July 29, 2020: Learning from Buffett's and Munger’s Q&A on management and culture with snippets on mistakes and businesses. Core to the learnings were their view on compensation, assessing CEOs, and the most important trait in management. All from the Buffett FAQ site that acts as a precursor to the CNBC archive of Berkshire videos. Special thanks to the Focused Compounding podcast for enlightening me to this wonderful site.

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Episode Notes:

Buffett FAQ - http://buffettfaq.com/#questions

On Management & Culture:

Required No.1 Trait: Passion

• Money managers need temperament. Business owners need passion. Look for indications that they will want to run the business until they die (i.e. Mrs. B running Nebraska Furniture Mart until 103). Buffett calls it love for the business. 

• Passion is the most important thing… afterwards: "I’d say intelligence, energy, integrity. If you don’t have the last one, the first two will kill you."

• Hire passionate people. Pay them fair because unfairness makes them resent you. Then, you let them paint their own canvas. 

Selecting Good Management

• Good management teams stick out like star athletes. But no one is perfect so it’s always a judgment call. 

• Natural selection weeds out incompetent management by the time they get to Berkshire. It’s about discerning whether the manager has passion/love for the business or just wants to cash out. 

Assessing CEOs

• Be wary of CEOs inexperienced in capital allocation relying on the help of “experts”. Most are not trained in capital allocation as that’s not how they built the company so watch for how they utilize their skills in this pursuit.

• Evaluate management on their track record. Not what they say to you in a meeting or pedigree. Look at their record of executing in running the business and assume they won’t screw it up after you hire them. The “find people who batted 0.350 for 10-50 years”. This reminds me of Mark Seller’s essay on how to be a great investor and how a lot of comes down to how you are wired. This may be the same for great CEOs. It’s not a matter of the various experiences they accumulated but the wiring they had since youth. So, may be worth it to dig into their stories of how they formulated decisions at a young age. 

• In assessing integrity, it’s about picking the one most effective at working with people. The one you’d want to be in the trenches with together. That’s how Buffett picked Deryck Maughan to run Solomon when he took over. He interviewed 12 people for 15 minutes each. Chains of habit are too heavy to be broken and they will show up in how they lead their lives. 

• Managers who learn to be great investors will become better managers as a result. The principles are transferrable. 

Compensation

• Envy is the deadliest sin of all and it makes its way into compensation in all its mediums. Compensation should be set for fairness with factors that are within management’s control as metrics of performance to keep them accountable. If the business is driven by excessive commodity price swings, base compensation on management of costs. 

• The greater sin is to have the wrong person than to overpay the person. Running a large company is no easy feat. It’s more important to have the right manager for the organization. 

• Hiring comp consultants is no positive sign. Think of the incentives. Comp consultants aren’t hired for suggesting rational/fair pay. They’re paid as a signal of “doing something” but comp consultants are fed for suggesting higher pay than others. It’s a lousy system. 

• Buffett’s system of individualization: "The seventy businesses we have each have different economics – we don’t set a standard Berkshire compensation plan. A BNSF needs lots of capital, others could be run by a chimpanzee, while others with Alfred P Sloan as CEO couldn’t run them well. I try to figure out the best strategy – and we find that managers stay with us. It is not rocket science. But I spend time on it, and it takes ability to differentiate. An HR dept would be a disaster, and they would have people telling them all sorts of different equations. It requires common sense and interaction with managers. We agree on a measure of what they are adding to company.” 

Board of Directors

• As far as boards go, have them be paid nothing or next to nothing. The more they are paid, the more they won’t be independent. Instead of proxies arguing for why board compensation is aligned, they should be paid close to nothing so there is nothing to defend. 

• Most CEOs want irrational pay structures. Especially when everyone is getting the same irrational pay structure. Hence, they will probably want to bring on compensation committee members that give them that…. And the board members on the committee will get a fair share of the irrational pay. 

Organization System & Culture

• The purpose of systems/structures in an organization are to eliminate bad behaviour. Weed out the bad and the good stuff will take care of itself. As munger says: "So much of bad behavior comes not from malevolence, but from the subconscious justification of poor decisions as being just part of the system. Best cure is that people that make the decisions bear the consequences."

• It’s extremely hard to change a culture. You’re better off starting a new one from scratch (this is where Ricardo Semler firing the entire executive staff when he took over Semco made sense). Munger’s own failure rate was 100% in trying to change existing culture. 

• Culture starts with management. As Buffett notes: "if you have someone at the top who cares a great deal, that will be evident across the organization. [The type of people managing the business is a very important criteria, then?] Yes, contracts don’t protect you; you have to have confidence in the people.” 

Business & Mistakes:

Businesses to buy:

• Businesses that operate on negative capital => magazines, insurance, things people pay for first

• Services businesses, consumer businesses 

Businesses to avoid:

• Ones where you reinvest in the same thing as everyone else. A crowded market where what you are reinvesting is obvious and can be replicated…. In modern day case it’s the reinvestment into talent and great engineers for software companies… but this is obvious… but it might be hard to replicate if the culture doesn’t support it. You also need to be a place that all the top people want to go to work at as well. 

Buffett on not looking back:

• “We [Warren and Charlie] never look back. We just figure there is so much to look forward to that there is no sense thinking of what we might have done. It just doesn’t make any difference. You can only live life forward."

Mistakes

• "You can learn something perhaps from the mistakes, but the big thing to do is to stick with the businesses you understand. So if there is a generic mistake outside your circle of competence like buying something that somebody tips you on or something of the sort. In an area you know nothing about, you should learn something from that which is to stay with what you can figure out yourself."