Reading Warren Buffett’s letter to shareholders (pdf) this week, I was struck by the parts of risk management he emphasizes: corporate culture, liquidity and reputational risk.
Berkshire’s culture encourages entrepreneurship, and Buffett calls that culture one of the company’s three key advantages (the others are quality managers and a conglomerate’s flexibility in redeploying retained earnings):
[A] hard-to-duplicate culture . . . permeates Berkshire. And in businesses, culture counts. . . . The directors who represent you think and act like owners. Our directors . . . monitor Berkshire’s actions and results with keen interest and an owner’s eye.
And that culture starts at the top: “Cultures self-propagate. Winston Churchill once said, ‘You shape your houses and then they shape you.’ ”
Bureaucratic procedures beget more bureaucracy, and imperial corporate palaces induce imperious behavior. . . . As long as Charlie and I treat your money as if it were our own, Berkshire’s managers are likely to be careful with it as well.
Our compensation programs, our annual meeting and even our annual reports are all designed with an eye to reinforcing the Berkshire culture, and making it one that will repel and expel managers of a different bent. This culture grows stronger every year, and it will remain intact long after Charlie and I have left the scene.
Berkshire’s approaches to liquidity permeate the paper, but most clearly when Buffett discusses “Life and Debt.” Most of the time, companies are able to borrow new funds to pay off the old funds – rolling over their debt. And that generally works.
Occasionally, though, either because of company-specific problems or a worldwide shortage of credit, maturities must actually be met by payment. For that, only cash will do the job.
Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that’s all that is noticed.
So Berkshire commits to holding $10 billion cash on hand, but the actual amount is generally twice that. The most it has had to pony up at once: $3 billion, from Hurricane Katrina. So Berkshire’s actual liquidity is around seven times what a stress test would recommend.
I wouldn’t expect that level of liquidity everywhere. Few companies have Berkshire’s current resources. But the general lesson, I think, holds true: Hold more cash than you think you need. A lot more.
Finally, Buffett addresses reputational risk in a memo to Berkshire’s managers, reproduced at the end of the letter to shareholders. He doesn’t use the phrase reputational risk, he just says Berkshire’s “top priority” is “to zealously guard Berkshire’s reputation.”
As I’ve said in these memos for more than 25 years: “We can afford to lose money – even a lot of money. But we can’t afford to lose reputation – even a shred of reputation.” We must continue to measure every act against not only what is legal but also what we would be happy to have written about on the front page of a national newspaper in an article written by an unfriendly but intelligent reporter.
He goes on for three paragraphs, which is pretty significant for a 10-paragraph memo – especially when the first paragraph contains a stale joke and the last asks people to stop bugging him about the Gates Foundation. The only other thing he requests is to get a heads-up if there are problems.
Buffett is famous for letting his managers run their own shows, so at Berkshire, missives from the big boss are rare. But one of Buffett’s strengths is he lets his own reputation do the heavy lifting.
Imagine you ran a Berkshire company. You work for Warren, but you never hear from him. People ask you about him all the time, but you don’t know a whole lot more than they do.
Like your friends, you read about him all the time – he plays bridge with Bill Gates, he pontificates on estate taxes, he buys and bails out major corporations, and his shareholder letters are parsed like the Rosetta Stone – but to you most of the time he is no more visible than, oh, Natalie Portman. And he’s your boss.
Then you get a memo. Just one. It is short. It has two messages:
- Don’t embarrass the company.
- If there’s a problem, let me know early.
As the boss, what two things will you make sure of?