Warren Buffett explains the rationale behind issuing preferred stock

the second item of business of this

meeting is to consider the

recommendation for directors to amend

the company certificate of incorporation

the proposed amendment would add a

provision to the certificate of

incorporation authorizing the board of

directors to issue up to 1 million

shares of preferred stock in one or more

series with such preferences limitations

and relative rights as the board of

directors may determine now we discussed

this some in the in the annual report

but I would say and we'll find out the

exact number but I think we probably had

11 or 12 maybe 12 thousand or so shares

voted against the proposal I think we

had a couple thousand shares that I

abstained and since there really is no

downside to the proposal that indicated

to me that that I had not done a very

adequate job of explaining the logic of

authorizing the preferred so I'd like to

discuss that for a minute now and I'd

also like anybody that would like to ask

questions about it they can do so now we

can talk about it later too but if you'd

like to do it before the vote that'd be

fine the authorization is just that it's

an authorization it's it's it's not a

command issue shares it's not a

directive it simply gives the directors

of the company the ability in a

situation or it makes sense for the

company to issue preferred shares to do

so now when we acquire businesses and

I'll tell you about one when we're we're

through with this in a few minutes when

we acquire businesses sometimes the the

seller of the business wants cash

sometimes they would like common stock

and it's certainly possible as one

potential seller did last year that they

wanted in that case a convertible

preferred stock now from our standpoint

as long as the value of the

consideration that we give equates we

really don't care

aside from a question of tax basis we

might obtain but we in in in other

economic respects we don't care what

form of consideration we use because we


the value of cash versus a straight

preferred versus a convertible preferred

versus common stock whatever it may be

so if the worry is that we will do

something dumb in issuing the preferred

stock you should that's a perfectly

valid worry but you should worry just as

much we'll do something and dumb in

terms of using cash or the common stock

I mean it's if we're going to if we're

if we're going to do something

unintelligent we can do it with a

variety of instruments and we will not

get more licentious in our behavior

anything but simply because we have they

preferred stock and the preferred stock

I preferred you in this stock may offer

sellers of a business the chance to do a

tax free exchange with us and they may

not want common stock because they may

have an ownership situation where they

don't want to run the risks of common

stock ownership and that's why our

preferred is flexible as to terms

because we could give those people a

straight preferred with a coupon that

made it worth par at the time we issued

it and then they would know what their

income would be for the next ten years

and and that may be of paramount

interest to them we could issue them an

adjustable rate preferred which as money

market conditions change would also

change its coupon and then they would be

sure of a constant principal value for

the rest of their lifetimes and one or

both of those factors could be more

important to one seller or another so

that we simply have more forms of

currency available to make acquisitions

if we have the ability to issue various

forms of preferred because a preferred

stock if it's properly structured allows

for the possibility of a tax-free

transaction with with it with the seller

and that's that's important to many

sellers now in the end many sellers will

prefer cash just as in the past and

probably most of the sellers that don't

want cash will want common stock but we

will have a preferred stock

woman we're only authoring authorizing a

million shares because under Delaware

law there's an annual I think there's an

annual fee I know there's an initial fee

and I think there's an annual fee that

relates to the amount of shares

authorized so if we authorized a hundred

million shares it would we would be

paying at larger annual fee which is

something mr. Munger wouldn't let me do

so what we will do if we issue this we

will issue undoubtedly will oh we will

issue some sub shares so that the number

of shares for taxation purposes is

relatively limited but that we will

issue sub shares to make it easier to

make change essentially in the market we

may issue if the occasion demands we may

issue convertible prefer but that

convertible preferred would not be worth

any more at the time we issue it than a

straight preferred we would adjust in

terms of the coupon and the conversion

price and so on so we we can equate

various forms of currency to fit the

desires of the seller of the business

and this is this is simply one more tool

to do it there's no downside like I say

unless unless we do something stupid and

if we do something stupid with us we

would do something stupid

cash or whatever so it we probably

should have done this some time ago but

we we never had a case of of a seller

wanting that form of currency before and

so it just and and we always thought we

could get it authorized promptly but

there's no reason to lose a couple of

months if a transaction is pending to

call a meeting to get this on the books

so it's simply one more tool and if

there are any if there's anybody that

has any questions or comments on the

preferred like I say you can't hold them

till later but I'd be glad to have them

before we have the boat do we have any

yeah there's a question over there and

if you'll do wait just a second we'll

get a microphone to you

when you ask questions now or later if

you'll give your name and and and and

where you live I'd appreciate it

hi my name is dr. Lawrence Worcester I'm

from New York my question is this if you

want to buy a business and the people

who know business want cash you have to

have cash cash that you know this kind

of cash we're familiar with it yeah

but it's it strikes me that the

preferred isn't really cash it's it's

fiat currency that is its currency that

we can create that's true it's just like

it's like common stock in that respect

it is the it is a form it's an alternate

form of currency and but it is it is

just that in terms of common stock for

example assuming we had enough

authorised we have an unlimited ability

to create currency no if we created at

the wrong price that dilutes the value

of the old currency but go ahead on

until we vote in the affirmative which

I'm sure that this group will probably

do because of their confidence in you

but until we vote in the affirmative it

doesn't exist that is correct well you

were that that would be true

incidentally with common stock if we had

no more authorized common stock out than

we had issued we have I think a million

and a half authorized but let's assume

that we dish udall that we had

authorized until Morrow was authorized

by the shareholders there would it would

not be available to be issued but if

more were authorized by the shareholders

then isn't it true that the value of the

shareholders holding would be diluted

only only if we receive less in value

than we give that's the key to it I mean

if we issue two hundred million dollars

worth of preferred and we receive a

business that's only worth a hundred and

fifty million there's no question you're

worse off than before so are we

incidentally but but we're all we're

soft the and that's true if we give cash

that's worth more for a business than

the business is worth if we give two

hundred million of cash for a business

that's worth 150 million we are worth

soft we may not have issued a share of

stock but we have diluted the value of

your stock if we do that as long as we

get value received in terms of whether

with cash common stock or preferred

stock then you are not diluted in terms

of value it's an important point that

and I and obviously a number of

companies as as you may have Charlie and

I have commented about in reports and

elsewhere a number of companies in our


have issued common stock particularly

which has a value greater than what they

receive and when they do that they are

running what I what John Medellin of the

Wachovia called the chain letter in

Reverse and and that's cost American

shareholders a lot of money I don't

think it'll cost them any money at

Berkshire but it's a perfectly valid

worry for shareholders to have because a

management can build an empire but just

by issuing these little pieces of paper

which which they feel don't cost them

anything that I think Charlie had one

story about that in the past I didn't

want to comment on that Charlotte no

names basis of course there was a

particular bank where one of the

officers wanting stock options pointed

out to the management that they could

issue all these shares and it didn't

cost anything

imagine hiring a manager who thinks that

way and paying the money to behave like

Judas at your various and your very

midst we have we have had conversations

with managers where they tell us how

fortunate they feel because the stock is

down and they can issue options cheaper

now if they were issuing those to the

third parties you know I'm not sure I'm

not sure whether they have exactly the

same attitude but we have no feeling

that that we're getting richer when we

issue shares we we have a feeling we're

getting richer when we get at least as

much value in a business as the shares

are worth that we issue and we don't

intend to issue them under any other

circumstances but it's a perfectly valid

valid worry the second part of the

question is that obviously with

preferred issue you have a situation

where the Carmen's shareholder is moves

to the back of the line as it were why

should the Carmen shareholder in this

room want to step to the back of the

line if he's at the front of the line

now well it but it's also true if we buy

a business for cash and let's say we

borrow the money the bank that we borrow

the money from will come ahead at the

common shareholder there's no there's no

question anytime you move you engage in

transactions that involve the capital

structure you are changing the potential

for each part of the capital structure

if you issue a lot of common and you've

got some debt outstanding you've

generally improved the position of the

debt and the question really becomes

whether you think that the position of

the common shareholder is improved by

issuing either preferred stock or

perhaps borrowing a lot of money to make

an acquisition I mean with a couple of

times in the history of Berkshire we've

borrowed money to to buy something if to

buy a business and when we do that we

are placing a bank or an insurance

company or whomever ahead of the

position of the common shareholder we

did that when we issued some some debt a

few years back and and there's a

question of weighing whether the common

shareholders are going to be better off

by by borrowing money but borrowing

money is not necessarily at all harmful

to the shareholders although certainly

if it's carried to excess it is and the

preferred is a form of quasi borrowed

money that does rank ahead of Michigan

the common shareholder but then at the

same time we're adding a business which

we think is going to benefit the sheriff

shareholder if we issue that so that's

the trade-off