Trust: How Far Should You Take It?

Even casual readers of this blog should know my twin mantras of Trust and Transparency. But a "DealBook" article in today's New York Times is getting me to think more about what I mean by Trust.

Is it, to follow Ronald Reagan, "Trust but Verify"? Pretty much.

Andrew Ross Sorkin, in the above-mentioned article (full story, here), quotes Berkshire Hathaway vice-chairman Charlie Munger as saying,

By the standards of the rest of the world, we overtrust. So far it has worked very well for us. Some would see it as weakness.

He was arguing, Sorkin wrote, that "Instead of filling your ranks with lawyers and compliance people [you should] hire people that you actually trust and let them do their job." This explains why Berkshire Hathaway, one of the largest companies in the United States, has neither a general counsel nor a human resources department (many of its subsidiary companies, however, have their own general counsels and HR departments).

Munger, and his boss, famed investor Warren Buffett, allow that this doesn't always work. Three years ago, Buffett's then heir-apparent David Sokol resigned over questionable stock trades in a company that Sokol had invested in and then recommended that Berkshire Hathaway purchase (for more details, see my 2011 blog post on the story, here; Sokol denied illegal insider trading and Buffett apparently agreed; the SEC investigated, but did not file charges). As Sorkin reported from last weekend's Berkshire Hathaway meeting,

"We will have a problem of some sort at some time," Mr. Buffett said to his faithful audience. He added, "300,000 people are not all going to behave properly all the time."

That's a risky position to take, I think. It's not just a question of money made or lost; it's a question of reputation, which is a lot easier to wreck than to repair.

How scalable is the Berkshire Hathaway model? Sorkin asked two Stanford University researchers: 

A trust-based system can be more efficient than a compliance-based system, but only if self-interested behavior among employees and executives is low. The risk is that the board makes an incorrect assessment of an executive’s ability and integrity and selects the wrong C.E.O.

So as long as your hiring techniques and intuition are perfect, you should be fine. (How many of us are willing to say that of ourselves? Not me, for sure.)

Worse yet, if you are confident in your methods, will it make you too confident?

I was surprised when Buffett was quoted as saying last weekend that he wasn't bothered by the $4 billion error that Bank of America reported late last month (Times article on the subject, by Peter Eavis and Michael Corkery, here). Apparently, Buffett trusts the bank's management.

I was disappointed when Buffett, who has spoken out publicly against excessive corporate compensation, "punted" (to quote Joe Nocera; full Times column, here) an opportunity to press Coca-Cola on what he himself thought was an excessive equity compensation plan. Buffett's explanation:

I love Coke. I love the management. I love the directors. So I didn’t want to vote no. I didn’t want to express any disapproval of management. But we did disapprove of the plan.

Really? That's the best you could come up with. Oh, but see: "I love the management." In other words, he trusts the management.

I was surprised and disappointed in January when Buffett said, of JPMorgan Chase CEO Jamie Dimon's huge jump in pay, "Over all, I think the shareholders of JPMorgan and the American people should be happy that Jamie Dimon has been running the bank over this period." This despite multi-billion dollar fines and more (my blog post on the issue, here).

Maybe there's such a thing as Too Much Trust?