Wednesday, June 8, 2011
The Appearance of Reality: Stock Buy Backs
This is the ninth post in my effort to clarify corporate governance terms and concepts that now seem misleading to me. We all know what these words mean in a literal sense but in the context of governance, of business and of our post-crash world do they still mean the same thing?
I look forward to your comments.
Stock buy backs
One of the dirty little secrets of corporate management referred to (but not focused on) during recent investigations is the dual nature of the CEO’s responsibilities: he must run the business but he must also – and this is no less important -- run the stock. One reads frequently that management buys back stock because it is a better use of cash from a cost/benefit point of view.
Much scholarship has been devoted to the proposition that stock buy backs are simply a device to transfer wealth from shareholders to senior managers -- particularly as the holders of mega grants of stock options. Buy backs provide a way to conceal the dilution that these grants of executive stock would otherwise cause – and be publicly seen as the cause – of shareholder equity.
Some have concluded that buying back stock is a confession of the inadequacy by management when identifying suitable projects for corporate development. In a world that is short of energy resources and where demand is growing predictably, doesn’t it seem strange that multinational oil companies barely maintain their hydrocarbon reserves from year to year and yet are among the leaders in size of stock buy backs?
Are stock buy backs fair to the investing public? That is a key question: after all the management has unique knowledge of the timing of corporate disclosures that will have impact on the market price. No board of directors has yet been found liable for negligence of fiduciary duty in stock buy-back deals but consider the circumstance of several major financial companies: In the years 2005- 2007 Citigroup repurchased $20.457 billion worth of its outstanding shares; Merrill Lynch $18.01 billion; and Morgan Stanly $7.2 billion.
Furthermore, during the crisis years, each bank struggled to raise new capital; the absence of which was a major factor in requiring the active involvement of foreign investors and subsidy by the U.S. Federal Government. The first TARP tranche (respectively $billions, 20, 10, 10) in September 2008 was a virtual mirror of the funds these companies had bought back from their capital in the previous three years.
Management of capital is the single most important responsibility for a financial institution – so isn’t it careless, or even negligent of executives and boards to let capital fall dangerously low in a chase for quick returns?
Here are my questions:
1. Should boards of companies like Merrill, Morgan and Citigroup be accountable for losses resulting from negligent buy back policies?
a. To their shareholders?
b. To the public?
2. Should shareholder consent be required for stock buy back?
3. Does the present U.S. federal tax policy provide inappropriate incentive to buy back stock rather than to pay dividends?
a. If so, how should it be amended?
June 8, 2011 in CEO power
, fiduciary duty
, responsible ownership
, CEO Pay
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