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Berkshire Hathaway
In Defense of Hypocrisy

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By In Defense of Hypocrisy
May 23, 2003

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In reference to a number of posters in various places who, in their support of the dividend tax cut, have attempted to tarnish Warren Buffett, who has publicly stated his opposition to it, I feel that a few points regarding his actions are in order. Most of these who decry Buffett's opinion do so not on the merits, but on some unseen bias, a motivation to maximize his personal wealth at any expense, even that of the proverbial 'little guy'. The unspoken argument is that Warren Buffett isn't talking from his mind or his heart, but from his wallet, so why should we believe him?

Often I let stuff like this pass, but at times I think it's important that someone step up and set the record straight, in case others, seeing no defense, actually begin to believe the garbage being propagated. This is long, and many of the regular posters and Berkshire Hathaway owners are already familiar with most of the actions and events described here. Some who profess to admire him appear not to be, and would benefit most from learning more.

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-In 1977 in his letter to shareholders, Warren Buffett explained that although the textile business portion of Berkshire Hathaway earned sub-par returns on capital versus the other businesses run by the company, he would not shutter the operation because 1) the business' textile mills were the largest employers in their respective towns, 2) the employees and union members had demonstrated an understanding of the economics of the business and had cooperated in trying to maintain profitability, 3) management had been straightforward about the difficulties posed by the business and energetic in trying to solve them and 4) it seemed likely that the company would be able to continue to eek out modest, though sub-par profits for the foreseeable future, and that as long as it did so, he would continue to support it, though he had other places he could profitably invest that money.

In 1984, seven years later, Buffett reluctantly closed the operation and sold off its assets, explaining forthrightly to shareholders that it did not now appear that the business could produce profits in the future. The business' equipment, which had cost about $13 million when purchased and had a book value after accelerated depreciation of $866,000 was sold for $163,122, not including costs of sale. In aggregate and over time, the textile business had produced losses of $10 million, and the opportunity costs of not investing that capital in other, more attractive businesses years earlier was probably much greater.

-In this era of egregious and escalating CEO salaries, few would argue that Warren Buffett does not deserve to be one of the most highly paid on the merits. Warren's response? Since the beginning of his tenure at Berkshire Hathaway, he has paid himself the same meager salary: $100,000, nor has he granted himself any stock options. Assume for argument's sake that he could have earned an average of $10 million annually over that same period without much squawking from shareholders. Certainly it would have been much lower in earlier years and much higher in later ones. The total figure represents roughly $300 million in foregone earnings. That money, which could have been his alone, instead went back into Berkshire generating much more than that in earnings to the benefit of all shareowners, and not just one.

-For years, Warren Buffett, by far the largest shareholder, has been forthright about his intentions regarding his ownership in Berkshire Hathaway. He will not sell a single share, and upon his death and that of his wife, almost all of it will pass to a charitable foundation. He has chosen who will run that foundation and charged them to 'think big', but he has not told them how to allocate those funds. To be sure they are aware of his primary concerns, nuclear proliferation and world overpopulation, but he has not instructed the trustees to fund those causes.

From that, a few things should be obvious. He gains, and he suffers in proportion to those who invest with him. When Berkshire dropped from it's high in the mid-80,000 range to its low in the mid-40,000 range, Buffett did nothing to stop it. Where most companies would have stumped about the undervaluation of their shares through press releases, conference calls and other channels, to anyone who would listen, Buffett was silent.

It is also clear that, from the point of view of his standard of living, his Berkshire shares have had no direct impact. Though he would be the largest beneficiary of a dividend, he has not declared one. Though he could live in a house rivaling Bill Gates' 40,000+ square foot compound, he lives modestly for his position in a house purchased for $31,500 in the early 1950's, (though I believe he's added on to it a couple times over the years, including installing a racquetball court). Those who argue that Buffett's desire to build his wealth in any way possible is his primary motivation, forever seem to ignore the fact that he receives no material benefit from it. None. Zip. Nada. Or as Dr. Evil might say: "www.zilch.com".

-In 1996, concurrent with the issuance of Berkshire's class B stock, Buffett put forth a set of ownership principles, a codification of the way that he and Charlie Munger think about Berkshire Hathaway and about ownership of it. Among those principles:

7. We use debt sparingly and, when we do borrow, we attempt to structure our loans on a long-term fixed rate basis. [...] This conservatism has penalized our results, but it is the only behavior that leaves us comfortable, considering our fiduciary obligations to policyholders, lenders, and the many equity holders who have committed unusually large portions of their net worth to our care. [...] The financial calculus that Charlie and I employ would never permit our trading a good night's sleep for a shot at a few extra percentage points of return. I've never believed in risking what my family and friends have and need in order to pursue what they don't have and don't need.

11. You should be fully aware of one attitude Charlie and I share that hurts our financial performance: Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital-allocation mistakes that led us into such sub-par businesses. And we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures. (The projections will be dazzling and the advocates sincere, but, in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.) Nevertheless, gin rummy managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in that kind of behavior.

We continue to avoid gin rummy behavior. True, we closed our textile business in the mid-1980's after 20 years of struggling with it, but only because we felt it was doomed to run never-ending operating losses. We have not, however, given thought to selling operations that would command very fancy prices nor have we dumped our laggards, though we focus hard on curing the problems that cause them to lag.

An Added Principle. To the extent possible, we would like each Berkshire shareholder to record a gain or loss in market value during his period of ownership that is proportional to the gain or loss in per-share intrinsic value recorded by the company during that holding period. For this to come about, the relationship between the intrinsic value and the market price of a Berkshire share would need to remain constant, and by our preferences at 1-to-1. As that implies, we would rather see Berkshire's stock price at a fair level than a high level. Obviously, Charlie and I can't control Berkshire's price. But by our policies and communications, we can encourage informed, rational behavior by owners that, in turn, will tend to produce a stock price that is also rational. Our it's-as-bad-to-be-overvalued-as-to-be-undervalued approach may disappoint some shareholders. We believe, however, that it affords Berkshire the best prospect of attracting long-term investors who seek to profit from the progress of the company rather than from the investment mistakes of their partners.
Those who argue that actions speak louder than words may discount these principles � fortunately, each of them can be easily checked against Buffett and Munger's behavior over the years.

-Concurrent with the release of the 'B' shares, Warren and Charlie made an unusual statement � they publicly proclaimed that they would not purchase Berkshire shares at then prevailing prices, effectively discouraging existing and potential shareholders. I can recall only one other instance where a similar statement has been made: by Steve Ballmer of Microsoft. That statement, and the other points mentioned above, demonstrate that while the managing partners of Berkshire Hathaway do indeed have a drive to build the value of those shares, they desire even more strongly that it be done through building the business, not by taking advantage of their influence.

* * *

For those looking for examples where Buffett sacrifices his principles to benefit himself financially, more digging will unearth just the opposite. As he stated in his recent Washington Post piece, he does not take advantage of tax shelters, though I don't doubt that a detailed look at the finances of most Fortune 500 executives these days are dotted with exotic partnerships, collars and dealings that disengage their fortunes from the fortunes of their shareholders. The same is not true at Berkshire Hathaway.

To those who support the dividend tax cut, I have no real beef with you. I disagree, but as long we can debate the issue on its merits, there is no real problem. However, for many, I think Buffett's opposition to the plan represents a threat because he is a source that has real credibility. One way to eliminate that threat has been to invent a reason to discount it, to claim bias from the source, thereby discrediting his views. There I do have a problem. It is simply a distortion to claim that Buffett's sole motivation in decrying the tax cut is to line his own pockets, when there are so many examples we know of where he has passed on opportunities to enrich himself where he obviously could have. And indeed, all that is needed for anyone to take avail themselves of the same dividend tax advantage that Berkshire has is to invest in the company. There are always willing sellers and many here, to a greater or lesser degree, have done just that. To claim that Buffett is merely attempting to preserve this prerogative for himself is laughable, and if Warren Buffett's actions and opinions make him a hypocrite, then the world needs a lot more hypocrites.


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