01 March 2010
Published in: Risk governance
“Don’t delegate risk control,” Buffett urges CEOs
"We have long invested in derivatives contracts that Charlie and I think are mispriced, just as we try to invest in mispriced stocks and bonds," explains Warren Buffett, chairman of Berkshire Hathaway in his latest letter to shareholders. But he and Charlie Munger, the company's vice-chairman, warn, as they have done many times previously, of "the dangers that derivatives pose for both participants and society when these contracts lead to leverage and/or counterparty risk that is extreme."
Buffett says nothing like that has occurred at Berkshire, nor will it. "Charlie and I believe that a CEO must not delegate risk control. It's simply too important." He made a similar point in last year's letter (see IERM, 2 March 2009, Risk governance, "The CEO must be the CRO, says Buffett").
"At Berkshire," Buffett stresses, "I both initiate and monitor every derivatives contract on our books, with the exception of operations-related contracts at a few of our subsidiaries, such as MidAmerican, and the minor runoff contracts at General Re. If Berkshire ever gets in trouble, it will be my fault. It will not be because of misjudgments made by a Risk Committee or Chief Risk Officer."
Buffett lambasts the boards of companies that failed over the past two years. "In my view a board of directors of a huge financial institution is derelict if it does not insist that its CEO bear full responsibility for risk control." And he points out that the CEOs and directors of the failed companies have largely gone unscathed. "They still live in grand style," he notes. "It is the behaviour of these CEOs and directors that needs to be changed. CEOs and, in many cases, directors have long benefited from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well."
Buffett says that the company has changed only a few of its derivatives positions since last year. Some credit contracts have run off. The terms of about 10% of the equity put contracts have also changed: maturities have been shortened and strike prices materially reduced. "In these modifications, no money changed hands," he stressed.
He reiterates his view from last year that "though it's no sure thing, I expect our contracts in aggregate to deliver us a profit over their lifetime, even when investment income on the huge amount of float they provide us is excluded in the calculation."
Berkshire's gain in net worth during 2009 was $21.8bn, increasing the per-share book value of the stock by 19.8%. Net income in 2009 was $8.1bn, compared with $5bn in 2008.
Berkshire's landmark transaction last year was the $26bn acquisition of Burlington Northern Santa Fe railway. Always the most diligent salesperson of his company's products, Buffett rounds off his letter urging "shareholder-partners" to attend the company's 1 May annual meeting ("our annual Woodstock for Capitalists") and adding, "P.S. Come by rail."