Berkshire Hathaway
Bad Behavior

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By rclosch
August 14, 2002

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I really do not care how stock options are expensed. Actually, I probably do not care that much if they are expensed.

However I will not in the future invest in any company that has a substantial option program. I want my managers to be owners. I want outright ownership of a substantial amount of stock, otherwise I ain't buying. Or as Charlie says: "It's time to zip up the purse."

Options may lead to misrepresentation of compensation expense, and it may be that our accounting system would be more honest if they were expensed, but this misrepresentation does not begin to measure the damage options have done to our financial system.

I will never invest in a company with a big option program because they give management the wrong incentives. Options were supposed to align management interest with shareholder interest, but recent history shows clearly they do nothing of the kind; mainly what they provide is encouragement for all manner of bad behavior.

It is my opinion, option induced behavior was at the heart of our recent bubble. They gave rise to and fed the expectation of easy wealth. Too often they [were] easy money, instant gratification, monetary cocaine. Options are all or nothing, if the stock price goes down the option holder not only gets nothing, but more importantly he loses nothing, he has no money on the table. He gets to bet the pot without putting up any of his own money, yet, if the stock price goes up the CEO with big options wins the lottery.
If you are an owner this is a crazy way to compensate the people that work for you it is letting them gamble with your money. If they win they win. If they lose you lose.

Options encourage managers to roll the dice, to spend for questionable capital improvements, to cook the books, anything to get the price of the stock up a buck or two. The longer that stock prices go up the harder it is to support that price, so the bad behavior has to keep ramping up, smoothing the lump leads naturally to cooking the books.

A manger that owns a large block of his company's stock is in an entirely different position. He has lots to lose if the stock goes down, and he is more likely to act like an owner because he is one. He will not risk his present wealth for a few more bucks in the stock price.

Option mania and our beloved bubble grew hand in hand. Incentives are the key to any compensation system. If the incentives encourage bad behavior you are going to get bad behavior, and this is all you are ever going to get from stock options.

Charlie and Warren realized this ages before it dawned on anyone else. They did not own Enron or Global crossing or any the other of CNBC's favorite disasters. This was not a coincidence and has nothing to do with luck. To those asking advice about investing, I suggest that you forget the CFA forget the MBA buy one "B" share and start going to the annual meetings. You will learn things that they do not teach anyplace else.

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