A recent build up of articles on GuruFocus.com has convinced me to re-read and re-listen to anything I can find in the library or on the internet that focuses on the man whom I personally consider my role model, Charlie Munger (vice chairman of Berkshire Hathaway). As most know, Charlie is not one to hold back from letting his opinion be known (a good counterbalance to the Dale Carnegie-like demeanor of his partner, Warren Buffett). During a two hour interview with CNBC anchor Becky Quick, which took place at the University of Michigan in September 2010 (see link below for video), Charlie had some interesting thoughts and revelations from his own personal experience about both life and business for the next generation of college graduates soon to enter the workforce.
One issue that Charlie discussed was the importance (or lack thereof) that accountants (âthe adultsâ as he calls them) played during the recent crisis. Not one to disappoint, Charlie was blunt and critical of the role they played: âThe accountants utterly failed us; and by the way, there is practically no sign of any intelligent reversal of the failure of that profession.â
Charlie, as a rational and intelligent person and businessman, understands the importance of incentives (âNever, ever, think about something else when you should be thinking about the power of incentives.â), and the perverse effects that they can have when not properly aligned. As he notes in the speech when talking about the ridiculous premise of mark-to-market accounting used by Enron, the people who were going to the SEC (which is led by accountants) and suggesting these accounting rules were the same people who were going to be purposely misusing and looking to profit from these rules. âHow could anybody have any respectable understanding of human nature without realizing that the kind of people who were going to be tempted by that accounting were not going to be able to resist the temptations? It was disgusting. And theyâre [the accountants] not ashamed yet.â
When asked how this can happen, Charlie reverts back to a basic premise in the understanding of human nature: âPartly, the establishment accountants want to please the people who are writing the checks, and partly the academic accountants get full of people who overdosed on mathematics. And they want everything to be in balance, and they donât think âthat really isnât rational when creating rules for a human behavioral systemâ. Theyâre too mathematical and not rational enough when dealing with their fellow humans. You cannot give the average Wall Street CEO really lenient standards of accounting and expect the figures to be good. The accountant is like the referee in soccer⌠they have to be the adults that prevent the mayhem. They donât want to be the adults⌠but it is their duty under god and they failed us miserably.â
As Becky Quick is quick (no pun intended) to note, where does the Wall Street CEO fall into this equation? Are they inherently bad people who wonât follow the rules unless someone is there to put them in their place? Charlieâs response highlights the typical qualities of a CEO: very competitive and aggressive at accomplishing what they want to do. âThey canât help themselves, theyâre that competitiveâ, as Charlie puts it. The blind recreation by leaders of what the CEO in the building next door is doing has been thoroughly discussed by Warren Buffett. He calls this the institutional imperative (first discussed in the 1989 annual report), the drive to follow the path of the other guy, regardless of the potential consequences of that subsequent action. Unfortunately, little has changed in regards to this habit by CEOâs over the past 20+ years.
However, this is not a justification for their behavior. As Charlie notes, he does not think is a productive quality to have: âI donât believe in being that competitiveâ. Regardless of his personal thoughts on CEOâs, he retorts back to his original viewpoint: âYou canât blame the miscreants as much as you can the adults whose duty it was to prevent the miscreancy⌠You canât blame the tiger for behaving like a tiger; you have to have a gamekeeper.â
I personally agree with Charlie, but think that the âtigerâ is let off to easily in these situations. Unfortunately, the âgamekeeperâ is often trailing the accounting gimmicks, and is left playing a game of catch up with Wall Street firms âcreativityâ. The blame for this can easily be placed on the accounting police, but completely avoids a fundamental flaw in the equation: the incentive for firms to continue with accounting gimmicks. As far as I am concerned, accounting fraud needs to become a much bigger issue, and be appropriate punished based on the corporate malfeasance being committed. David Einhorn, the President of Greenlight Capital, highlighted this during a recent interview with Charlie Rose. âAfter Enron you had Sarbanes-Oxley, and there have been hardly any prosecutions under it. You put in a tough anti-fraud law. The CEO has to sign there is no fraud. The CFO has to sign that the financial statements are correct. If not, there are going to be criminal consequences....But then they didn't enforce it. Once the bad guys figured out that the law wasn't being enforced, it effectively provided cover, because everybody said, âLook, we have the tough anti-fraud law. The fraud must have gone awayâ.â
In my opinion, this is the key issue. Accounting standards certainly need to be set to prevent accounting tricks on financial statements (to the extent this is possible). Beyond that, executives need to be given a serious disincentive for lying and cheating, which I believe starts with stronger criminal consequences for white collar business crime. Until that time, there is no reason to believe that executives will stop pulling any strings necessary to report phony earnings increases which keep investors happy and lead to larger bonus checks at the end of the year.
Link to video: _http://rossmedia.bus.umich.edu/rossmedia/SilverlightPlayer/Default.aspx?peid=4d215177cbe44b1e8e94d0dd68f5058f
One issue that Charlie discussed was the importance (or lack thereof) that accountants (âthe adultsâ as he calls them) played during the recent crisis. Not one to disappoint, Charlie was blunt and critical of the role they played: âThe accountants utterly failed us; and by the way, there is practically no sign of any intelligent reversal of the failure of that profession.â
Charlie, as a rational and intelligent person and businessman, understands the importance of incentives (âNever, ever, think about something else when you should be thinking about the power of incentives.â), and the perverse effects that they can have when not properly aligned. As he notes in the speech when talking about the ridiculous premise of mark-to-market accounting used by Enron, the people who were going to the SEC (which is led by accountants) and suggesting these accounting rules were the same people who were going to be purposely misusing and looking to profit from these rules. âHow could anybody have any respectable understanding of human nature without realizing that the kind of people who were going to be tempted by that accounting were not going to be able to resist the temptations? It was disgusting. And theyâre [the accountants] not ashamed yet.â
When asked how this can happen, Charlie reverts back to a basic premise in the understanding of human nature: âPartly, the establishment accountants want to please the people who are writing the checks, and partly the academic accountants get full of people who overdosed on mathematics. And they want everything to be in balance, and they donât think âthat really isnât rational when creating rules for a human behavioral systemâ. Theyâre too mathematical and not rational enough when dealing with their fellow humans. You cannot give the average Wall Street CEO really lenient standards of accounting and expect the figures to be good. The accountant is like the referee in soccer⌠they have to be the adults that prevent the mayhem. They donât want to be the adults⌠but it is their duty under god and they failed us miserably.â
As Becky Quick is quick (no pun intended) to note, where does the Wall Street CEO fall into this equation? Are they inherently bad people who wonât follow the rules unless someone is there to put them in their place? Charlieâs response highlights the typical qualities of a CEO: very competitive and aggressive at accomplishing what they want to do. âThey canât help themselves, theyâre that competitiveâ, as Charlie puts it. The blind recreation by leaders of what the CEO in the building next door is doing has been thoroughly discussed by Warren Buffett. He calls this the institutional imperative (first discussed in the 1989 annual report), the drive to follow the path of the other guy, regardless of the potential consequences of that subsequent action. Unfortunately, little has changed in regards to this habit by CEOâs over the past 20+ years.
However, this is not a justification for their behavior. As Charlie notes, he does not think is a productive quality to have: âI donât believe in being that competitiveâ. Regardless of his personal thoughts on CEOâs, he retorts back to his original viewpoint: âYou canât blame the miscreants as much as you can the adults whose duty it was to prevent the miscreancy⌠You canât blame the tiger for behaving like a tiger; you have to have a gamekeeper.â
I personally agree with Charlie, but think that the âtigerâ is let off to easily in these situations. Unfortunately, the âgamekeeperâ is often trailing the accounting gimmicks, and is left playing a game of catch up with Wall Street firms âcreativityâ. The blame for this can easily be placed on the accounting police, but completely avoids a fundamental flaw in the equation: the incentive for firms to continue with accounting gimmicks. As far as I am concerned, accounting fraud needs to become a much bigger issue, and be appropriate punished based on the corporate malfeasance being committed. David Einhorn, the President of Greenlight Capital, highlighted this during a recent interview with Charlie Rose. âAfter Enron you had Sarbanes-Oxley, and there have been hardly any prosecutions under it. You put in a tough anti-fraud law. The CEO has to sign there is no fraud. The CFO has to sign that the financial statements are correct. If not, there are going to be criminal consequences....But then they didn't enforce it. Once the bad guys figured out that the law wasn't being enforced, it effectively provided cover, because everybody said, âLook, we have the tough anti-fraud law. The fraud must have gone awayâ.â
In my opinion, this is the key issue. Accounting standards certainly need to be set to prevent accounting tricks on financial statements (to the extent this is possible). Beyond that, executives need to be given a serious disincentive for lying and cheating, which I believe starts with stronger criminal consequences for white collar business crime. Until that time, there is no reason to believe that executives will stop pulling any strings necessary to report phony earnings increases which keep investors happy and lead to larger bonus checks at the end of the year.
Link to video: _http://rossmedia.bus.umich.edu/rossmedia/SilverlightPlayer/Default.aspx?peid=4d215177cbe44b1e8e94d0dd68f5058f
