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"Cutting the Cake": Warren Buffett and An Outstanding Example of Underwriting.

|Includes: Berkshire Hathaway, Inc. Cl A (BRK.A)

A model example of good underwriting was given by Warren Buffett, who is an exemplar in other ways.

Berkshire Hathaway had acquired Illinois Bank and Trust Company of Rockford, but was forced to divest it by new banking regulations. One means of doing this would be to distribute pro rata shares of the bank to Berkshire Hathaway shareholders. But distrustful of commission costs, while knowing that some shareholders would want shares in the new "Bancorp," while others would rather have only Berkshire Hathaway shares, Warren Buffett undertook an "exchange offer" of new Bancorp shares for Berkshire shares.

As the largest Berkshire shareholder, Mr. Buffett was the exchanger of last resort, meaning that he would be the loser if he priced the exchange improperly, and shareholders chose to "dump" one or the other stock on him.

The results were as follows:

"Five years ago we were required by the Bank Holding Company Act of 1969 to dispose of our holdings in The Illinois National Bank and Trust Company of Rockford, Illinois. Our method of doing so was unusual: we announced an exchange ratio between stock of Rockford Bancorp Inc. (the Illinois National’s holding company) and stock of Berkshire, and then let each of our shareholders - except me - make the decision as to whether to exchange all, part, or none of his Berkshire shares for Rockford shares. I took the Rockford stock that was left over and thus my own holding in Rockford was determined by your decisions. At the time I said, “This technique embodies the world’s oldest and most elementary system of fairly dividing an object. Just as when you were a child and one person cut the cake and the other got first choice, I have tried to cut the company fairly, but you get first choice as to which piece you want.” Last fall Illinois National was sold. When Rockford’s liquidation is completed, its shareholders will have received per-share proceeds about equal to Berkshire’s per-share intrinsic value at the time of the bank’s sale. I’m pleased that this five-year result indicates that the division of the cake was reasonably equitable."Berkshire Hathaway, 1985 Annual Letter to Shareholders.

Disclosure: Long BRk/A