1

An Introduction toEthics-Based CEO Communication

Operationalizing Governance Standards and Processes

March 30, 2004© Copyright 2004 andBEYOND Communications Inc.

2

Ethical Challenge: Continuing Loss of Trust75% of Americans find the image of large corporationsto be “not good” or “terrible.” – NY Times, March 14, 2004

79% of executives believe “almost all” or “most of them” operate honestly and fairly. – Wirthlin Worldwide, November 2003

Executive pay issues accounted for 44% of all corporate governance proposals in 2003. – IRRC, February 12, 2003

2003 CEO compensation in BusinessWeek’s Executive Pay Scoreboard will be up 10% to 15% or more, on average when the final numbers are tallied in April.– BusinessWeek, February 2004

Charlie Munger,Vice Chairman,

Berkshire Hathaway

* Based on 57 early proxy filers.

…I think you’re getting a widespread perception that the very topcorporate salaries in America are obscene. And it is not a good thing for a civilization when the leaders are regarded as not dealing fairly with those for whom they are stewards. – Charlie Munger, Vice Chairman, Berkshire Hathaway

3

: Radically Reorient BusinessMake Stewardship the

Core Operating Business Principle

Berkshire Hathaway 2002 Shareholder Letter

Both the ability and fidelity of managers have longneeded monitoring. Indeed, nearly 2,000 years ago,Jesus Christ addressed this subject, speaking (Luke 16:2) approvingly of “a certain rich man” who told his manager, “Give an account of thy stewardship; for thou mayest no longer be steward.”

Business schools need to teach the spirit and practices of entrustment, not entitlement, in all courses – not only in special ethics classes.

Warren Buffett,CEO, Berkshire Hathaway

4

Capital Stewardship Measures*

CapitalCapitalStewardshipStewardshipFinancial FlexibilityFinancial Flexibility

Cash FlowCash Flow

Stock OwnershipStock Ownership

DividendsDividends

Balance SheetBalance Sheet

Cost CuttingCost Cutting

IncentiveIncentiveCompensationCompensation

Decision SystemsDecision Systems

MetricsMetricsCredit RatingsCredit Ratings

Stock RepurchaseStock Repurchase/ Split / Options/ Split / Options

CapCap--XX

Short / LongShort / LongTerm ViewTerm View

GoalsGoals

UsesSourcesFree vs.

OperatingAmount

Expenses

Productivity

FinancialFinancial

OperatingOperating

Debt Reduction

Cap Ratio

SG&A

Amount

Uses

Increase / Shrink

FinancialFinancial

OperatingOperating

Profit DriversProfit DriversCAGRPE

Stock PriceStock Price

Yield

Profit Focus

Gross Margin Productivity

Top Line /Bottom Line

StewardshipStewardship

SensitivitySensitivity

* All measures have been identifiedin one or more shareholder letters

1 5

CapitalCapitalStewardshipStewardship

RelationshipsRelationships

CandorCandor

VisionVision

AccountabilityAccountability

StrategyStrategy

LeadershipLeadership

The Rittenhouse Model™ of The Anatomy of a Business

Left Brain Subsystem

- Business Opportunities- Positioning Actions- Competitive Advantage

- Goals Linked with Results- Financial Results- Transparency

1 6

CapitalCapitalStewardshipStewardship

RelationshipsRelationships

CandorCandor

VisionVision

AccountabilityAccountability

StrategyStrategy

LeadershipLeadership

The Rittenhouse Model™ of The Anatomy of a Business

Right Brain Subsystem

- Personal Responsibility- Civility

- Emotion- Stories- Innovations

1 7

CapitalCapitalStewardshipStewardship

RelationshipsRelationships

CandorCandor

VisionVision

AccountabilityAccountabilityLeadershipLeadership

The Rittenhouse Model™ of The Anatomy of a Business

Backbone Subsystem- Balancing Stakeholder Needs- Empathizing

- Jargon- Confusion- Hyperbole

StrategyStrategy

8

Capital Stewardship – Cash Flow

Best Practice: Johnson & Johnson 2002 Shareholder Letter

Our cash flow from operations continued to be very strong in 2002, at $8.2 billion. This is net of approximately $750 million, after tax, that we invested in our various pension plans during the year to ensure their continued strength. More relevant is what we monitor as “free cash flow,” or the portion of operating cash flow that remains after the Company has made the necessary investments through capital expenditures to support the growth of the business. In 2002, strong free cash flow of $6.2 billion provided fuel for a $5 billion share repurchase program, acquisitions of $.5 billion, and the dividend increase referred to earlier. We did this while maintaining the Company’s outstanding “triple A” credit rating. (3 points awarded for each cash flow reference = 30 points)

% of Companies Reporting

Survey Year

65%54313726%

20022001200019991998

9

Accountability – Financial ResultsBest Practice: Knight Ridder 2002 Letter• For 2002, Knight Ridder earned $3.04 per

diluted share, up 40.7% from the $2.16 per diluted share earned in 2001, on a GAAP basis(all results, unless otherwise noted, are GAAP –Generally Accepted Accounting Principles). The $3.04 includes a second-quarter charge of $0.29 for Knight Ridder's share of a write-down in goodwill taken by Career Holdings, Inc., and a third-quarter charge of $0.13 for its share of the conversion of CareerBuilder to a limited liability company.

• 40% failed to mention the EPS number in the letter.

• 9% failed to match the EPS number in the letter with the income statement.

• 18% failed to report any financial results in the letter.

Only 33% of the companies accurately reported their EPS “bottom-line grade.”

2002 CEO Letter Survey

Special charges reportedGAAP basisDiluted EPSGives 2001 and 2002 resultsReports dollar EPS

10

Leadership – What Went Wrong

Best Practice - Wells Fargo 2002 Shareholder Letter Losing retail customers

In an average year, we lose almost one of every five of our retail customers! … Our goal is to cut in half the number of our customers who leave us every year. To do that we have to “Wow!” them. We all know what that feels like. We’re all customers!

% of Companies Reporting

Survey Year

48%44326855%

20022001200019991998

Best Practice - GE 2002 Shareholder Letter Write-off in ERC business

Earnings were on track to grow 17% to $16.5 billion, but we recorded a $1.4 billion charge for increasing ERC’s reserves….ERC stands in sharp contrast to GE’s expectations for business performance. We pride ourselves on having sound strategy with strong operating accountability. A GE business can briefly get out of balance strategically or operationally, but rarely do we get both wrong at the same time.We did with ERC.

11

Candor – A Case Study

FOG(Jargon, Spin,

Confusion)48%

Relationships

Strategy13%

Vision14%

Capital Stewardship

Leadership

Accountability4%

10%

5%

6%

BoeingLockheed Martin

In 2001, Lockheed’s fog represented a larger percentage of total content in its shareholder letter than did Boeing’s fog, but the examples were benign, not alarming.

2001 Shareholder Letters

Relationships

Leadership

Accountability

StrategyVision

FOG

Capital Stewardship

5%

9%

8%

6%

10%

6%

(Jargon, Spin, Confusion)56%

12

Candor – A Case Study

Alarming Fog – Boeing

What’s the difference between meddling and accountability? What was the cost of moving headquarters?

When the headquarters is located in proximity to a principal business — as ours had been in Seattle — the corporate center is inevitably drawn into day-to-day business operations. We don’t want to meddle. Our function is to concentrate on vision and strategy. We are focused on where we are going and how fast, how to allocate capital and resources across the corporation, how to make the best use of the Boeing brand and how best to develop our intellectual capital.

2001 Shareholder Letter Survey

Benign Fog – LockheedNeed details. What makes it most important?By all indicators, we achieved our goals with 2001 representing a second consecutive year of consistently strong operational and financial performance and enhanced shareholder value. It also included winning the Joint Strike Fighter program, arguably the most important competition in our Corporation’s history.

Run-on sentenceIf there was a first among equals in our financial priorities for 2001, it was to further drive our culture to manage for cash and reduce debt, and we exceeded expectations in both.

13

Candor – A Case StudyBoeing

FOG

116%

(Jargon, Spin,Confusion)

Lockheed

Fog(Jargon, Spin,

Confusion)25%

Vision4%

Strategy17%

Relationships20%

Leadership8%Accountability

7%

Capital Stewardship

19%

Accountability9%

Leadership20%

Relationships20%

Strategy27%

Vision9%

Capital Stewardship

15%

Boeing’s letter is one of two in our 2002 survey that recorded more negative fog points than total content points. 2002 Shareholder Letters

14

What is the correlation between fog and stock price?Boeing vs. Lockheed Martin

March 15, 2001 – March 15, 2004

$44.34$39.782004$56.10

BA

2001 $37.50

LMT

15

Can language reveal how leadership and corporate culture determine performance?

Coca-Cola

Accountability12%

Leadership16%

Relationships16%

Strategy9%

Vision18%

Fog(Jargon, Spin,

Confusion)11%

Capital Stewardship

18%

PepsiCoFog

(Jargon, Spin, Confusion)

7%

Vision18%

Strategy15%

Relationships9%Leadership

18%

Accountability11%

Capital Stewardship

22%

In 1996 Coca-Cola and Pepsi had virtually identical allocations among all seven systems and relatively low levels of fog. These total content scores placed the letters in the top decile of our annual CEO benchmarking survey.

1996 Shareholder Letter Survey

16

Coca-Cola

Capital Stewardship

6%

Fog(Jargon, Spin,

Confusion)54%

Vision6%

Strategy9%

Relationships10%

Leadership8%

Accountability7%

Total Points: 415 Fog Points: (224) Net Content Points: 191

PepsiCo

Accountability10%

Leadership17% Relationships

13%

Strategy20%

Vision17%

Fog(Jargon, Spin,

Confusion)7%Capital

Stewardship16%

The amount of content in Coca-Cola’s 2002 letter substantially declined from 1996. The percentage of fog increased five times indicating weak alignment of cultural values and a potential lack of stewardship.

2002 Shareholder Letter Survey

PepsiCo’s 2002 language scores were virtually identical to their 1996 scores indicating consistent and strong alignment

between leadership, corporate culture and values.

17

What is the correlation between strong leadership,corporate culture and stock price?

PepsiCo has outperformed Coca-Cola March 15, 1999 – March 15, 2004

$47.71$51.352004$38.63

PEP

1999 $68.69

KO

18

Declining trends in CEO communication

Avon Products

Capital Stewardship

19%Accountability

16%

Leadership6%

Relationships11%

Strategy14%

Vision2%

Fog(Jargon, Spin,

Confusion)

32% Fog(Jargon, Spin,

Confusion)

51%

Vision4%

Strategy9% Relationships

7%

Leadership5%

Accountability12%

Capital Stewardship

12%

1999 2001 2002

Avon’s CEO authored a top-ranked shareholder letter at the start of her tenure in 1999. The letters written since show a decline in the amount of content reported and an increase in the amount of content obscured by fog.

Fog(Jargon, Spin,

Confusion)14%

Vision10%

Strategy20%

Relationships13%

Leadership9%

Accountability15%

Capital Stewardship

19%

19

Anomalous relationship betweenlanguage scores and stock price

Avon ProductsMarch 15, 1999 – March 15, 2004

$71.3020041999 $45.44

AVP

20

Positive relationship betweenlanguage scores and stock price

$92,00020042001 $67,800

BRK.A

Berkshire HathawayMarch 15, 2001 – March 15, 2004

21

His letter should be read by:Leaders who want to succeed via principles, not expediency.

Investors who want to learn how to spot leaders to entrust with their money.

Directors who want to demonstratestewardship in both form and substance.

A Buffett for SuccessBe Smart and Principled

22

Buffett’s shareholder letter demonstrates stewardship in five key CEO relationships.

LeadershipShows how actions are based on unchanging valuesPrinciples

VisionOffers insights into global economicwell-beingSociety

Stakeholder-relationships

Describes his emotional connection with investors, managers, family, and shareholders as customers

People

Accountability,Candor

Reports on his mistakes andthe successes of his peopleHis word

Stewardship,Strategy

Avoids jargon and uses common words sensiblyWords

ReflectsCharacteristicsRelationship with…

23

Prophecy

The job of CEOs is now to regain America's trust – and for the country's sake it's important that they do so. They will not succeed in this endeavor, however, by way of fatuous ads, meaningless policy statements, or structural changesof boards and committees. Instead, CEOs must embrace stewardship as a way of life and treat their owners as partners, not patsies. It's time for CEOs to walk the walk.

– Warren Buffett, CEO Berkshire Hathaway 2002 Shareholder Letter

www.andbeyondcom.com

Trust will be regained only when CEOs embrace stewardship

as a way of life