Collection: Warren Buffett - #330 'The Danger of Earnings Expectations'



[Transcript]

AUDIENCE MEMBER 00:00

Andrew Noble (PH) from England.


Apart from the catastrophic insurance events or Armageddon scenarios that you’ve been talking about earlier, in relation to the operations of Berkshire Hathaway, what are your greatest fears?


WARREN BUFFETT 00:20

Well, the greatest, I would say — we don’t worry about the economics of the businesses we have.


We’ve got a very diverse group. By and large, they’re very good businesses. By and large, they’re run by some of the best managers in the country. But we worry about something going wrong.


I mean, you know, you heard about the Salomon [Brothers] thing in the movie. And, I mean, we’ve got 180,000 people out there, and I’ll guarantee you something is going wrong someplace, as we talk. That’s just the nature of it.


But, what you hope is that it’s relatively unimportant or that we catch it. And — but that’s, you know, that is something that we know will happen.


We try to have a culture that minimizes that. And I think we do have a culture that minimizes that.


We — it’s very important, in our view, to have the right incentives. And many places, we think, have incentives that aren’t so good.


I mean, when I get on an airplane, and we own the company, like NetJets, the last thing in the world I want to tell the pilot is that I’m running late and I hope we can get to New York a little faster.


I mean, that is dumb, to incent a pilot, who may be worried that, you know, somehow you affect his job or something, to get in a hurry about the takeoff or the checklist or whatever it may be.


And companies do that time after time in their compensation plans or things that they incent people, in our view at least, some of the wrong things.


That doesn’t mean nothing wrong will happen under any circumstances. But you should not have a system that causes people to, for example, worry about quarterly earnings.


None of our — our managers do not submit budgets into Omaha. I have no idea what we’re going to earn next quarter.


And I have no implicit body language out there, or anything of the sort, to our managers that I’m hoping to earn X dollars per share in the quarter.


Because in the insurance business particularly, you can report any numbers, basically, that you want to, if you write long-tail business for a short period of time.


And, you know, we’ve got 45 billion of loss reserves. Well, who knows whether the right figure is 45 billion or 46 or 44?


And if the desire is to report some given number in a given quarter, instead of saying 45 billion, you say 44-and-three-quarters billion, or something of the sort.


So we have no incentives, in terms of how people are paid, or in terms of the fact they just don’t want to let me down.


Let’s assume at the start of the year I asked everybody to submit budgets and then I went on Wall Street and preached a bunch of numbers.


Even if their compensation didn’t depend on it, the managers would feel, you know, we don’t want to let Warren down on this. So, you know, we’ll take an optimistic view of reserves, and that’s easy to do, at the end of the quarter and we won’t let him down and then he won’t look like a jerk in front of Wall Street.


So we try to avoid that sort of thing. But even then, that is what we worry about.


We don’t worry about this place making money. I mean, we’ll make money. And if we don’t, it’s my fault. That’s not that’s not the problem.


The problem right now, in addition to the one we just talked about, the problem is deploying capital, and that’s my job, too.


And, you know, I haven’t done a very good job of that recently, but with a little luck, you know, we will — and a different kind of market situation — we will get a chance to do that.


Charlie?


CHARLIE MUNGER 03:56

Yeah. Well, if you stop to think about it, the history of much of which we don’t like in modern corporate capitalism comes from an unreasonable expectation, communicated from headquarters, that earnings have to go up with no volatility and great regularity — corporate earnings, I mean.


That kind of an expectation from headquarters is not just the kissing cousin of evil. It’s the blood brother of evil.


And we just don’t need that blood brother in our headquarters.


WARREN BUFFETT 04:35

Businesses do not meet expectations quarter after quarter and year after year. It just isn’t in the nature of running businesses.


And, in our view, people that predict precisely what the future will be are either kidding investors, or they’re kidding themselves, or they’re kidding both.


Charlie and I have been around the culture, sometimes on the board, where the ego of the CEO became very involved in meeting predictions which were impossible, really, over time.


And everybody in the organization knew, because they were very public about it, what these predictions were and they knew that their CEO was going to look bad if they weren’t met. And that can lead to a lot of bad things.


You get enough bad things, anyway, I mean. But setting up a system that either exerts financial or psychological pressure on the people around you to do things that they probably really don’t even want to do, in order to avoid disappointing you, I mean, I just think that that’s — it’s a terrible mistake. And, you know, we’ll try to avoid it.


(Source: https://buffett.cnbc.com/2005-berkshire-hathaway-annual-meeting/)

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[YAPSS Takeaway]

Setting up a system that either exerts financial or psychological pressure on the people around you to do things that they probably really don’t even want to do, in order to avoid disappointing you, I mean, I just think that that’s — it’s a terrible mistake. And, you know, we’ll try to avoid it. ~Warren Buffett