2007: What are your thoughts on executive compensation?

AUDIENCE MEMBER: Hi. (Inaudible). I lived most of my life in India, but now in Hoboken, New Jersey.

Warren, first thank you for replying to my letter. I misspelled your name, and where I come from if I did the same thing, the reply would have been, more on, get my name correct before asking a question. So thank you once again.

Investment managers nowadays are benefiting a lot more at the expense of the investors and the (inaudible).

My question is both to you and Charlie is, what do you think is the best structure/fees that managers should have that will give him an opportunity to maximize the time (inaudible) and money (inaudible) over the next few decades and being fair to the profession — the investors and himself? Thank you.

WARREN BUFFETT: Before I answer that, I think I should tell you a very short story. It’s a little embarrassing, but I got worried a few years ago about Charlie’s hearing.

But I mean, the guy’s been my pal for 45 or 50 years. I didn’t really want to confront him with this apparent evidence of old age.

So I went to a doctor and I said, “You know, I got this good pal. I don’t think he’s hearing so well. I really don’t want to confront him with it, so what do you suggest I do to check this out?”

He said, “Well, stand across the room, talk in a normal tone of voice, see what happens.”

So the next time I was with Charlie, I got across the room and I said, “Charlie, I think we ought to buy General Motors at 30. Do you agree?” Not a flicker. Not a flicker.

I went halfway across the room. I said, “Charlie, I think we ought to buy General Motors at 30. Do you agree?” Nothing changes.

Get right next to him, put my voice in his ear and said, “Charlie, I think we ought to buy General Motors at 30. Do you agree?”

Charlie said, “For the third time, yes.” (Laughter)

So, Charlie, would you like to address that question? (Laughter)

CHARLIE MUNGER: Yes. The question addressed the problem of unfairness of executive compensation and the effects of that unfairness on investors. And now that you know the question, you can solve the problem. (Laughter)

WARREN BUFFETT: Well, Charlie and I have plenty to say about compensation, and some of it makes our stomach turn.

I will say this, though. There are more problems with having the wrong manager than with having the wrong compensation system.

I mean, it is enormously important who runs — you name the company — Proctor & Gamble, Coca-Cola, American Express — and any compensation sins are generally of minor importance compared to the sin of having somebody that’s mediocre running a huge company.

That said, Charlie and I think that compensation has — there’s a natural tendency — because of ratcheting, because of the publicity of what other people get, and because of the lack of intensity in the bargaining process.

I mean, you read about labor contracts, you know, where impasses go on for weeks and where they negotiate till 3 in the morning and, you know, both sides take their case to the press and everything.

I ask you, when have you heard of a comp committee, you know, working until 4 in the morning, declaring an impasse for a week, not being able to make a deal?

It just doesn’t happen because the CEO cares enormously how he or she is paid, and to the comp committee — and they’re doing, perhaps, a little better job now — but it’s basically play money.

And, of course, as I’ve pointed out in the past, I’ve been on 19 boards. They put me on one comp committee and they regretted it subsequently.

You know, they are looking for cocker spaniels with their tails wagging to put on comp committees and, you know, they’re not looking for Dobermans.

And I try to pretend I’m a cocker spaniel just to get on one, but it doesn’t work. (Laughter)

But it is not — there is not a parity of intensity in the bargaining process. One guy cares enormously and the others don’t.

And as Charlie has pointed out in the past, what really drives a lot of this ratcheting impact is envy.

I saw that on Wall Street. You can talk about greed, but if you paid somebody $2 million, they might be quite happy until they found out the guy next to them made 2 million-one, and then they were miserable.

And Charlie has also pointed out that envy, of the seven deadly sins, is probably the dumbest, because if you’re envious of somebody, you feel terrible and, you know, the other guy isn’t bothered at all.

So all you get out of envy is this miserable grinding in your stomach and all that sort of thing.

You know, compare that to some of the other sins like gluttony, which we are about to engage in. (Laughter)

You know, there’s some upside to gluttony. I’m told there’s upside to lust, but I’ll leave that to Charlie to explain. (Laughter)

But envy, where the hell is the upside, you know? But it does produce this ratcheting effect in pay.

The comp committee sits down. The human relations person comes in. The human relations person knows what the CEO thinks of them is going to determine their future, and the human relations department recommends some comp consultant. The comp consultant knows that his recommendation to other firms is dependent on what these people say about him.

So under those circumstances, you know, can you imagine that it’s anything like a fair fight? It’s a joke.

Charlie?

CHARLIE MUNGER: Yes. The process is contributed to by a wonderful bunch of people called compensation consultants.

And that reminds me of the old story where the mother asked the child why she told the census taker that the man of the house was in prison for embezzlement. And the child said, “I didn’t want to admit he was a compensation consultant.” (Laughter)

WARREN BUFFETT: We’ll get around to the rest of you later on, too. Don’t feel smug because we haven’t attacked your —

I just had a note handed to me. We do have about 27,000 people here. The overflow rooms are full, and we will have a whole bunch in the exhibition hall as well. (Applause)