2002: How does Buffett think about audit fees?

AUDIENCE MEMBER: On March 1, the Wall Street Journal analyzed the auditing fees and non-audit fees for the 30 Dow Jones Industrial Average companies. It found an inverse correlation between the ratio of non-audit fees to market capitalization and two metrics: five-year compound earnings growth and total return. Companies with lower non-audit fee ratios had 10% annual earnings growth and 18% annual returns, while those with higher ratios had only 5.2% earnings growth and 11% returns. Is this because non-audit fees are unproductive, a random fluctuation, or is there something deeper going on?

WARREN BUFFETT: I hadn’t seen that study, but the result doesn’t surprise me. At Berkshire, we appreciate companies that keep a close eye on expenses. Jack Welch once wrote that no company ever went broke by cutting costs too aggressively, and I think there’s some truth to that.

When management is lavish with expenses, including non-audit fees, it often reflects a broader attitude of inefficiency, which can ultimately impact shareholder returns. However, I can’t statistically prove this relationship or know whether that Wall Street Journal analysis was causation or coincidence. The methodology for setting up a valid sample would be tricky.

At Berkshire, we’re very conscious of expenses, including audit fees. While our audit costs aren’t as low as they used to be, they’re still reasonable, partly because we care deeply about simplicity. I wouldn’t recommend basing stock decisions on a metric like this, even if it backtests well. You need a deeper understanding of each business.

CHARLIE MUNGER: One reason our audit costs are low is that we have a passion for simplicity. We don’t want to create operations that are difficult to audit. For example, See’s Candy is a seasonal business where all cash comes in at the end of December, making it incredibly straightforward to audit. An idiot could audit See’s without getting into trouble. (Laughter)

Many of our businesses are similarly simple, making it hard to mess up their audits. Simplification is a philosophy that benefits us in ways beyond just cost savings.