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Sunday, March 17, 2013

VALUE WALK: Origins and Value of The Essays of Warren Buffett: Lessons for Corporate America


In 1995, I was a third-year professor of corporate governance researching literature about the disciplining effect of stock markets on managerial behavior. Stock markets were viewed as so efficient that price was a transparent report card on executive performance.  This implied a modest need for other governance devices such as board oversight or fiduciary duties.  But there were also nagging questions about market efficiency.  Called anomalies, these were exceptions to efficiency where the evidence showed that price was noisy, not always a clear signal.
A rich debate would soon take place when economists attracted to behavioral psychology, such as Robert Shiller, began to study these anomalies and try to explain them. As they did, more anomalies emerged, not just strange ones such as how markets tend to fall in January and rise on Friday, but more widespread gyrations in price throughout every trading day all year which could not be explained by changes in fundamental values.
This, of course, is the story of markets that had been told many decades earlier by Benjamin Graham, that teacher and investor who wrote The Intelligent Investor and Security Analysis, but whose work had been largely ignored by two generations of professors.  My research led me to write my first major article, tracing the intellectual history of market efficiency to reveal important questions about its underpinnings, especially concerning its implications for laws about fiduciary duty and corporate disclosure.
In the course of this research, I encountered Warren Buffett’s letters to the shareholders of BerkshireHathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B). The company had an impressive record of outperforming peers, including boasting an investment portfolio Buffett managed that tended to outperform the market. Buffett had been referenced in some of the literature as an anomaly, since his performance defied accepted theory. Buffett had written an article, “The Superinvestors of Graham-and-Doddsville,” challenging that assertion by identifying a dozen fellow investors who also regularly beat the market, noting one common trait: they were all disciples of Graham.
Smart, witty and arresting like that article, Buffett’s letters addressed not only investment theory and practice but other subjects of interest to investors and managers such as governance, mergers and accounting, all topics of great interest to me and about which I would teach and write for the rest of my academic career.  Despite the power of these letters, however, they were undervalued in academia, scarcely cited in the literature.
So I decided it would be appealing to host a symposium featuring the letters, gathering a group of scholars to dissect their content.  For it to work, I needed Buffett’s permission and, for it to be transcendent, his attendance. I contacted Monroe Price, the former Dean of my Law School, a connector known to know every sixth consequential person alive. Did he know Buffett or anyone who did? “Yes,” Price said, “Bob Denham, Buffett’s top legal advisor, is a close friend.” Price introduced me to Denham and we spoke on the phone about the concept.  He got it and recommended I write Buffett directly, which I did. Buffett wrote back agreeing to the proposal: a symposium featuring his letters that he would attend, along with his wife Susie, son Howard, business partner Charlie Munger and insurance maven Ajit Jian.
To organize the conference, and the collection, Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B) gave me printed volumes of letters, dating 1977 to 1994, which in those pre-internet days the company maintained, and I also obtained electronic copies from the SEC’s electronic retrieval service. Several times I read through and annotated those letters, contained in two massive three-ring binders (which I still have). Among the extensive writings (adding to 400,000 words today, the equivalent of 4 average length non-fiction books), I searched for organizing principles and radiating themes.
The organizing principle readily emerged as the fundamental idea that price and value are different things: stock markets are not so efficient as to invariably produce a price that is a reliable proxy for value. That topic is so deep, and went so against the grain of prevailing literature and classroom teaching, that it would receive an entire section of the collection and separate panel at the symposium.
But it was even larger than that because pretty much all the other principles—about governance, mergers, accounting and so on—followed from that fundamental idea. Governance is important because stock prices are not a transparent report card, mergers can increase or decrease shareholder wealth because relative values of two companies must be calculated rather than read off the ticker tape and accounting conventions matter because stock price does not necessarily pierce the alternative ways to present financial information to make the forms irrelevant.

Seeing the letters that way, it reminded me of how a sculptor, looking at a marble slab, sees the statue in his mind as he begins to work, exquisitely described by Michelangelo as “liberating the statute from within the block.” The core of the statue that became The Essays of Warren Buffett, and that conference, was the topic I labeled “Finance and Investing,” in  which Buffett both lays out and then challenges prevailing orthodoxy in passages I put under the heading “Debunking Standard Dogma. The panel and section on “Corporate Governance” discussed the hottest topics of the day, beginning with important points on the variety of corporate structures that warrant different governance designs, the downside of a one-size-fits-all approach, the hidden dangers of stock option compensation and the challenges of dealing with ailing businesses. 

“Mergers and Acquisitions” debated the motives behind mergers, the risks of overpayment and the fundamental disciplinary principles managers can use to minimize that risk. “Accounting” took up particular topics in that field as well as the utility and limits of financial information in investing and management.
After publishing a mimeograph of the collection for the conference (held in 1996) my initial collection, self-published, debuted in 1997 (tan cover, 219 pages); I updated the collection first in 2001 (blue cover, called the first revised edition, 245 pages) and then in 2008 (green cover, called the second edition, 291 pages). In each of these editions, the cover was plain, emulating the simplicity of Berkshire Hathaway Inc. (NYSE:BRK.A) (NYSE:BRK.B)’s annual report covers.
The latest edition of The Essays of Warren Buffett, being released in 2013 and spanning 308 pages, has a snappier cover. The main reason: the book’s traditional covers could be seen well in physical form but pictures of them, shown on the internet, could not. Since most sales are done over the internet these days, the cover needed a face lift. The adage remains, however, that one should not judge a book by its cover.  This book should be judged on its content and organization, its articulation of a distinctive investment and business philosophy radiating from the fundamental insight about price-value differences.
Lawrence Cunningham is the Henry St. George Tucker III Research Professor at George Washington University Law School and Director of GW’s Center for Law, Economics and Finance (C-LEAF) in New York. He is the author of numerous books including The Essays of Warren Buffett: Lessons for Corporate AmericaThe AIG Story (written with Hank Greenberg), and Contracts in the Real World: Stories of Popular Contracts and Why They Matter. His research appears in leading university journals, including those published by Columbia, Cornell, Harvard, Michigan, Vanderbilt and Virginia; his op-eds have run in the Baltimore Sun, the Financial Times, the National Law Journal, the New York Daily News and the New York Times. On Amazon, Cunningham has been ranked one of the top 100 authors in the category of business and investing.

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