Thursday, October 22, 2015

Understanding Contracts

Our kids must understand the importance of comprehending contracts.  Failure can be baked into the contract to such a degree that all your best efforts might be doomed to failure.  Great success might lie more in the details of your contract than in your efforts after the contract.  First, let's review one of the most famous corporate bankruptcies due to a contract.  Rolls Royce signed a contract with Lockheed to deliver jet engines with price and performance goals that bankrupted Rolls Royce.  I remember reading that Rolls Royce asked Lockheed for relief from their contract and Lockheed refused, which drove Rolls Royce into bankruptcy.  Important lesson:  if you make a mistake in your contract do not ever believe that that the other guy will cut you some slack.

I remember reading of a medical doctor who signed a contract he did not fully understand.  The doctor trusted that the insurance company would not offer him a bad contract.  He was wrong.  They paid him less than it cost to treat those patients so the contract drove him into bankruptcy.  Important lesson: do not trust the counterparty to offer a fair or reasonable contract.  The best way to rob someone is through a contract; this makes the theft legal.

I remember the final walk-through on my first house.  As I was signing the paperwork listing the fixes I required to close on the house, I mentioned to the construction superintendent that I was sure they would fix things I missed on the list.  The superintendent choked when I said that.  I suppose I was surprisingly naive.  Important lesson:  do not expect anything beyond what is promised in the contract.

Next, let us consider Warren Buffett's success.  Think to yourself, if Buffett was the employee of his investors, then how did he become richer than them?  They had the money, and he ended up with more money than any one of them. How did he do this?  Is was not just good investments because his partners shared his success.  His superior wealth must be due to his contract. When I first thought this through it seemed like a revelation:  great wealth can depend more on a smart contract than on smart investments.

I will walk you through how Buffett got rich, but I will do that in some other post.  It requires math modeling.


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