Incentives & Financial Shenanigans

After talking a little bit about incentives, nothing better than debating some of the possible outcomes. As we’ve learned in the previous entry, high paychecks with misaligned terms may be an issue: CEOs feeling pressured about beating analysts’ short-term quarterly estimates may ‘play dumb’ destroying shareholder value in detriment of his own paycheck. As one CEO has put it,

“The most important thing we do is meet our numbers. It’s more important than any individual product. It’s more important than any individual philosophy. It’s more important than any individual cultural change we’re making. We must stop everything else when we don’t make the numbers.” – Joseph Nacchio, speech at January 2001 employee meeting, disclosed in a U.S. SEC complaint (March 2005)

Aggressive accounting may take its form in different ways, such as booking revenues too soon, recognizing undue revenue (nevermind PoC accounting method!), misclassifying items so they don’t pass through the P&L, shifting current expenses to the next period, boosting operating income by one-offs and so on.

Since executives are well regarded, competent and competitive people, they do not like to lose – I get that. But how could both (i) investors analyze companies financial results in a proper timeframe and (ii) executives be aligned with the right incentives and KPIs so performance evaluation for both parties would be fair and accretive for the three entities in question, namely investors, executives and the company itself?

As Munger put it in one of his speeches,

“The system is responsible in proportion to the degree that the people who make the decisions bear the consequences.”

I do not aspire to share a proposal, but things such as

  1. A shareholder base aligned with the strategic planning horizon of a company;
  2. A well calibrated compensation package, with the vesting period aligned with the strategic planning timeframe (even in Brazil there are companies with 10-year vesting periods);
  3. A more spaced financial results release (half yearly, maybe?); 

should be steps in the more correct direction. That’s my 2 cents. What do you think?


While below you may find the transcript of this another talk, right here you can find the video.

Governance & Culture: Munger, Peter Thiel & Netflix Combined

Combining Munger takes on Governance, Peter Thiel’s insights and Netflix HR presentation was fun to delve into intelligent governance frameworks sourced from an equity investor, a venture capitalist and a company. So, what are them?

  • The fundamental principle: good character – when in doubt, there’s no doubt. Do not hire;
  • Strive for a trust-based environment;
  • Provide context to people (why, why, why?), over-communicate – candor & clarity are musts;
  • Inspire responsible behavior through freedom and independence, though reinforce accountability;
  • Less formal processes, DOs and DON’Ts: “Act in Netflix’s best interest”. Yes, that’s it. It’s a principle-based approach that works with minimal good sense and intelligence; 
  • Offer modest fixed salary, roughly equal to fixed costs. Align with equity ownership;
  • Control is for beginners: “When we don’t give our people the space to take calculated risks, learn, apply, and iterate, we are really risking our future. While there is a risk to improvising and spontaneity, control brings its own insidious dangers. In our push for perfection, we over-engineer. We add so many bells and whistles that it takes a Ph.D. to use the product. Just because we can doesn’t mean we should. Just because we can practice to perfection doesn’t mean that’s best.” – HBS Article

Munger’s Quotes

“Three rules for a career: 1) Don’t sell anything you wouldn’t buy yourself; 2) Don’t work for anyone you don’t respect and admire; and 3) Work only with people you enjoy.”

“In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time – none, zero. You’d be amazed at how much Warren reads – and at how much I read. My children laugh at me. They think I’m a book with a couple of legs sticking out.”

“It never ceases to amaze me to see how much territory can be grasped if one merely masters and consistently uses all the obvious and easily learned principles.”

“I’m not entitled to have an opinion unless I can state the arguments against my position better than the people who are in opposition. I think that I am qualified to speak only when I’ve reached that state.”

“We don’t claim to have perfect morals, but at least we have a huge area of things that, while legal, are beneath us. We won’t do them. Currently, there’s a culture in America that says that anything that won’t send you to prison is okay. We believe there should be a huge area between everything you should do and everything you can do without getting into legal trouble. I don’t think you should come anywhere near that line. We don’t deserve much credit for this. It helps us make more money. I’d like to believe that we’d behave well even if it didn’t work. But more often, we’ve made extra money from doing the right thing.”

Reiterating Simplicity: stop deceiving yourself

Is there any easier way to say something intelligent than by quoting Buffet & Munger? So let them speak:

I have no use whatsover for projections or forecasts. They create an illusion of apparent precision. The more meticulous they are, the more concerned you should be. We never look at projections (Warren Buffett)

Projections are put together by people who have an interest in a particular outcome, have a subconscious bias, and its apparent precision makes it fallacious. They remind me of Mark Twain`s saying “A mine is a hole in the ground owned by a liar”. Projections in America are often a lie, although not an intentional one, but the worst kind because the forecaster often believes them himself. (Charlie Munger)

Evoking the storytelling discipline, there`s a little story that says a CIO was presenting a M&A proposal to the key management and the board of directors. He made a very detailed slideshow, full of premises and sensitivity analysis. Being harshly questioned by his audience, he gave up by saying: “Ok, fellas! The deal doesn`t make any sense! I just need to beat the street`s growth estimates and earn my bonus!”

Remember, the more simpler, the more fairer. If you can`t explain it in plain straightforward language, there`s a chance you are deceiving even yourself.

Charlie Munger on The Daily Journal Meeting

It`s proved that we only learn when we are able to make connections between things. Moreover, metaphors can help us out in order to understand what we could not comprehend at first sight. That said, Buffett`s partner is a intriguing mind. Charlie Munger has thought us how to be a fox, learning the basic principles from many relevant areas of study and developing our own mental models.

So here is the last speech available from Charlie Munger. Hope you learn from this brilliant mind.