1995: How does Buffett feel about FASB caving on the stock option accounting proposal?

AUDIENCE MEMBER: Hi, my name is Philip King (PH) from San Francisco.

And my question has to do with how the FASB has caved in on the stock option proposal.

And the people opposed to the proposal argue that it would hurt capital formation for companies and that the cost of stock options is already reflected in shares outstanding, in fully diluted calculations.

And I was curious, what is your feelings about what’s happened?

WARREN BUFFETT: Well, as those of you have followed this issue — FASB did cave, and they were — they hated it. I mean, they knew they were right. Matter of fact, most of the, what are now, I guess, the big six auditing firms, many years ago, sided with the position.

But in my opinion, the auditing firms caved to their clients, in that respect.

In terms of capital formation, I would argue that the most intelligent form of capital formation follows from the most accurate form of accounting.

I mean, it — if all the companies with — whose names began with A through M didn’t have to count depreciation and all the ones with N through Z did, or something, you know, that might help in capital formation for companies that were — had names with A thru M. And incidentally, they probably all change their names.

But I don’t think that bad accounting is an aid to capital formation. In fact, I think probably over time, it distorts capital formation.

Because if we were to pay all of the shareholders with — I mean, all of the people who worked for Berkshire Hathaway — in stock, and therefore record no wage expense, you know, we might be able to sucker in a bunch of people who thought the earnings were real.

But that would not be a great step forward for capital formation, in my view.

I really think that — you know, I’ve talked privately to a number of managers about this. And they understand it. But they, you know, they prefer the present situation. And they used a lot of muscle in Washington many years ago.

And I think I have this authenticated now. This fellow — mathematics professor — sent me some material after I’d written this. I try to get a little proof after the fact when I can.

I believe it was in the Indiana legislature, where a legislator introduced a bill to change the value of pi, the mathematical symbol pi, to three. Because he said that it was too difficult for the schoolchildren to work with this — (laughter) — complicated 3.14159.

And he was right. I mean, it was difficult. And I — and Congress, in connection with the stock option question, received all kinds of pressure to, in turn, pressure FASB and the SEC to not count stock option costs as part of compensation.

I’ve never met anybody that wanted to be compensated that felt that, if he received his present salary plus an option, he was not getting compensated more than if he just received a salary. So, he thought it was compensation.

And I will tell you that if we’d been issuing options over a period of time at Berkshire for things unrelated to the performance of the entire business, that we would’ve had a cost, perhaps measuring in the billions of dollars, whether it was recorded or not.

So, it goes back to Bishop Berkeley’s question of whether a tree that falls in the forest and doesn’t make a sound, you know, when — et cetera.

But it — I think it is — I really think that it makes you a bit of a cynic about American business when you see the extent to which a group has pressured — even to the extent of talking about financial — withdrawing financial support from the Financial Accounting Standards Board — the degree to which they’ve pressured people to make sure the value of pi stays at three instead of 3.14, simply because it was their own ox that was being gored a bit.

In any event, it’s — it looks like it’s all over now for some time. In fact, now they’re pressuring them to even weaken further the standards that have been set. So, self-interest is alive and well in corporate America.

Charlie?

CHARLIE MUNGER: Yeah, I think dishonor won. And I think that — I think it is quite important for a civilization to have sound engineering and good accounting.

And it is a very regrettable episode, leading politicians — leading venture capitalists.

I think to some extent, it’s an indictment of the educational system, that this thing could be so widely looked at, and so wrongly.

WARREN BUFFETT: It’s bad enough people want to cheat on their accounting. And they do cheat on their accounting. But to want it to be endorsed as the system —

CHARLIE MUNGER: Yeah.

WARREN BUFFETT: — is really kind of disgusting.

CHARLIE MUNGER: Yeah, corruption won.

WARREN BUFFETT: Well, put us down on undecided on that and we’ll move on to zone 6. (Laughter)