Lawrence Cunningham: Part 1 of an interview by Bob Morris

CunninghamLawrence 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 three editions of The Essays of Warren Buffett: Lessons for Corporate America (Third Edition, March 8, 2013), The 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, Cunningham has been ranked one of the top 100 authors in the category of business and investing.

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Morris: To what extent has your formal education been invaluable to what you have accomplished in life thus far?

As a university professor, it would be blasphemous but to declare my formal education invaluable and there’s also a lot of truth in it. I learned some of the most important things I know from classroom work in economics in college and in law and business in law school. I’ve learned a great many things in the decades since, of course, but those days trained me to think, encouraged me to be curious, taught me how to interact with others, and nurtured countless other traits.

Morris: What do you know now about the business world that you wish you knew when you went to work full-time for the first time? Why?

Cunningham: The importance of relationships to opening doors and keeping them open. Merit seemed as important as anything else when I began my career as a corporate lawyer in 1988. And while merit matters, what’s more important over the longer term is the quality of the network of friends, colleagues, mentors, and fans that you develop and maintain at each phase of your life and career. There is a lot of truth in the old saying: “It’s not what you know but who you know.”

Morris: Of all the films that you have seen, which – in your opinion – best dramatizes important business principles? Please explain.

Cunningham: Other People’s Money. Hollywood has always had a bit of a hate affair with American business in portraying corporations and capitalists in negative lights. The exception is Other People’s Money, as it presents both sides of the story in a difficult circumstance of a company in decline: whether to stick it out or close it down. (Incidentally, it is akin to the angst portrayed in The Essays of Warren Buffett concerning a struggling New England textile company that Buffett eventually shut down.)

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Morris: Here are several of my favorite quotations to which I ask you to respond. First from Voltaire: “Cherish those who seek the truth but beware of those who find it.”

Cunningham: Truth is elusive. Searching for it is indeed noble. But be skeptical of anyone who claims to have found it.

Morris: From Albert Einstein: “We cannot solve our problems with the same thinking we used when we created them.”

Cunningham: Reminds of a quip, attributed to Will Rogers, quoted in The Essays of Warren Buffett: “When you find yourself in a hole, stop digging.” It also reminds me of another Einstein quip: “Everything should be as simple as possible, but not more so.”

Morris: Finally, from Peter Drucker: “There is surely nothing quite so useless as doing with great efficiency what should not be done at all.”

Cunningham: I wish such wisdom had been taken to heart by the financial engineers whose derivative products fueled the mortgages behind the housing boom that collapsed so catastrophically in 2008.

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Morris: In Tom Davenport’s latest book, Judgment Calls, he and co-author Brooke Manville offer “an antidote for the Great Man theory of decision making and organizational performance”: organizational judgment. That is, “the collective capacity to make good calls and wise moves when the need for them exceeds the scope of any single leader’s direct control.” What do you think?

Cunningham: The wisdom of crowds and the power of markets are real. But within an organization it can be difficult to maintain a “collective capacity” for decision making, which would resemble a democratic vote. Shareholders do a little of that when electing directors and voting in annual meetings when no single person is entitled to make such extraordinary decisions. But with such choices made, directors and the senior executives they appoint cannot discharge their duties by referendum.

True, within boards of directors, corporations have always drawn on a fundamental notion of organizational judgment. A team rather than an individual speaks for and binds the corporation. Law even gives such board decisions reverence, under the “business judgment rule,” which keeps judges out of second-guessing.

The danger to watch for in any move to such organizational judgment is the risk of authority without accountability, which I know we will discuss a bit more later.

Morris: Here’s a brief excerpt from Paul Schoemaker’s latest book, Brilliant Mistakes: “The key question companies need to address is not ‘Should we make mistakes?’ but rather ‘which mistakes should we make in order to test our deeply held assumptions?'” Your response?

Cunningham: I am not sure about the notion of having an appetite for mistakes, even as a way to test assumptions. There are other less costly ways to test assumptions, such as by logical critique, contained experiments and consulting analogical experience. The wisdom I see in this quotation might be flipped around, to say there is a class of mistakes we should avoid absolutely. Foremost among these would be any decisions that impair a company’s reputation, for instance, another point I know we’ll discuss more later.

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Morris: Now please shift your attention to the latest edition of Buffet’s Essays. To what extent is it a sequel to the Second Edition? What’s new among the material provided?

Cunningham: We like to come out with a new edition every five years on average, with editions in 1997, 2001, 2008 and 2013. As I explain in the Preface:

“Like the first revised edition of The Essays, this one retains the architecture and philosophy of the original edition but adds selections from Mr. Buffett’s annual shareholder letters written since the previous editions. As with the other letters, these are woven together into a fabric that reads as a complete and coherent narrative of a sound business and investment philosophy. . . .”

The new edition is called for not because anything has changed about the fundamentals of sound business and investment philosophy but because Mr. Buffett’s articulation of that philosophy is always done in the context of contemporary events and business conditions. So periodic updating is warranted to maintain its currency.

The topics most expanded in new edition are corporate governance and investing, much of the new material concerning five years of Buffett’s reflections on the financial crisis of 2008 and its aftermath, both for corporate risk management and individual personal finance. We also rearranged some of the material, especially concerning accounting, to sharpen some of the themes

Morris: Were there any head-snapping revelations while writing it? Please explain.

Cunningham: My role was to assemble Buffett’s letters on thematic lines and write the introduction, rather than write the text, which is his (along with a few contributions from Berkshire Vice Chairman Charlie Munger). The greatest revelation was how all the hundreds of powerful ideas and bits of wisdom it contains can be traced to a single organizing principle: the fundamental idea that price and value are different things. That is, stock markets are not so efficient as to invariably produce a price that is a reliable proxy for value. Implications radiate for investing, governance, mergers, accounting and so on. 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.”

Morris: To what extent (if any) does the book in final form differ significantly from what you originally envisioned?

Cunningham: What I envisioned, way back in 1995 when I conceived of the initial project, has been substantively quite similar to the resulting product across various editions including the new 2013 third edition. But I had originally envisioned a relatively small and particular audience for the book, whereas interest has been broad across readers of general non-fiction and deep in terms of enthusiasm. Buffett’s own writings during the period, from 1995 to 2013, have also broadened. They concentrate on Berkshire Hathaway, of course, and some principles vital to it, but expand to include a range of topics of general interest to a general readership.

For those more interested in some of those historical details, the first version of the book, in 1995, was called a “Preliminary Edition,” a 134-page pamphlet for a law school conference, with 40 copies made for participants on a Xerox machine. We then printed a slightly lengthier version of that in the law school’s academic journal, along with 20 scholarly papers reviewing aspects of it. Copies of that also sold as a 214-page book, which drew good reviews in Forbes, Money, Publisher’s Weekly and USA Today. I published the book myself so that, after a day at work, I’d go home and pack up shipments and tally orders etc. I did that for nearly a decade, until I enlisted some friends who run a small academic press to help with distribution.

Morris: The book’s subtitle refers to “Lessons for Corporate America.” Presumably the lessons can be of substantial value to leaders of organizations throughout the world.

Cunningham: True. In fact, Joe Nocera of the New York Times recommended that President Obama read The Essays of Warren Buffett. Nocera stressed that the lessons are not for corporate executives only, and not only for the chief executive of the United States, but for “everyone,” Nocera said. He said he believed that because, to quote him (from a feature story in Washington Monthly, January 2009):

The best kind of investing “has a value system attached to it. Buffett buys companies, not stocks. He thinks about the long term, not the short term. He became very rich by not trying to get rich quick. He has tackled the problems with stock options, and with executive compensation. (Believe it or not, Buffett’s executives at Berkshire Hathaway don’t get any options; he doesn’t believe in them.) In many ways, his rules for investing are rules to live by, and Obama could do worse than use his bully pulpit to preach them to the rest of us.”

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Morris: For those who have not as yet read the Third Edition, please explain the most important lesson to be learned from the financial crisis since 2008 and its continuing implications for investors, managers, and society.

Cunningham: Buffett wrote quite a bit about the financial crisis in each year since the crisis and the collection collates these writings into a coherent narrative of what went wrong and what’s still not right. In short, excessive debt is the ultimate vice in the financial crisis, Buffett explains. To blame were people from every walk of life who overlooked the dangers of debt, from government, to homebuyers, lenders, bankers, financial innovators, investors, insurers, rating agencies.

The Essays explain in very accessible terms some of the underlying forces in the housing market and the derivatives markets that fueled the crisis. But above all, the key lesson is one we have not yet fully absorbed: authority and accountability were never more separated than in the crisis and society’s response. CEOs had control but shareholders took the losses. Shareholders as a group that paid the largest price, with more than 90% of value wiped out. The CEOs and directors of the failed companies got off Scot-free. The Essays make a very good case for why that must change.

Morris: What about for controlling risk and protecting reputation in corporate governance?

Cunningham: Risk management and reputation protection have always been important aspects of corporate governance, dramatized by the financial crisis. But corporate America’s response has been misguided, because it has focused on the creation of the new executive dubbed the chief risk officer or, at some companies, risk committees on the board of directors. These are misguided responses because the CEO must be the chief risk officer. Risk management cannot be delegated, as it is too important and mistakes too costly. It may be comforting to have a risk officer or a board committee involved but neither can assume the responsibility. Buffett takes a hard line on this, saying he’d consider a large financial institution’s board to be derelict (his word, which he italicizes) if it did not insist that the CEO bears full responsibility for risk control.

Morris: Finally, what about investment possibilities today?

Cunningham: Many people enjoy The Essays because of their extensive, entertaining and accessible tutorials on investing. Those readers will not be disappointed in the new edition, which retains all the classic statements so worth re-reading, and adding thoughtful reflections on the current state of the investing landscape. In short, Buffett remains characteristically bullish on America. He also remains focused solely on productive assets, meaning businesses that make things or provide services, as opposed to investments in money markets or commodities or collectibles.

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Morris: In your opinion, what are defining characteristics of the reader who will derive the greatest benefits from a careful reading of the Third Edition? Please explain.

Cunningham: The reader who is interested in business, curious, willing to be contrarian, open-minded and prepared to become immersed in a book that is difficult to put down and very easy to pick up—especially after many reads.

Morris: Here are two separate but related questions. First, what are Charlie Munger’s unique contributions to the on-going success of Berkshire Hathaway?

Cunningham: Buffett runs big tough ideas or problems by Munger as a sounding board and top adviser. Munger is a quick, sagacious, pithy fellow. Buffett gets a smart and succinct assessment. Results range from steering away from a tempting investment to innovating solutions to thorny corporate governance problems ranging from charitable giving to suspected insider trading.

Morris: Also, again in your opinion, should almost any organization have someone like Charlie Munger among its leaders? Please explain.

Cunningham: Maybe so: instead of a “yes man,” Charlie seems often to be more of a “no man.” Instead of endorsing every great idea the CEO gets, he is prepared to veto ideas and explain firmly why.

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Morris: Here are a few questions evoked by your Introduction and, if I may say so as I did of your Introduction to the Second Edition, all by itself, it’s worth much more than the cost of the book. The essays address some of the most important governance problems. In your opinion, which of them poses the greatest challenges? Please explain.

Cunningham: The two greatest challenges are in a way the simplest: avoid following fashions in corporate governance and beware of the dangers of a one-size-fits-all approach. Each corporate situation is unique and warrants different provisions. Yet in our system, we too often see fads in corporate governance in which everyone is expected to join.

That said, if we insisted on finding one to condemn universally, the best candidate would be age limits for directors. That was a fashionable idea a decade ago that is just silly and would certainly have been a disaster at Berkshire, throwing off the board both Warren and Charlie Munger and several other distinguished directors. If we insisted on looking for one universally good corporate governance idea, at least for public companies without a controlling shareholder, it might be to have regular periodic board meetings solely for the purpose of a CEO assessment, without the CEO participating.

But many other general principles can backfire for given companies, whether separating CEO/Chairman, staggered board or not, even the optimal degree of independence.

Morris: Who or what is “Mr. Market”? Its significance?

Cunningham: An allegory for the overall stock market invented by Ben Graham, Buffett’s teacher and mentor. It refers to market volatility at prices which depart from value, sometimes too high and sometimes too low. Buffett elaborates more fully, and poetically, on Mr., Market, but my Introduction summarizes it this way:

One of Graham’s most profound contributions is a character who lives on Wall Street, Mr. Market. He is your hypothetical business partner who is daily willing to buy your interest in a business or sell you his at prevailing market prices. Mr. Market is moody, prone to manic swings from joy to despair. Sometimes he offers prices way higher than value; sometimes he offers prices way lower than value. The more manic-depressive he is, the greater the spread between price and value, and therefore the greater the investment opportunities he offers.

Mr. Market is very significant for disciplined investing—and stands in stark contrast to the widespread beliefs of modern finance theorists who say that markets are efficient in the sense of invariably offering prices that are reliable estimates of value. Buffett thinks there is a world of difference between price and value and that the difference defines the most important principle of investing: invest only when there is a credible basis for believing that there is a wide gap between price and value. Graham called that the margin of safety and Buffett believes those are the three most important words to say about investing.

Morris: What is the “circle of competence principle”? Its significance?

Cunningham: Stick to your knitting. It’s a fundamental insight in which Buffett quotes Tom Watson, a former legendary CEO of IBM: “I’m smart in spots, and I stick around those spots.” Again, Buffett explains this idea pithily and repeatedly in the collection, including on several occasions when he made mistakes by straying outside his circle of competence. Here is my brief summary from the Introduction:

“The circle of competence principle is the third leg of the Graham/Buffett stool of intelligent investing, along with Mr. Market and the margin of safety. This commonsense rule instructs investors to consider investments only concerning businesses they are capable of understanding with a modicum of effort. It is this commitment to stick with what he knows that enables Buffett to avoid the mistakes others repeatedly make, particularly those who feast on the fantasies of fast riches promised by technological fads and new era rhetoric that have recurrently infested speculative markets over the centuries.”

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Morris: Let’s say that a CEO has read and then (hopefully) re-read Third Edition of Buffet’s Essays and is now determined to strengthen the structural integrity and personal accountability at all levels and in all areas of the given enterprise. Where to begin?

Cunningham: In corporate life, CEOs, boards and other C-level executives have a vital role to play in setting the tone at the top. Buffett sends a biennial letter to Berkshire managers reemphasizing that Berkshire’s top priority is that all continue to zealously guard Berkshire’s reputation. He’s written in that memo for 25 years the same gospel truth: “We can afford to lose money—even a lot of money. But we can’t afford to lose reputation—even a shred of reputation.” His test:

We must continue to measure every act against not only what is legal but also what we would be happy to have written about on the front page of a national newspaper in an article written by an unfriendly but intelligent reporter.

To those who argue that playing it close to the line is profit maximizing, Buffett sniffs: there is plenty of money to be made in the center of the court without straying near to the sidelines.

Morris:  For more than 25 years, it has been my great pleasure as well as privilege to work closely with the owner/CEOs of hundreds of small companies, those with $20-million or less in annual sales. In your opinion, of all the material you provide in Third Edition of Buffet’s Essays, which do you think will be of greatest value to leaders in small companies? Please explain.

Cunningham: Read The Essays by imagining that at some point, when it’s time to sell, you’d like to call Berkshire. Buffett has designed Berkshire to be the buyer of choice for companies, especially family-owned or other closely-held businesses. He has a clear statement of his acquisition criteria and his writings elaborate on the kind of managers, businesses, and practices he endorses. Those owner-managers who have sold to Berkshire are an extraordinary group that any other owner-manager would be proud to join.

Morris: Which question had you hoped to be asked during this interview – but weren’t – and what is your response to it.

Cunningham: “What happens when Buffett dies or becomes incapacitated?” That is a governance question about succession that has been raised by Berkshire shareholders and discussed by its board for a decade or more. Plans are in place concerning personnel and assignments and that seems to mostly ease any concern. But I’d offer a broader point about this question that is underappreciated. Berkshire Hathaway has become bigger than Warren Buffett such that it is poised to transcend his time and prosper and endure well beyond his departure from the scene. That may be the ultimate accomplishment. Many great companies never become greater than their founding visionary/builders. The Essays demonstrate that, in this case, the company will survive the man.

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Larry cordially invites you to check out the resources at these websites:

Publisher’s page for The Essays

Amazon’s page for The Essays



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