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After the movie, Warren Buffett and Charlie Munger come out onto the stage. Buffett complains that Charlie always seems to get the girl in the movie and quips that it must be because of the "Anna Nicole Smith" rule - When Choosing Between Two Old Rich Guys - choose the older one! After a number of thanks you and announcements that Q1 2006 pre-tax earning were up handsomely to $2.8 billion and also their announcement that they had acquired Iscar Metalworking Companies an Israeli company. Berkshire had first been approached by Eitan Wertheimer via a one and a half page letter sent to him in October 2005. On May 5, 2006 Berkshire announced that it had agreed to purchase 80% of ISCAR for $4 billion (valuing the entire business at $5 billion). Buffett noted that character and talent sometimes jump of the written page, and that this was the case with the letter he recieved from ISCAR. Buffett noted that Iscar had risen to be the top in its field in the world and that the average quality of people in Iscar was off the charts which was impressive because they were still all young. Buffett then introduced Eitan and his team to the entire audience and Eitan said a few words to the 24,000 shareholders in attendance at the Quest Center in Omaha, Nebraska. He noted that he was representing 5869 employees of Iscar and their families. Iscar was a family company this a strong culture and they wanted to join a company like Berkshire where they could know that the culture could be preserved. He thanked his customers for whom they work hard everyday to stay competitive. Iscar has been in the field for 34 years and is the 2nd largest cutting tool manufacturer in the world and it is a secular growth industry as there is a global need for better cutting tools. Q: Question about Social Security Buffett: Each society has to figure out how to allocate wealth fairly. Since 1935, government decided that it should provide for the elderly. This is not a big stretch because it has provided for the young (in the form of schools). In the US, we produce about $40K per person in GDP per capita. Some people like Warren and Charlie are wired to earn a lot, while others are not and they have a harder time in retirement. The US can handle the social security issue. It is amazing to see that we run a 300+ billion current deficit bet still make a big deal about a $100 billion deficit decades from now. Since we are going to produce more each year as a country (i.e. it is a growing pie), we can decide to take care of the older people. Munger commented that obviously if there are no changes made to the current system, the social security system will run low on funds, but with growth in our economy is should be easy to deal with this problem. Social security is a low overheads, high efficient program that has done a lot of good - it is one of the must successful programs we have had in the US Buffett quipped that this is what happened when you ask two old guys about social security (laughter) Q: How do you design compensation schemes to reward performance - i.e. pay for performance for example so that you don't have undeserved windfalls based on cyclical industry pricing? Buffett: that is a terrific question. If you have a copper company when copper prices are now $3.50/lb you could be a bad manager, but the company would still be extremely profitable. When it is 80 to 90 cents per lb, the level it has been for most of my life, you can be a great manager and it is still very tough. Berkshire designs compensation systems for each of its subsidiaries and key is that each compensation arrangement is different and has to be tailored for that specific company and its business model/business characteristics. A good compensation should reward managers for performance over time. For example, if you were designing a compensation system for an oil company, a good metric might be to tie compensation to lower the average unit finding costs (as opposed to a system that rewards based purely on record profits when oil is at $70 per barrel). Today, half of the companies have grossly unfair compensation systems. We have 68 operating company, but some of this are subsidiaries of our subsidiaries, so we have directly designed 40 compensation arrangements. We have never had a compensation consultant (maybe at a subsidiary, but they are smart enough not to tell me about it - laughter). It is not rocket science to design a fair arrangement. Munger: At Salomon Brothers, when we were the largest shareholder, Warren was on the board and the compensation committee. At bonus time, Warren pushed slightly towards more reasonable compensation and he was voted down. Buffett: Our experience is that ENVY, rather than GREED, is the key driver. If you give someone a $2 million bonus but their co-worker got $2.1 million, they're miserable. Of the seven deadly sins, ENVY is the most useless - it makes you miserable and you lose a lot of sleep. At least with GLUTTONY there is some upside for the sinner (I've had some good times with gluttony) and I wont get into LUST (laughter). The SEC is pushing fro more transparency in compensation arrangements and this is a good idea.
Q: How do you train your successors? Buffett: The annual letter is an effort to create a record that communicate what we are about. The annual meeting is also to convey and transmit our culture. We want our people to know our values and do things consistent with the Berkshire culture. Just like children who watch grownups at home and learn to act in the same way. Companies have cultures and so do countries. Berkshire's managers can pick up on the consistency with which Charlie and I act. There is not format training that his successor will require, there are three candidates, and none of them would miss a beat if they had to step into Warren's shoes. It is their culture too. Munger: Warren kept the faith for 75 years, and he will do a similarly good job on the succession issue. The Berkshire culture and faith will go on for a longtime after Warren and I are gone. We don't train executives, we find them and they are not that hard to find. Q: Does the trend towards majority voting help corporate governance? Munger: I don't think it will improve ethics. There are fashions in corporate governance that come and go and majority voting as a current fashion. Most boards are a mixed lot and then you implement new govenance rules, you need to give careful consideration to who is going to be most active in using/potentially abusing them. Buffett: the quality of a company's governance is determined by whether board members actually think like owners and whether they have business saavy. These are the factors that really matter - switching to majority voting doesn't have a major impact. Boards that are effective have people in the board room who are busnes saavy, and this is not something you can mandate with a rule chance. The main function of the board is to hire the right CEO and to prevenet them from overreaching and also to exercise independent judgment on important acquisitions because many CEOs are more than rationally motivated to do deals. Only antidote for bad governance is to have the large shareholders work to make sure that these issues are prioritized. Large shareholders should oversee comp plans for instance and withhold votes when it makes sense to do so. Interestingly, many of the large institutions now outsource their voting decisions, and this makes no sense. You need large shareholders (and board members) to think like owners and take steps than an owner would in a similar situation. Q: Question about technology investing Buffett: technology is outside our circle of competence. Some types of businesses like most technology businesses change too fast to be predictable. Generally we buy businesses that we think will be the same 10 years from now. Its likely that ISCAR will be bigger in 5 to 10 years and that the key drivers are going to stay the same. In contrast, the telecommunications business has changed incredibly in the past 5 to 10 years. We have three boxes on our desks: IN, OUT, and TOO HARD. Most of the stuff goes in the TOO HARD pile. Tom Watson Sr. liked to say that "I am no genius, but I'm smart in spots and I stay around those spots" And I have been exposed to technology - in fact because I sat on a university Board with Bob Noyes (of Intel), I was there and aware of the company very early on. Intel recently has been surprised by AMD's recent success. It illustrates that that industry is one that is difficult if not impossible to predict. Munger: A reporter once commented to me that "You dont seem smart enough to have done so well, how do you account for your success." I told him that we know the edge of our competence better than most people - Its not a competence if you don't know the edge of it. Q: Would you rather own a share of median family income or a share of all corporate income as a long-term investor? Buffett: I'd rather own ISCAR (laughter). The tax breaks for the wealthy have been extraordinary. Members of te forbes 400 pay a lower portion of their income in taxes than the receptionist does. That wasn't true 30 years ago, and should not be a case in a rich society. My tax rate (as a percentage) was the lowest of anyone working in the office (about 16 people in total). I think that does not make sense. The median income has not risen as much so many average individuals have not shared in the prosperity of the last 10 years as much as the rich. Munger: I'm not that concerned about median household income. GDP per capita growth is far more important because it tells you whether (and how much) the overall pie is growing. While tax system changes may not be completely sensible, they haven't been that important in the context of affecting the rate of growth over the long-term in GDP per capital. |
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