Why stories of fraud should not lead to excessive pessimism
“If you rise high in a corporation or elsewhere in life, you have a duty to be an exemplar. You have a duty to take less than you deserve, to set an example. This goes all the way back to Athens.”
The sordid tale of Sam Bankman-Fried’s fraud at FTX, a leading cryptocurrency exchange, has dominated headlines over the past week. What prompted this young man to conduct himself with such extreme dishonor? There is no way to get into the minds of people with apparently severe antisocial personality disorders. Trying to understand how these individuals can exhibit callous indifference to the pain caused by their actions is futile. Such individuals have no conscience, and it is hard for those of us who have a conscience to understand their frame of mind.
It is more productive, pleasant, and uplifting to invert our mindset and consider the opposite of the Sam Bankman-Frieds of the world. The nature of the news cycle is that sensational stories usually focus on dishonorable cretins rather than exemplars.
Most readers are probably familiar with Warren Buffett and Charlie Munger’s history at Berkshire Hathaway. These men never claimed to be saints, but they are exemplars who have made considerable efforts over many decades to create a culture of deserved trust. Decades of compounding have made them both famous, but there are also many other leaders who act as exemplars quietly, every single day, and remain quite obscure.
Recently, I have been reading about Fastenal, a distributor of industrial products. The fifty-five year old company started out distributing threaded fasteners (think of screws and bolts) and such products still account for a third of the company’s business.
In comparison to the latest crypto/blockchain innovation, some might say this is a “boring” business, but the financial history is anything but boring. Fastenal has twenty-six years of annual reports on its website documenting an amazing journey starting from a relatively modest company with 484 locations, $288 million of revenue, and $33 million of net income in 1996 to a powerhouse with 3,209 locations, $6 billion of revenue, and $925 million of net income in 2021.That’s exciting, at least it is to me.
Fastenal was founded in 1967 by Robert A. Kierlin and capitalized with $31,000, the equivalent of $274,000 in 2022 dollars.Mr. Kierlin came up with just over half of the funds and four of his friends invested alongside him.
I find it useful to read shareholder letters sequentially over long periods of time to get a sense of how a company has evolved and how management communicates with shareholders. As I went through the annual letters from 1996 to 2021, I could not help but note the modesty of management’s narrative, often quick to take the blame for what seem like transitory issues, and avoiding excessive self-congratulatory verbiage.
Mr. Kierlin served as President and CEO until 2002 when he stepped down. When I read the 2003 annual report, I came across something called the “Robert A. Kierlin Option Plan” in the notes to the financial statements. The note stated that Mr. Kierlin had sponsored an option plan for Fastenal employees using his own shares and granted options in 2000, 2001, and 2002. Intrigued, I looked at the 2000 proxy statement in search of more details. Here is what I found:
“Effective January 3, 2000, Robert A. Kierlin adopted a stock option plan for employees of the Company and granted under the plan to a broad group of employees options to purchase up to an aggregate of 720,700 shares of Common Stock of the Company currently owned by Mr. Kierlin. In general, the options expire on December 31, 2002 and are exercisable during the six-month period ending on that date. The benefits to the Company of the stock option plan are three-fold. First, the plan aligns the interest of the employees of the Company with the long-term interests of the Company's public shareholders. Second, the plan allows employees of the Company the potential to accumulate some wealth. Third, since the options are backed by outstanding shares of Common Stock owned by Mr. Kierlin, no new shares will be issued by the Company when the options are exercised and the options will result in no dilution of the Company's outstanding Common Stock.”
Fastenal did not historically pay employees with stock options and held its share count constant for several years. Rather than adopting a stock option plan like countless other companies at the time, Fastenal held firm in avoiding dilutive option plans. With his retirement approaching, Mr. Kierlin set up a pool of his own shares, forfeiting potential upside by granting options to employees to purchase those shares.
This is quite remarkable. Although Mr. Kierlin did not make an outright gift of his shares to set up a stock compensation system, as Charlie Munger did recently at Daily Journal Corporation, there was no reason compelling him to forfeit potential upside from his holdings in order to provide a benefit to employees. Mr. Kierlin owned 11.4% of the company at that point yet he bore the entire cost of Fastenal’s stock option plan for the first three years of its existence.
Why did Mr. Kierlin do this? Most likely because he wanted to act as an exemplar for his employees and shareholders. As the largest shareholder and founder of Fastenal, Mr. Kierlin took only a very modest salary ($117,000 in 1999) and his wealth was attributable to the meteoric rise of the stock over the years since its public offering in 1987. Perhaps he felt that he had enough and was more concerned about cementing the culture and legacy that had been his life’s work.
Bob Kierlin and Charlie Munger both made gifts to their companies upon retirement from official roles. The gifts were intended to preserve the culture, and I would argue that the effects far outlast the gift itself. For one thing, employees are likely to be far more motivated when such an obviously unnecessary and optional gesture is made. Can you imagine being an employee of Daily Journal Corporation and receiving shares of stock that were given to you by Charlie Munger? The sense of loyalty to the company will no doubt increase and employees will work harder as a result.
In the short run, acting as an exemplar, as Mr. Kierlin and Mr. Munger did, might reduce a totally meaningless number on their very large personal balance sheets, but I would argue that in the long run, such moves are likely to be extremely profitable. By cementing a corporate culture and demonstrating loyalty to employees and shareholders, a virtuous feedback loop will take hold and ultimately generate a far more valuable company.
The news cycle will always highlight cases of fraud rather than highlight those who are acting quietly as exemplars every day. Fastenal did not trumpet Mr. Kierlin’s option plan in the annual letter. I only found out about it by reading a note to the financial statements and then going back to the proxy statement. Similarly, Mr. Munger’s gift was disclosed in a press release but not trumpeted by the company.
Just because the news cycle does not highlight exemplars does not mean they do not exist, and we should bear this in mind before getting too pessimistic about the state of the world when we read about morally bankrupt characters like Sam Bankman-Fried. Incidentally, frauds like “SBF” always seem to want to trumpet their “virtue” from the rooftops which is the exact opposite of the quiet virtue of exemplars like Bob Kierlin and Charlie Munger.
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Fastenal — Coming later this month!
Costco Wholesale Corporation, October 25, 2022
Union Pacific Corporation, September 26, 2022
Burlington Northern Santa Fe, August 25, 2022
CarMax, August 16, 2022
Tractor Supply Company, July 13, 2022
Investors Title Company, June 30, 2022
America’s Car-Mart, June 8, 2022
DaVita, May 20, 2022
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On 12/31/1996, Fastenal had 484 retail stores. On 12/31/2021, Fastenal had 3,209 “in market selling locations” comprised of 1,793 retail stores and 1,416 onsite locations that represent selling locations within customer facilities.
CPI Calculator provided by the Bureau of Labor Statistics indicates that $31,000 in October 1967 dollars is equivalent to $274,135.67 in 2022 dollars. Data queried on November 17, 2022.
Fastenal later created its own stock option plan not sponsored by Mr. Kierlin.