2001: Is Buffett helping FASB understand stock options?

AUDIENCE MEMBER: Robert Piton (PH) from Chicago. The Honorable Warren Buffett and the Honorable Charlie Munger, I felt it would be appropriate to address you both in a manner that reflects the tremendous amount of value that the two of you have been instrumental in unleashing for your shareholders, your employees, and the good of society. (Applause)

The area that I’d like to inquire about is stock options. As you are aware and have written about in the past reports, companies have been taking advantage of, and contributing to, FASB’s inadequate rules regarding stock options.

In particular, the lack of having to expense them on the income statement and the lack of having to report them as a liability on the balance sheet.

My question is, are either one of you doing anything to help FASB’s current stance on the issue?

If not, have either one of you ever considered establishing a, quote, “real,” end quote, independent body of accountants that would actually try to make companies produce accounting statements that reflect economic reality?

WARREN BUFFETT: Charlie, I’ll let you. You have the history on it.

CHARLIE MUNGER: Well, we don’t like the accounting, which we’ve called “corrupt,” or at least I have. And I don’t think that’s too strong a word. I think it’s corrupt to have false accounting because you like a certain outcome better than another.

All that said, I don’t think either of us spends a lot of time fighting with FASB or trying to create a better one.

It’s like splitting your lance against stone or something. You can get a lot of back pressure from the butt of the lance. And we can’t be expected to cure all the ills of the world.

WARREN BUFFETT: We’ve written about it and talked about it. Obviously, you’ve picked up on it. And when it was an active issue whenever it was, about, I don’t know, four years ago or so, Senator [Carl] Levin of Michigan was one of those who felt as we did. And, of course, FASB felt as we did.

But the pressure was incredible that American business brought on, on Congress. They weren’t getting — they tried to put pressure on FASB and they weren’t getting a result, so they just said, “Well, we’re not going to let FASB set the accounting rules, we’ll have Congress set the accounting rules.”

And I thought that was a bad idea, per se, but I thought in this — and, but they got plenty of supporters. Got a huge number of supporters. I mean, they —

And at the time, I compared it, I think — there was a bill introduced in the Indiana legislature in the 1890s, I believe. And the bill was to change the value of the mathematical term “pi” to three even, instead of 3.1415... (Laughter)

And the legislator who introduced it said that it was too difficult for the school children of Indiana to work with this terribly long, unending term. And it would be so much easier if pi was just three. And he thought they ought to enact that.

Well, I thought that was quite rational compared to, you know, what the Congress of the United States was going to do in telling people that, since it — one of the arguments was that, “It makes it very tough for startup companies if they have to expense this.”

Well, it makes tough if they have to pay their electricity bill, too. But, I mean, but those were the kind of arguments you got.

And my memory is, Charlie is better on this than I am probably, but I think the accounting firms 40 years ago or 50 years ago were in accord with our position.

But every client would put pressure on, you know, and they don’t want to report expenses. They particularly don’t want to report expenses that are paid to them, and that could be huge, and that might prove obnoxious if recorded by conventional accounting. But if it’s sort of lost in a table in the proxy statement, people don’t pay much attention.

So, the only way it will get changed — we wrote about it and I even talked to a few senators at the time — the only way it will get changed is — and this is the only way corporate governance problems generally will get changed — if 15 or 20 large institutional investors would band together in some way on this.

But some of them have the same problem because they’re getting paid extraordinary sums for doing something that, you know, is really not adding that much value.

So, they’re not really inclined to call attention, in many cases, to what Charlie would refer to as “obscenities” in other people’s compensation.

So, I think it’s going to go on. I mean, it’s a fascinating subject. But the institutional investors seem to focus very much on matters of form and not substance.

I mean, you get a lot of — they, you know, they cluck a lot about little things that don’t have anything to do with their economic return over time, whereas on stock options they’re something that’s terribly important. They’re the ones that are paying the costs, and the costs are there whether they get recorded or not.

But American management will not change its position on that voluntarily. Consultants will never change their position. They’re getting paid to encourage people to look at other companies, and it just keeps ratcheting up. So, I don’t think you’re going to see change unless institutional investors do it.

As I say, I get these questionnaires, you know, about the composition of the board or a nominating committee. None of that makes any difference in terms of how a business performs.

I got one form that said they wanted a list of directors broken down by sex. And I said, “None that I know of.” (Laughter)

But it just is not germane.

Charlie?

CHARLIE MUNGER: Well, I can’t top that one. (Laughter)