1995: Why are investment bankers paid so much?

AUDIENCE MEMBER: My name is Dan O’Neil from Santa Fe, New Mexico.

And I would ask — like to ask you a more specific question about Salomon Brothers, which is, why do we pay our employees there so much?

WARREN BUFFETT: Why what?

AUDIENCE MEMBER: Why do we pay our employees there so much money? The conventional theory seems to be that there’s just a different pay scale on Wall Street than the rest of the world.

And it’s based on the idea that traders are smarter than — that some traders are smarter than others, and, in some supernatural way, are able to receive signals that the future is sending back to the present. And how do we know that that isn’t just an urban legend like alligators in the New York City sewers?

Another theory would be that the large amount of shareholders’ capital allows the traders to capture inefficiencies that are in the market in the same way that the house does in Las Vegas.

I mean, if we owned a casino, it wouldn’t make any difference if we hired Albert Einstein or Forrest Gump to run the blackjack table, and we would pay them the same. And I wonder which theory you think is closer to the truth.

WARREN BUFFETT: Well, you put it well. (Laughter and applause)

In the end, of course, you end up paying at a, what you think, at least, is a market rate. And to some extent, the market tests you out by whether people leave because they can get a higher rate.

But the limiting factor on that should be that you pay them a market rate as long as you are getting a market rate on capital. But it’s harder to measure the market rate on capital in a short period than it is to measure the market rate on compensation.

So, the — a good many of the people that have left — but far from all — have left because they felt that they would obtain — presumably — because they would obtain greater compensation elsewhere.

The market was working in that way, just as it works in entertainment that way and it works in the athletic field that way.

And whether it — when it works that way, it leaves a return for capital that’s adequate, is an open question. I mean, I haven’t looked at the figures on all the baseball teams, but I’ve seen some of them. And certainly, in some of the smaller markets, I mean, the books were not phony.

I mean, it is very hard to pay market rates for ballplayers in Kansas City and still make money running a ball team, where you’ve got a smaller television market and all of that of the big cities.

So, in the end you’re going to have to pay market rates to retain people, but part of that will also depend upon the period over which they measure their — what they are going to be paid.

I mean, if you want to look at Goldman Sachs last year, they were paid nothing. Does that mean that everybody will leave because they can get paid something someplace else? No, because 80 percent of the partners, or 90 percent of the partners, have a longer time horizon than that. And they have an anticipated earnings figure in mind when comparing it with what they’re being offered elsewhere.

If you have a situation where market rates, you know, exceed the earning capacity of the business, then at some point, capital will flow away from the business.

In the airline industry, which I use as an example, the market rate — most — well, the — in terms of the bigger airlines, people are not being paid market rates, they’re being paid contractual rates. Well, you can’t blame anybody for that.

If you have a contract that entitles you to X and the current market is a half of X, you’re going to hang onto that contract very aggressively. And like I say, you don’t blame anybody for that, it’s just if you end up in that condition, though, you’ve got a real problem.

And if you have the same problem that you have if the market is higher than — or a similar problem — the one you have if the market is higher than one that you can sustain in your own business.

My guess is that there — that, in effect, Salomon has put in a more Goldman Sachs-like system because, essentially, it created, to a degree, a partnership within it. That —

To have that work, A, over time, the partners have to earn good money or it won’t work, but, B, you have to have people that have a partnership mentality in it. And if you change from one culture to another, you are not going to get a hundred percent acceptance of any new system.

Charlie?

CHARLIE MUNGER: Yes, it was kind of a bad break to put in a new compensation system and then have a very bad year. In the very nature of things, people are going to blame the compensation system subconsciously.

And then, two, I think that Wall Street generally has more envy-jealousy effects than are typically present elsewhere.

I have a friend whose grandmother used to say that she couldn’t understand why people got into envy-jealousy, because it was the only one of the sins that you could never possibly have any fun at. And — (Laughter)

But generally speaking, on Wall Street I think a lot of people have had the wrong kind of grandmothers. (Laughter and applause)

WARREN BUFFETT: Yeah, I’ve commented from time to time that — what’s his name? Robin Leach has it all wrong on “Lifestyles of the Rich and Famous,” because he’s presenting all these wonderful things that will happen to you if you get rich.

But they really aren’t that all that wonderful, these fancy houses and boats and all that. The real advantage of being rich, as I explain to people, is that it enables you to hate so effectively.

That if you’re terribly rich, you know, and — but your brother or whomever, cousin or somebody, is getting a little more attention in the world or something of the sort, you can hate in a very major way.

You can hire accountants and lawyers to cause him all kinds of trouble. If you’re poor, you just snub him at Thanksgiving and don’t show up or something of the sort. (Laughter)

But I’ve noticed that these rich people, particularly when they inherit great amounts of money, sooner or later they start — frequently — they get very antagonistic toward siblings, or cousins, or whatever it may be.

And they really can — they can hate in a way that — or get envious in a way that the rest of us really can’t really aspire to. So, that’s the benefit that hasn’t appeared on Robin Leach lately, but I —

But you see that — you see a little of that in the athletic field and the entertainment field, and perhaps even on Wall Street, that making a million dollars a year looks great until this guy that sits next to you that can’t possibly be as smart as you is making a million-two. And then the whole world, it turns into a very unfair place. (Laughter)