes. We're all human. We all make mistakes. The problem here is

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there's not, there's no mechanism to correct it. The, the, the practice in that community is for the

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proxy advisor to, you know, make sort of run through its data and then, you know, produce the

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recommendations and leave it at that. So when a company discovers there's a mistake, this director

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isn't on that other board. This director never consulted for us, there's no way to fix it. And so

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you just get a lot of mistakes. I think you can attach a letter to the recommendation somehow. I

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like, I've run into the circumstance in the, in the past where you can attach a letter, but they

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will not change the recommendation after it's been made even if it was made based on incorrect information.

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So that is a bit disturbing as well. Yeah, maybe the fact checking is a, is a job for AI. We'll see.

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One question I had, Larry, while you were discussing the kind of erosion of quality shareholding,

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do you think that there's a correlation between that evolution and the last 10 years of monetary

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policy, low interest rates and that then of speculation and the homogenization of interest

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costs at the company level to where I just made more sense to own the index. And if that is true to

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some degree, is it a good sign that interest rates are going back up and companies are starting to

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disaggregate in their performance? And will that create more shareholder interest? Yeah, it's an

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excellent point. You said it better, better than I can, but certainly investors or anybody trying

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to allocate capital respond to the macroeconomic environment, interest rate environment, and will take

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decisions, you know, based influenced by the rate of interest, the cost of capital.

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And I think your thesis is credible about the past decade. And I suppose, it will probably alter

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some, some incentives and provoke a more, you know, fundamental analysis among certain

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cohorts. So I'd say yes, my only hesitancy is that, you know, it doesn't, you know, the

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allure of the index remains, you know, powerful and strong because just, you don't have to do it,

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you know, it's arm - rocking chair investing, so anybody can do it. so I think the allure

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won't completely disappear. And then for my, be it, armchair policy advice, I,

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I think monetary policy is critical, but I think we, I think, I think working on the mechanism to,

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calibrate the voting power with, with sort of the homework, you know, so the business model is,

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let's do no homework, and and we'll all get the index. That's fine. But then, I don't think you

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can then also,  fairly claim that you get the voting power. You're not, just doesn't seem logical.

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And obviously there's nothing illegal about anything that's been done, but by, I think that 

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the invention,  the system didn't adjust entirely for the invention. I think we still

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have to do that work. And, and again, there are proposals galore about how, how to do it. And some of

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the funds are trying to self regulate, but there are proposals in Congress and their, their proposals in

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state legislatures to try to try to change the, the power and the index voting and, and, and the proxy

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plbing as it, as it's called, the, the process through which these votes  are cast 

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and oust directors or effect other changes. And so I think we really need to work on that.

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Even if interest rates stabilize or people are otherwise incentivized to focus on fundamentals,

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I think that mismatch between what the index does as an economic matter, what it's able to do is

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a policy, governance matter, need to be adjusted. Is there been some blowback on the role of the ETF

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providers and proxy voting? I'm thinking particularly along the lines of ESG and maybe that there's

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a growing awareness of their power? Yeah, I think that's exactly right Scott, because the indexers

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had a problem in the beginning, say 20 or so years ago, they began to have this governance authority,

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this governance power, and they didn't really know what to do with it, and the solution was to

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promulgate these guidelines, these proxy voting guidelines that announced our expectations around

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the various governance points that I've been listing, you know, board size, makeup,

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relationships, roles and stuff like that, and it wasn't a terrible design. I think it's full of

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flaws, but it wasn't a disaster. They found some academic studies in here or some intuitions that say,

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you know, having independent directors is probably helpful for, you know, financial reporting if

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nothing else, having an audit committee with independent people and some authority over the

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auditors is probably a good idea to promote fidelity, and financial reporting. So it wasn't

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and even separating the chair of the CEO, the evidence is mixed, but it wasn't an

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irresponsible idea. It was still trying to focus on what's the best for this company in running

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this business for the benefit of the shareholders. So it wasn't entirely out of whack, but as the ESG

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movement gained power on its own and gained moment and entered into these, these not just governance,

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but environmental behavior and reporting and social behavior and reporting, particularly how

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in the workforce, how recruiting retention, promotion, training, and so on is done.

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It's a whole new world. It's deep into the interior, functioning and operations of companies,

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where we put the plant, how we manage the pollution, how we sequester the carbon,

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who we hire in what geographies and what mix, and what gender of race, of religion, and so on.

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That's deep inside the operations of the company. What in the world would index funds know about that?

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And where would they get their guidelines?

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I mean, its governance was, you know, okay, a bit of a can of worms, but it wasn't,

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it was very much about the administration of the organization rather than its internal operations.

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When it's come to E&S, you know, and in the early days of that movement, it was also well-intentioned

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and actually probably benign. It's an old-fashioned thing to the way you make money for your stockholders

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is by catering to your customers and nurturing your employees. And protecting the community,

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including the Earth. So it's in some ways innocent, but in the past five years, an enormous

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ecosystem has just gotten behind that and pushed it in some cases to extremes that have nothing to do

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with the performance of particular companies, but instead try to advance much larger social or

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environmental agendas that have become increasingly controversial on their own in the political

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sphere. And then within particular companies, it's just become a bit combustible. And so you've gotten

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a very significant backlash or resistance or repudiation to some of these more extreme overtures.

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And yes, all engines in the field have felt the blowback, including the index funds, who

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they've been asked to vote on, well, let's take Berkshire Hathaway. This year,

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there was one proposal, a governance proposal that split the CEO and chair role, but there was another one about

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it's been on the ballot for several of the past few years. Please report your carbon emissions

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from all of your operations and those of your customers and those of your suppliers. Please report

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the diversity, the gender and racial makeup of your employees across all these businesses. And

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in Berkshire's, these are not practical or effective strategies to promote ecology or diversity

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at the complex, diverse, decentralized autonomous organization that we have. They try to explain this.

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But again, the quality shareholders would study that debate, which is an interesting debate.

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And then make a resolution based on the particular facts at Berkshire Hathaway. But the indexers

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are ill-prepared to do that. So they simply instead have a guideline that says, we're in favor of

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environmental reporting. We're in favor of diversity reporting without, without evaluating whether this is

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appropriate for this company or even helpful to the ultimate causes that the agenda is seeking. So

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that, you're exactly right. A very big light has been shown on this aspect of corporate administration.

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And it's hard to predict how it will resolve. But if you look back at history, we've had six different

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corporate social responsibility movements since the 30s and 40s. And they follow a pattern where

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good ideas initially make some productive adjustments. And then the success attracts zealots

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and extremists who push too far and a backlash ensues and you return to some sort of equilibrium.

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I think ESG may be in the process of finding that equilibrium.

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Yeah, it feels like there's a backlash right now against ESG. It's such an interesting topic

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for me to talk about as a female on three corporate boards. The whole diversity on board

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component, I see the value of having a diverse board. Of course, that's probably one of the reasons

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I'm serving on some of the boards that I serve on. But then also the absurdity of voting against

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the nominating and corporate governance chair because there aren't exactly one third of the women

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on the board, not exactly one third of the people on the board are women. So I see the absurdity in

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that and it's a really hard, it's a hard thing to tackle. I think that's why the shareholder letters

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are so important because if you have a CEO that can communicate very clearly and directly to shareholders

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and a CEO that has cultivated that trust both within the organization among the executives and

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among shareholders, shareholders will actually listen to that CEO, explain these issues and what is best

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for the company. And it sounds like you think that Warren Buffett is just a great example of

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somebody who does that very effectively. Yeah, and you make, I agree, and you're right about my views

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on that. And I think that Dear Shareholder book that we mentioned a little earlier also

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gave examples of some female CEOs who excel or have excelled at letter writing.

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At Pepsi, HPE, I think it was Meg Whitman and Katherine Graham and I single, at Washington Post

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Company, I single her out because she and Warren Buffett had a very productive symbiotic

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business relationship where Berkshire became a significant shareholder in Washington Post Company.

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It was public and she cultivated that quality shareholder and then he helped strategize and mentor,

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I guess, Kay Graham and also gave very useful technical advice on certain topics like how to manage

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their company, pension fund. She was remarkably candid and clear, so she's an exemplar.

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And to the team, yeah, I think you're right. It's a very different, it's a board gender diversity,

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as you say. It's needed, you know, it's 25 years ago, most boards of big public companies in America were

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insiders, executives of the company, older, white, and male. I just happen to be doing a study. You take

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the Nike board in 1997, 13 people, all but two were that description. One was Japanese American and

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they had one female. Fast forward today, it's still 13. There are four women and four people of color

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and all but one person is an outsider and all but two because I think Phil Knight is on the board.

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So we've changed the composition of the board dramatically and there's undoubtedly still

377
00:43:32,080 --> 00:43:38,960
need, especially in some boards for a little more of that diversity. But, and I think that's all

378
00:43:38,960 --> 00:43:43,920
exactly right and good. But I also agree with you or at least the implication that I was taking,

379
00:43:45,520 --> 00:43:54,160
it's critical to promote that inclusiveness, to use a popular word. But it might tip to say you have

380
00:43:54,160 --> 00:43:59,680
to have three of this color and two of this gender and one of this sexual orientation. That gets,

381
00:43:59,680 --> 00:44:06,480
and I think, you know, it's unfortunate that some people think that's how you have to design a board.

382
00:44:06,480 --> 00:44:12,560
I would rather have it much more organic looking and I disagree with you, Lauren, about why you're on the

383
00:44:12,560 --> 00:44:23,200
board. You're a supremely talented analytical investor with great business skills. And that's what I

384
00:44:23,200 --> 00:44:30,880
look for. Well, thank you. I mean, it's a component. I mean, I've been on boards that went through a process of going from all male to 40% or

385
00:44:30,880 --> 00:44:38,800
30% female. But we did it and I think this is the way to do that. We weren't thinking we need to have

386
00:44:39,680 --> 00:44:43,440
five people or six people or seven people out of this number of people. We weren't doing a numerator-

387
00:44:43,440 --> 00:44:49,040
demoninator deal. We were trying to find the very best people and we made sure we had a net that

388
00:44:49,040 --> 00:44:56,400
included all kinds of backgrounds, diversity, gender, race, ethnicity, religion, aboriginal status. I

389
00:44:56,400 --> 00:45:01,280
mean, and then we picked the best ones. So I think it was a conscious, deliberate,

390
00:45:02,000 --> 00:45:09,200
search, but then the choices were entirely on who will help this company the most at this moment.

391
00:45:09,200 --> 00:45:13,120
And I know one of the problems with that approach,

392
00:45:13,120 --> 00:45:19,360
proponent, you know, activist thinkers will say, as it takes too long, you're not going to get

393
00:45:19,360 --> 00:45:25,200
parity. You know, we've already been working on this. I took the case for 25 years.

394
00:45:26,320 --> 00:45:33,840
That's a long time and you're still not quite there. And there's a frustration about just how long it takes

395
00:45:33,840 --> 00:45:41,280
and it's a fair criticism. I think that's where the debate is. The opponents would say,

396
00:45:41,280 --> 00:45:50,960
that's a enormous progress on a social topic. So it's looking at the identical things and

397
00:45:50,960 --> 00:45:58,400
interpreting different ways. Yeah, it's so interesting. So I want to talk to you about two different

398
00:45:58,400 --> 00:46:04,560
topics they are related, but one you've written or you co-authored a book with your wife,

399
00:46:04,560 --> 00:46:10,960
Margin of Trust, can you talk about trust? Why it's important to an organization? And also,

400
00:46:10,960 --> 00:46:17,200
could you equate that to the insurance industry? I've heard you talk about the consolidation of

401
00:46:18,080 --> 00:46:24,640
quality businesses, trust-based businesses in the insurance industry. And why you get so many of

402
00:46:24,640 --> 00:46:30,320
these CEOs in the insurance industry that are great letter writers and quality shareholders in

403
00:46:30,320 --> 00:46:35,280
the insurance industry? Can you tie that together for me a little bit? Yeah, thanks for the opportunity.

404
00:46:35,280 --> 00:46:41,520
Thanks for doing that, Lauren. That's really nice. To trust is critical in any relationship,

405
00:46:41,520 --> 00:46:48,160
starting with the family and moving into the neighborhoods, the schools, the civic

406
00:46:48,160 --> 00:46:57,360
dimensions, and in business. And you have to be able to rely on your counterparties,

407
00:46:57,360 --> 00:47:04,400
or you can't do business. There's no way we can pre-commit to handle every possible situation

408
00:47:04,400 --> 00:47:10,480
from now until doomsday in some exquisite way. We have to appreciate that as things change,

409
00:47:10,480 --> 00:47:16,240
as adversity comes, we will both need to pivot or adjust or change this relationship. And so

410
00:47:16,240 --> 00:47:22,640
ex-ante, when you start in relationship, the only way it's going to succeed is if you have a degree

411
00:47:22,640 --> 00:47:31,280
of trust so that you can fluidly rely upon each other and work things out. So it's a critical feature.

412
00:47:31,280 --> 00:47:37,760
And many of the most important economic events in history were done on a handshake,

413
00:47:37,760 --> 00:47:43,120
done on trust, without elaborate commitments or contracts or written agreements,

414
00:47:43,120 --> 00:47:50,720
going back to the railroads and even through large business transactions through the '60s or '70s.

415
00:47:50,720 --> 00:47:57,840
And so it's critical to have trust. It's critical at that high level. It's also critical when you're

416
00:47:57,840 --> 00:48:06,560
hiring a workforce, training them that we are thinking as a team that I will help you understand how

417
00:48:06,560 --> 00:48:12,480
to perform these functions. And then you will contribute that value to this organization and not go

418
00:48:12,480 --> 00:48:19,360
spill the trade secrets and go into competition with me somewhere else. So the sense of trust is

419
00:48:19,360 --> 00:48:27,040
critical in all businesses. In America in the past 20 or 30 years, the culture has tended to defy

420
00:48:27,040 --> 00:48:32,800
the importance of trust by increasing the emphasizing mechanisms of control.

421
00:48:34,160 --> 00:48:40,800
Hierarchical arrangements where people are given very defined functions in very specific orders

422
00:48:40,800 --> 00:48:46,720
and with little or no discretion or autonomy to pivot or adjust as circstances require.

423
00:48:46,720 --> 00:48:52,960
Significant lines of reporting authority have been designed to promote accountability,

424
00:48:52,960 --> 00:49:03,680
which ends up eroding trust. And so it begins to harm the functioning, the prosperity of the organization,

425
00:49:03,680 --> 00:49:09,120
the sense of loyalty people might feel, the sense of fidelity, the sense of team, the sense that we're

426
00:49:09,120 --> 00:49:14,720
in this together. And so there's an optimal point within any organization about what's the right

427
00:49:14,720 --> 00:49:21,680
mix between trust and control, between giving people discretion and having bounded authority.

428
00:49:21,680 --> 00:49:28,400
So where that balance is or how to dial it varies from company to company. As a macro matter,

429
00:49:28,400 --> 00:49:34,720
when I just look out at the overall system is pretty clear that the general dialing has been towards

430
00:49:34,720 --> 00:49:40,800
control and away from trust. So within that framework, you can then identify exceptions,

431
00:49:40,800 --> 00:49:48,240
organizations that still rely very heavily on trust. And the examples that I include in that book

432
00:49:48,240 --> 00:49:58,960
with Stephanie, my wife, Margin of Trust, are the common exceptions are large, conglomerations

433
00:49:58,960 --> 00:50:05,840
of diverse businesses under single roofs where the organization, it functions best when it's organized

434
00:50:05,840 --> 00:50:11,120
into decentralized components where the managers of the different business units have significant

435
00:50:11,120 --> 00:50:17,920
autonomy to call the shots about products, customers, pricing, and even capital reinvestment.

436
00:50:17,920 --> 00:50:23,600
And the reason is because in that kind of setting in a large diverse organization,

437
00:50:23,600 --> 00:50:30,000
it's even more important to grant people decision making authority over topics where they know best.

438
00:50:30,000 --> 00:50:35,760
And the exemplar for this is Berkshire Hathaway, Warren Buffett sitting at the top - 

439
00:50:35,760 --> 00:50:42,320
over 80 different operating subsidiaries, he would have no idea how to operate any of those businesses.

440
00:50:42,320 --> 00:50:48,000
He would not know how to price an insurance policy at Geico or think about product innovation

441
00:50:48,000 --> 00:50:57,760
in the candy business or how to build the recreational vehicles or construct a mobile home - wouldn't

442
00:50:57,760 --> 00:51:03,520
have the first idea. So he has to rely on people who are running those businesses to make 

443
00:51:03,520 --> 00:51:08,080
those calls. But the only way he can do that is if he trusts those people and they therefore have

444
00:51:08,080 --> 00:51:14,560
to be trustworthy. So he's incubated in a thick, rich, deep culture of trust at Berkshire

445
00:51:14,560 --> 00:51:20,240
Hathaway so they don't have command and control. Lines of reporting authority or

446
00:51:20,240 --> 00:51:25,840
tight job descriptions that they have some framework and some limitations and allocations

447
00:51:25,840 --> 00:51:32,800
or lanes if you will. But within them people have brought autonomy and the result of that,

448
00:51:32,800 --> 00:51:40,640
the academic literature tends to show that employees in trust-based organizations tend to excel.

449
00:51:40,640 --> 00:51:47,680
They perform better. They are more productive. They have fewer sick days, fewer injuries.

450
00:51:47,680 --> 00:51:56,000
The model remains very attractive even though the pendulum has swung. So in that book we identified

451
00:51:56,000 --> 00:52:01,360
I think 30 or so other companies. We went out and tried to investigate directly and indirectly

452
00:52:02,320 --> 00:52:08,320
the degrees of trust versus control in a large number of companies. We found about 30 that

453
00:52:08,320 --> 00:52:17,920
really clearly dialed towards trust. And so we have a bunch of examples in there: Danaher is

454
00:52:17,920 --> 00:52:27,840
a good example, Google or Alphabet now that the parent of Google and as we did, and some of

455
00:52:27,840 --> 00:52:33,600
other industrial companies of that sort. But what struck us, this comes to the second part of your

456
00:52:33,600 --> 00:52:40,320
question, was the density of insurance companies in this cohort of trust based culture. So we wonder

457
00:52:40,320 --> 00:52:48,640
why insurance companies might have a greater propensity to embed their organizations with trust.

458
00:52:48,640 --> 00:52:55,040
To use trust more than control in our thesis was that, well, insurance itself as a business relies

459
00:52:55,040 --> 00:53:02,160
almost entirely on trust. The product is a promise to pay money when a disaster, when some event occurs.

460
00:53:02,160 --> 00:53:09,120
That's all it is. And so it's essentially a trust business. It's very different from candy or

461
00:53:09,120 --> 00:53:14,560
housing or a t-shirt where you know, I guess there's some qualitative representation about it.

462
00:53:14,560 --> 00:53:22,000
It's taste or durability, but with insurance it's just a promise. It's one's word. I mean, it's written

463
00:53:22,000 --> 00:53:26,640
on a piece of paper and their exclusions and deductibles and limitations, but nevertheless,

464
00:53:26,640 --> 00:53:33,920
that's what's being bought and sold. So I think insurance people made as a matter of the business,

465
00:53:33,920 --> 00:53:44,160
accept and believe in trust to a greater degree than a manufacturing or a retailing company.

466
00:53:44,160 --> 00:53:51,040
And then the other half of it is on the investment side that insurance companies hold funds of others

467
00:53:51,040 --> 00:53:55,120
between the time they receive the premise and pay a claim and they have to invest that money.

468
00:53:55,120 --> 00:54:03,280
And so they are born fiduciaries. They are trustees of their policyholders' funds. And so they've got to

469
00:54:03,280 --> 00:54:11,280
invest under prudential regulations, huge slugs and fixed income securities, but typically we'll

470
00:54:11,280 --> 00:54:18,880
have additional capital to invest in equities or in some cases outright ownership of operating

471
00:54:18,880 --> 00:54:26,080
businesses. And they've found that, you know, that's a trust-based activity too, that they are

472
00:54:26,080 --> 00:54:33,040
stewards to use a word I know, "Templeton and Phillips" likes, of policyholders' capital. And they

473
00:54:33,040 --> 00:54:39,920
are stewards of their own shareholders' capital. And so I think that that trust is inherent in that

474
00:54:39,920 --> 00:54:46,560
that part of the insurance business too. So that's our hypothesis. It's more, it's an assertion,

475
00:54:46,560 --> 00:54:53,040
not something we empirically prove, but we think there's a good intuitive case and that's certainly

476
00:54:53,040 --> 00:54:59,360
what we've observed in a pretty decent sample. How do you think about measuring trust? Is it simply

477
00:54:59,360 --> 00:55:06,960
the lack of control or what is a good way for investors to think about measuring trust within

478
00:55:06,960 --> 00:55:14,000
an organization? Is it in their corporate values? Yeah, it's measuring is very difficult. It's like

479
00:55:14,000 --> 00:55:21,680
measuring a moat. We can articulate the theme. There may be some inferential ways to measure it.

480
00:55:21,680 --> 00:55:28,080
It's the absence of certain designated systems of internal control and accountability.

481
00:55:28,080 --> 00:55:39,040
And so it might be features such as the degree of centralized policymaking versus decentralized

482
00:55:39,040 --> 00:55:45,120
delegation and then sort of the numbers of direct reports that people down the organization have,

483
00:55:45,120 --> 00:55:52,880
the policies regarding capital allocation in particular to what extent are the managers who are

484
00:55:52,880 --> 00:56:01,520
generating returns required to dividend that upstream or permitted to redeploy it on their own.

485
00:56:01,520 --> 00:56:08,880
So you could start looking at who is making acquisition decisions. Are they always done at headquarters

486
00:56:08,880 --> 00:56:17,840
or are they tuck-in and add-ons, things that are being done by managers in the field in the industry

487
00:56:17,840 --> 00:56:24,880
rather than from headquarters? And to come back to your shareholder letters, that's an excellent

488
00:56:24,880 --> 00:56:31,040
place to look. I mean, managers will give signals if they're not even just express about it.

489
00:56:32,640 --> 00:56:38,720
And so you can discern from that, what level, what, you know, where the dials are between trust and

490
00:56:38,720 --> 00:56:45,360
control. And I hasten to add, managers who are skeptical of trust are perfectly intelligent and

491
00:56:45,360 --> 00:56:50,480
sound and it may be right. They need a lot of command and control and they cannot have any leakage

492
00:56:50,480 --> 00:56:55,200
and they cannot afford any deviation. I'm not saying it's terrible model or the business run

493
00:56:55,200 --> 00:57:02,480
that way is not a good investment. But there are trade-offs on both sides and it is useful

494
00:57:02,480 --> 00:57:08,800
as you develop a portrait of a company and whether it's right for you in terms of economics and

495
00:57:08,800 --> 00:57:15,040
sort of the culture. I think it's useful to think about that, the role of trust in the organization.

496
00:57:15,040 --> 00:57:20,960
Sure. I mean, it seems like if you're not going to have a bureaucratic organization, you're going

497
00:57:20,960 --> 00:57:26,480
to delegate authority that and have this culture of trust is really important who you're in business

498
00:57:26,480 --> 00:57:33,600
with. So you'd better be a pretty good judge of character, corporate cultural values are 

499
00:57:33,600 --> 00:57:39,680
going to start to play an important role for companies like that is the way I see it.

500
00:57:39,680 --> 00:57:43,920
Can you talk a little bit about, you've already written a book, you've also written a book about

501
00:57:43,920 --> 00:57:52,160
Berkshire Beyond Buffett. Another important thing is the role of trust in thinking

505
00:58:17,680 --> 00:58:27,280
about succession. 

509
00:58:50,240 --> 00:59:00,480
And the critical thing about

510
00:59:00,480 --> 00:59:07,200
trust in that setting is that the number one job, let's say, of a board of directors, I would say,

511
00:59:07,200 --> 00:59:13,600
is picking the CEO. And if you do a good job picking the CEO, then you won't have many other problems.

512
00:59:13,600 --> 00:59:21,600
If you do a bad job, you're going to have endless problems. But it's equally important to have that

513
00:59:21,600 --> 00:59:29,520
number two in place, have the successor in place. And that's where trust is critical. So if Warren

514
00:59:29,520 --> 00:59:35,440
fell over tomorrow, who would take over? And every, I mean, it takes a leap of faith for any of us

515
00:59:36,720 --> 00:59:47,600
to think that that will be okay. We will survive and indeed prosper. So that number two is critical and

516
00:59:47,600 --> 00:59:58,080
it's the perfect illustration of the importance of trust all around. And so in, and today,

517
00:59:58,080 --> 01:00:06,880
there are very good visible plans for succession at Berkshire. And that book, Berkshire Beyond Buffet,

518
01:00:06,880 --> 01:00:14,560
was about that succession. It was about, well, how will a company like this survive Warren Buffet,

519
01:00:14,560 --> 01:00:22,320
leaving the scene? Because so many people think it's, you know, he's the oracle and the magician,

520
01:00:22,320 --> 01:00:28,560
you know, at the top, whose absence would just destroy the company in some way. And so that book

521
01:00:28,560 --> 01:00:37,680
was an attempt to show that to debunk that myth is that is as vital, as unique as indispensable,

522
01:00:37,680 --> 01:00:46,160
irreplaceable as he is. The organization, and including its trust-based culture, is larger than

523
01:00:46,160 --> 01:00:53,840
anyone person, and it will survive even the departure of that, you know, dominant figure.

524
01:00:53,840 --> 01:01:01,280
And so, you know, and I think the key to this succession plan is, and it's practicality, is that

525
01:01:01,280 --> 01:01:07,920
Warren's role will be divided into four parts. He's basically had four jobs. He's been the chairman,

526
01:01:07,920 --> 01:01:12,800
the CEO, the CIO, and the lawyer, the shareholder. And so each of those roles has to

527
01:01:12,800 --> 01:01:18,960
be thought of in a succession plan. The CEO job is likely to go to Greg Able who now runs the

528
01:01:18,960 --> 01:01:24,320
energy business. The chairman job is most likely to go to Howard Buffet, Warren's son, or if not him,

529
01:01:24,320 --> 01:01:29,600
the Susan Buffet, his daughter, both of whom are on the board and have obviously Buffet DNA.

530
01:01:29,600 --> 01:01:36,160
And the CIO job, the chief investment officer job will be shared by two incbents who manage

531
01:01:36,160 --> 01:01:42,400
sub-portfolios at Berkshire: Ted Weschler and Todd Combs. So those are, and that's about, you know,

532
01:01:42,400 --> 01:01:47,280
good, all wonderful people. None of them is Warren Buffet. No one will do his good job. It won't be

533
01:01:47,280 --> 01:01:53,440
anything like what it's been, but all extremely competent, capable, and will be able to, you know,

534
01:01:53,440 --> 01:01:58,640
maintain the ship of state. The shareholder group is a little different. Warren's a controlling

535
01:01:58,640 --> 01:02:05,520
shareholder. And so, you know, even the ETFs or the index funds, the activists have not been able to

536
01:02:05,520 --> 01:02:13,440
dent the governance structure or the, the culture of of Berkshire Hathaway. But when he's gone,

537
01:02:13,440 --> 01:02:19,040
they might have a different agenda and economic activists might want to pounce and, you know,

538
01:02:19,040 --> 01:02:24,960
come and seek to have a cash dividend paid or to divest subsidiaries that aren't performing.

539
01:02:24,960 --> 01:02:32,160
And so that's probably the, the trickiest area. I think the good news is that there is a significant

540
01:02:32,960 --> 01:02:39,680
group of holders of the Class A stocks, so that after his, after his death, all of his Class A,

541
01:02:39,680 --> 01:02:45,360
which is the higher voting stock, gets converted into B, which is low voting, and then sold out into

542
01:02:45,360 --> 01:02:50,880
the market, and then by the Gates Foundation, which then donates the money somewhere. So these A's all

543
01:02:50,880 --> 01:02:58,880
disappear. And then the other A's will have slightly greater voting power. So there's still some

544
01:02:58,880 --> 01:03:04,640
significant quality shareholder ownership of Berkshire, which is nice, but it's still not the same as

545
01:03:04,640 --> 01:03:10,720
having one single individual with the iconic power of Warren. But so, so it's a complicated succession

546
01:03:10,720 --> 01:03:16,560
plan, and it's, it's critical. trust is, is critical in all of it. 

610
01:10:32,480 --> 01:10:38,320
So I look at Berkshire today and who are the people 

611
01:10:38,320 --> 01:10:44,080
and what are they likely, they're going to need to do. And,

612
01:10:44,080 --> 01:10:49,760
and I think it's an excellent group, because the main thing they're going to need to do, after

613
01:10:49,760 --> 01:10:56,720
appointing the successor CEO is defend that person and defend, no dividend, no,

614
01:10:56,720 --> 01:11:03,360
diversatures, and defend the cultures and the values. And so who are the, you know, those,

615
01:11:03,360 --> 01:11:11,280
those people are most of significant shareholders of Berkshire Hathaway, having bought the stock

616
01:11:11,280 --> 01:11:18,880
with their own money,  or managing funds that bought the stock and didn't receive it as a

617
01:11:18,880 --> 01:11:26,640
grant or an option. People who have owned that stock for a very long time, people understand the,

618
01:11:26,640 --> 01:11:35,440
you know, why the capital allocation policy results in no dividend payments, why the permanent

619
01:11:35,440 --> 01:11:43,360
time horizon philosophy results in not, you know, divesting very few, hardly any businesses,

620
01:11:43,360 --> 01:11:48,960
you know, so they, they will understand these points and be able to report them and argue them.

621
01:11:48,960 --> 01:11:55,600
And so while the, the State Streets and the Blackrocks may not have the capacity to listen,

622
01:11:56,480 --> 01:12:04,320
enough others will that I think that, they will be able to, sustain, the organization,

623
01:12:04,320 --> 01:12:10,640
long after Warren leaves the scene. Yeah, and Berkshire directors are not compensated.

624
01:12:10,640 --> 01:12:15,280
Right. It's, maybe a couple thousand dollars or seven thousand dollars and there's certainly,

625
01:12:15,280 --> 01:12:21,920
you know, not doing it for that money.  It's a sense, especially the ones. And by the way,

626
01:12:21,920 --> 01:12:28,400
when I say they own substantial positions, I'm thinking primarily in relation to their own

627
01:12:28,400 --> 01:12:33,920
net worth. So it's not as if anyone has five percent or 10 percent or something, but, as a

628
01:12:33,920 --> 01:12:38,880
percentage of their, of the overall company, but as a percentage of their own portfolio or their own

629
01:12:38,880 --> 01:12:47,520
net worth,  it's all meaningful or, more. And they're doing that, doing that job, not for

630
01:12:47,520 --> 01:12:53,440
their own, you know, personal income, you know, getting that stipend, but because they believe

631
01:12:53,440 --> 01:12:59,920
in Berkshire Hathaway and, and they want to protect the company and its shareholders,  as faithful

632
01:12:59,920 --> 01:13:04,000
stewards. And, and that's the little sense I get from, from who they are.

633
01:13:04,000 --> 01:13:10,080
I agree. I definitely get that sense from the directors. So I'm going to ask you one difficult

634
01:13:10,080 --> 01:13:16,640
question. You serve as a director of some organizations, Markel is one,  are you still in the

635
01:13:16,640 --> 01:13:23,600
board of Constellation Software? Do you think directors should be, I'm on the board of several

636
01:13:23,600 --> 01:13:29,600
companies I should say, myself: Fairfax Financial, Fairfax India and Canadian Solar. What do you

637
01:13:29,600 --> 01:13:37,200
think about director compensation? Well, I think, you know, a fair compensation for the,

638
01:13:37,200 --> 01:13:43,680
the wisdom, the time, attention and energy is appropriate. I think it's

639
01:13:43,680 --> 01:13:50,560
hard. No one does what Berkshire does. I actually just did a study. No one pays less than $10,000.

640
01:13:50,560 --> 01:13:59,040
The lowest among the S&P 500 is, or besides Warren, besides Berkshire is around 200K. And now

641
01:13:59,040 --> 01:14:04,720
there's also at the other end of the inspection, there are some, what I consider, unreasonably high.

642
01:14:04,720 --> 01:14:10,640
There's one that's two million dollars. There's one that's one million dollars - to me, this is

643
01:14:10,640 --> 01:14:18,080
out of sight. But those outliers aside, the band and, there's a congregation of,

644
01:14:18,080 --> 01:14:24,720
companies where the directors are, are paid close to, in the high 400s. But the sort of, the typical

645
01:14:24,720 --> 01:14:33,040
one is around 300K. And for that, you know, and it's paid partly in cash, about a third, partly in

646
01:14:33,040 --> 01:14:40,880
stock, stock is typically got to be held for some years. And so is this reasonable? I mean,

647
01:14:40,880 --> 01:14:47,200
the market has certainly signaled that that within that band, it is reasonable. I don't have any,

648
01:14:47,200 --> 01:14:54,480
any quarrel with the market with, with that. I recognize, and also those figures have all increased

649
01:14:54,480 --> 01:15:00,080
just above the rate, higher than the rate of inflation. They're, they're not galloping, but they've

650
01:15:00,080 --> 01:15:09,520
been increasing, over decade to decade. And I think directors have been asked to do a lot more

651
01:15:09,520 --> 01:15:16,400
and, and shoulder a lot more burden and risk in terms of, reputation in terms of time,

652
01:15:16,400 --> 01:15:25,120
you know, decade by decade. The current agenda is extremely full. So it's not a full time

653
01:15:25,120 --> 01:15:30,240
job, but it's an alertness and you always had to be prepared. There are meetings called on short

654
01:15:30,240 --> 01:15:37,040
notice late at night on weekends and you really can't miss a meeting. I mean, it's all publicized

655
01:15:37,040 --> 01:15:42,160
and reported out in the proxy statements and the proxy advisors will pounce. And so you know,

656
01:15:42,160 --> 01:15:50,400
yeah, so, yeah. So I think that they're probably some, some excesses and, you know,

657
01:15:50,400 --> 01:15:55,120
there's some extremes like there are in a lot of markets, but, you know, so the overall band seems,

658
01:15:55,120 --> 01:16:01,600
seems fair and reasonable. I think the trickiest thing there, Lauren, and I wrote a little piece on

659
01:16:01,600 --> 01:16:08,000
this is a who sets it, at, you know, because there's really nobody other than the board itself that

660
01:16:08,000 --> 01:16:13,040
can set the board's compensation setting up a inherent conflict of interest, which we're supposed to

661
01:16:13,040 --> 01:16:19,440
all avoid. And so I wrote this piece about, well, how do you get around that? And, I mean, the

662
01:16:19,440 --> 01:16:24,400
courts will even say: That's a conflict of interest that the court is going to second, it's going to

663
01:16:24,400 --> 01:16:29,360
scrutinize the decision for fairness, which, you know, courts usually defer to the business judgment of

664
01:16:29,360 --> 01:16:34,800
directors on almost all topics. But on setting their own pay, the courts have said we're going to

665
01:16:34,800 --> 01:16:41,200
have a second look, you know, we'll second guess the judgment. So I explained to boards the best,

666
01:16:41,200 --> 01:16:46,800
there are two things you should do. One is make sure that you're within that range of reasonable.

667
01:16:46,800 --> 01:16:53,040
You know, I discourage people from going up, you know, I'd even say try to be just, you know, you

668
01:16:53,040 --> 01:16:59,760
don't want to be a leader in that particular area. And the other is to try

669
01:16:59,760 --> 01:17:05,520
to design internal systems where people are not voting on their own pay. You've got

670
01:17:05,520 --> 01:17:10,880
some committee that is independent. But that would be a committee of the board, right?

671
01:17:10,880 --> 01:17:14,960
Yeah. And it's the compensation committee on the board. Yeah. That's typically who would do it,

672
01:17:14,960 --> 01:17:20,480
you know, and then I, that, that doesn't require me because there are still going to be

673
01:17:20,480 --> 01:17:26,560
people in that committee who are having this problem. And so I explore some creative

674
01:17:26,560 --> 01:17:34,880
strategies there where, it might be that, you have some directors, 

675
01:17:34,880 --> 01:17:41,600
be, are willing to serve at no pay or, at below market pay. And because they own a lot of

676
01:17:41,600 --> 01:17:46,720
stock in the company that have been there a long time or for some other reason, and you entrust

677
01:17:46,720 --> 01:17:54,720
the decision making to them.  It's a, you know, these are subtle and very firm specific

678
01:17:54,720 --> 01:17:59,200
kinds of things because it depends entirely on the character of that person, the personality of

679
01:17:59,200 --> 01:18:05,920
other people involved. And so it's a, it's certainly a case by case question. But, you know,

680
01:18:05,920 --> 01:18:10,480
the short version of answer to your question is I think directors are entitled to reasonable

681
01:18:10,480 --> 01:18:16,720
compensation for, you know, some pretty difficult work in many cases and they 

682
01:18:16,720 --> 01:18:23,040
they do have to act, you know, as strict fiduciaries in determining what that, what that level is.

683
01:18:23,040 --> 01:18:29,520
It's a big time commitment, for sure. So do you think if you screened companies on director

684
01:18:29,520 --> 01:18:37,280
compensation or CEO compensation, that would be a good, I don't know, short screen or a good screen for...

685
01:18:38,320 --> 01:18:42,800
Yes, I think it's a signal and I think, you know, I did some research for the Quality Shareholders

686
01:18:42,800 --> 01:18:51,360
Initiative that they probe this point and, and Quality Shareholders, we'll look at

687
01:18:51,360 --> 01:18:56,800
at this topic, take it seriously because after all the directors are, they're ambassadors, they're,

688
01:18:56,800 --> 01:19:02,800
they're representatives. So understanding their incentives or isn't, is critical. And what

689
01:19:02,800 --> 01:19:11,840
I've seen is a view that suggests that it's attractive to see directors own stock in the

690
01:19:11,840 --> 01:19:19,040
company, ideally through their purchase with their own cash, and that's, and it's

691
01:19:19,040 --> 01:19:25,360
perfectly fine for that to be a stipend for serving on the board paid in cash, but that they

692
01:19:25,360 --> 01:19:33,680
then use to buy the stock. And so the theory in Warren has used the quote that in that case,

693
01:19:33,680 --> 01:19:38,960
the directors will really walk in the shoes of the owner so they're buying, they're eating their own

694
01:19:38,960 --> 01:19:45,600
cooking and they're buying the stock with their own money. And I am a supporter of that, of

695
01:19:45,600 --> 01:19:52,000
that approach. I may not always be the most popular director on any given board,

696
01:19:52,000 --> 01:19:56,960
but any given board that I'm on, I would encourage, I would support a policy that said we,

697
01:19:56,960 --> 01:20:04,240
were paid, but then we should or, must use that money to buy the stock.

698
01:20:04,240 --> 01:20:11,760
Sure. Yeah. That makes sense to me. Well, this has been a very interesting conversation and we've

699
01:20:11,760 --> 01:20:17,280
been recording for about an hour and a half. So we really enjoyed the conversation. We appreciate

700
01:20:17,280 --> 01:20:24,080
your time so much. Scott, did you have any follow-up questions or? No, I thought that was excellent.

701
01:20:24,080 --> 01:20:31,040
A lot of great information. Thank you. Thank you so much. And we look forward to

702
01:20:31,040 --> 01:20:36,800
getting the recording back to you and we really appreciate your time. This has been an

703
01:20:36,800 --> 01:20:42,880
enjoyable conversation. Well, it was my pleasure. Both of you, I enjoyed our conversation too.

704
01:20:42,880 --> 01:20:49,920
I'm honored to participate. Yeah, it was fun. My dog actually threw up right next to me about

705
01:20:49,920 --> 01:20:54,640
15 minutes and a little bit of... and now she's tired. She's just laying down.

706
01:20:54,640 --> 01:21:01,840
So, I'm gonna show you my dog. I'm sitting next to a big pile of vomit. Oh, really? Oh my god, you gotta go get that. Come here,

707
01:21:01,840 --> 01:21:11,040
Journey. Just something to put you on TV. Luckily, it doesn't smell. Let's see. What is it?

708
01:21:11,040 --> 01:21:20,400
Oh, over here. Who is this? Oh, is it a Schnauzer? This is a Goldendoodle. It's a mix.

709
01:21:20,400 --> 01:21:27,520
even though she's like Golden Retriever and Poodle. Yeah. And she just, this is a Retriever.

710
01:21:28,160 --> 01:21:36,240
Nice. It's a English Cream and its breeder does Doodles. That's great. I guess, yeah, he's the Retriever part of

711
01:21:36,240 --> 01:21:44,160
the Doodle. That's awesome. What is this dog's name? Journey. Yeah, she's three. What?

712
01:21:44,160 --> 01:21:50,400
Are you a Journey fan? Yeah, that was my part of it. I like the music. My girls,

713
01:21:50,400 --> 01:21:55,840
though, kids thought it was because that's a common word people used today, but you're on some journey to

714
01:21:55,840 --> 01:22:01,600
some discovery. Okay, got it. Got it. Well, I don't, I don't actually like that

715
01:22:01,600 --> 01:22:08,320
we used that word in that context. That's awesome. Well, thank you so much. And I look forward to

716
01:22:08,320 --> 01:22:14,880
seeing you in person at one of these AGMs, one of these times. Okay. All right. Thanks so much. Bye.