Buffett’s Institutional Imperative–Alive and Well

Buffett wrote about the “institutional imperative” in his 1989 annual letter.  His comments on his “most surprising discovery” are at the bottom.  It pays to read the old stuff and it is interesting to see it in all of its forms on a daily basis.  A few weeks back, the SEC announced an insider trading prosecution of a Microsoft executive. Not much about this story is new: employee had insider information, bought out-of-the-money options on said information, rinse and repeat.  The bold portion below caught my eye in the news release.  See here.

The SEC alleges that Stokke later traded in advance of Microsoft’s fourth-quarter earnings announcement in July 2013.  As part of his duties at Microsoft, Jorgenson prepared a written analysis of how the market would react to the negative news that Microsoft’s fourth quarter earnings were more than 11 percent below consensus estimates.  He estimated that Microsoft’s stock price would decline by at least six percent.  Jorgenson tipped this confidential information to Stokke, who purchased almost $50,000 worth of Microsoft options.  After Microsoft’s announcement on July 18, its stock price declined more than 11 percent the next day from $35.44 to $31.40 per share.  Jorgenson and Stokke realized more than $195,000 in illicit profits.

Part of his job was to prepare a written analysis of how the market would react?  I wonder who has this job at Berkshire…

(An interesting bit of semi-useless trivia, Buffett first wrote about the institutional imperative in 1989, the same year the comic-strip Dilbert was created.)

Buffett’s words:

“My most surprising discovery: the overwhelming importance in business of an unseen force that we might call “the institutional imperative.” In business school, I was given no hint of the imperative’s existence and I did not intuitively understand it when I entered the business world. I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions. But I learned over time that isn’t so. Instead, rationality frequently wilts when the institutional imperative comes into play.

For example: (1) As if governed by Newton’s First Law of Motion, an institution will resist any change in its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.

Institutional dynamics, not venality or stupidity, set businesses on these courses, which are too often misguided. After making some expensive mistakes because I ignored the power of the imperative, I have tried to organize and manage Berkshire in ways that minimize its influence. Furthermore, Charlie and I have attempted to concentrate our investments in companies that appear alert to the problem.”


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