2008: How did Buffett choose his successors?

AUDIENCE MEMBER: Hello, Mr. Buffett, Mr. Munger. My name is Kevin Truitt (PH) from Chicago, Illinois.

My question is this: you have identified four investment professionals who will at some point in time be running the portfolio for Berkshire Hathaway.

What was the criteria that you used to select the four people and what will be the criteria for evaluating them going forward?

WARREN BUFFETT: Yeah. The criteria for selecting, I think, we laid out pretty well in the 2006 annual report.

We obviously look for people that have had pretty good records, but that criteria alone is nowhere near sufficient to come up with the candidates we want.

I mean, we care enormously about human qualities, and we think we can make that judgment in some cases, and in some cases we can’t.

I mean — and it’s no negative vote on people we skipped over. We just decided we didn’t know whether they would be the right kind of person.

We made an affirmative judgment on four, as to both their ability and their integrity.

And I would like to — there was one other item in here, I believe, which I think achieved a little added relevance in the last year. I said, “We therefore need someone genetically programmed to recognize and avoid serious risks,” and then I put in italics, “including those never before experienced.”

And then I said, “Certain perils that lurk in investment strategies cannot be spotted by one of the models — by use of the models — commonly employed today by financial institutions.”

Well, I think that proved to be somewhat prophetic of what happened last year. All of these places had models. I mean, the major banks, the major investment banks.

They would meet weekly at a risk committee, probably, and go over their models, and all of the statistics would be printed in nice columns and everything. And they didn’t have the faintest idea what risk they were involved.

You really need, in the investment world, someone very solid, someone you trust, reasonable analytical skills.

But you also need someone that actually can contemplate problems that haven’t popped up yet but which are starting to become possibilities, in terms of new financial instruments or new behaviors in markets and that sort of thing.

And that’s a rare quality. I mean, that inability to envision something that doesn’t show up in your past model, you know, can be fatal.

And Charlie and I spend a lot of time thinking about things that could hit us out of the blue that other people don’t include in their thinking.

And we may miss some opportunities because of that, but we feel it’s essential when managing other people’s money or, for that matter, managing our own money.

So I would say that you might go back and read the 2006 annual report again, but those are the criteria we’re looking for and we have identified as being met by the four people we’re thinking about.

Charlie?

CHARLIE MUNGER: Yeah. You can see how risk averse Berkshire is. In the first place, we try and behave in a way so that no rational person is going to worry about our credit.

And after we’ve done that, and done it for many years, we also behave in a way that, if the world suddenly didn’t like our credit, we wouldn’t even notice it for months, because we have such liquidity and are so unlikely to be — unable to be — pressured by anybody.

That double layering of protection against risk is like breathing around Berkshire. It’s just part of the culture.

And the alternative culture is just the opposite. You call a man the Chief Risk Officer, but often he is functioning as a guy that makes you feel good while you do dumb things. (Laughter)

So he’s like the Delphic oracle that convinced the Persian king to attack somebody or other. I mean, it’s — he’s just a dumb soothsayer.

And how can a guy be dumb when he’s got a Ph.D. and he can do all this advanced math?

WARREN BUFFETT: Easy.

CHARLIE MUNGER: You can — (laughter) — but you can. It’s very — all you’ve got to do is crave system and computation so much that you torture reality into fitting some model — mathematical model — which really doesn’t match, particularly, under extreme conditions.

And then, because of this work that you’re putting into everything and these computations about daily trading, risk, and so forth, you feel confident that you’ve clobbered the risk, but you haven’t. You’re just clobbered up your own head. (Laughter)

WARREN BUFFETT: Yeah. We really want to run Berkshire, you know — (Applause.)

WARREN BUFFETT: I’ll even applaud that one. (Laughs)

We really want to run Berkshire so that if the world isn’t working tomorrow the way it’s working today and it’s working in a way nobody expected, that we don’t have a problem.

We do not want to be dependent on anybody or anything else. And yet we want to keep doing things.

So, we’ve found a way to do it — we think we found a way — to do that. It may give up some of the — well, obviously gives up earning higher returns 99 percent of the time, and maybe 99.9 percent of the time.

Obviously, we could have run Berkshire with more leverage over the years than we have. But we wouldn’t have slept as well, and we wouldn’t feel comfortable — we’d have a lot of people in this room that have almost all their net worth in Berkshire, including me — and we wouldn’t feel comfortable running a business that way.

Why do it? I mean, it doesn’t — it just doesn’t make any sense to us to be exposed to ruin and disgrace and embarrassment and — for something that’s not that meaningful.

If we can earn a decent return on capital, you know, what’s an extra percentage point? It just isn’t that important.

So we will always try to behave in a way that, A, is not dependent on anybody else evaluating the risk except for us. It cannot be farmed out.

And you’ve seen what happened to some institutions where the management thought they were farming it out. And, you know, if that means a reasonable return instead of a slightly unreasonable return, we just accept it.