Buyer beware — the shareholder’s lament
Legislation, stock options and share buybacks — average investors don’t always get the benefits they ought to, says this U.S. advisory.
The public company “is an amazing economic device that permits strangers to invest in an enterprise with the hope of sharing in the profits.”
Yet the shareholder is at the bottom of a long chain of legal requirements and institutional practices that can get in the way of the smooth flow of profits.
Indeed, when you consider all the corporate and legal machinery, “it is amazing that profits materialize,” says one American commentator.
Mr. Max Bowser is a long-time advocate of microcap stocks and a staunch defender of the “little guy,” or the average shareholder.
In the Christmas issue of The Bowser Report, he discusses three cogs in the machine, one law and two corporate practices.
The law affects those Canadians that hold shares in U.S. companies, but it has a greater interest as well — it is notable for what it did not prevent in the past few years.
Then there are the common practices of stock options and share buybacks. The average shareholder should not expect to be first in line for benefits from either of these practices, says Mr. Bowser.
Death knell of fraud
The costs of running a company are high. Wages, insurance and taxes mount up (and medical insurance can be especially onerous in the United States). And that’s before you get to the actual costs of producing whatever it is you make your money on.
In 2002, those costs got a little more complicated in the wake of the scandals at Enron and WorldCom (the brainchild of Mr. Bernie Ebbers of Edmonton, now serving a long prison sentence in Louisiana).
Congress passed the Sarbanes-Oxley Act, which demanded stepped-up internal audits from companies. “It was intended to be the death knell of fraud,” says Mr. Bowser. “But that didn’t quite happen.”
The jail sentences handed down in the scandals came from existing laws, not the bill. But the rest of corporate America had to buckle down.
“In effect, the Act required corporate officers each month to certify that they hadn’t stolen anything from the corporation. (Theft from their wives’ purses is not covered.)”
Two years ago, larger firms spent an average of $846,000 on auditors’ internal control reviews, smaller firms about $500,000. Costs have shrunk as the audits have become a normal part of doing business, and a year ago firms with a market cap of $75 million or less were declared exempt.
Mr. Bowser is not convinced of the effectiveness of the law. Many claim that it keeps foreign stocks off the U.S. exchanges. But it has supporters who believe it helps a company practice more stringent management.
It certainly does not cover hopelessly complicated derivatives, which could be called many things, but are not legally fraudulent.
Shareholders pay management
In 1992, Congress passed the Budget Reconciliation Act, which barred corporations from deducting salary payments over $1 million as a business expense. The substitute for high salaries: stock options.
The politicians assumed that stock options would be beneficial, since they are tied to the performance of the corporation.
“Managements love stock options,” says Mr. Bowser. “It’s a way for them to almost directly get the shareholders to pay part of their salaries.”
Starting in 2006, stock options became an expense item, resulting in pages and pages of detailed reports submitted to the Securities and Exchange Commission (SEC). You can follow them if you have the time and patience, says this editor.
He also notes that while companies “bellyache” about Sarbarnes-Oxley, they never complain about stock options.
“These devices lend themselves to a certain degree of manipulation,” he states. “If the stock price drops precipitously, backdating can be brought into play, lowering the exercise price.”
Shareholders, of course, have no such option.
Avoiding responsibility
Mr. Bowser quotes an article in USA Today: “Technically, share buybacks should be a good thing. All things being equal, if a company buys its own shares and thereby reduces the number outstanding, then those that are left should be worth more.”
So why doesn’t it always work out that way? For one thing, companies may announce a share buyback (good publicity) and fail to follow through.
“In addition,” says the same article, “many companies don’t actually retire stock when they repurchase it. Instead, the shares sit in the treasury and are used for other purposes.” They may go to stock awards for employees, for instance. No value-added for the common shareholder.
It can also be seen as a sign of timidity. If a company decides to pay a dividend, “it makes an implied promise that it will do so indefinitely,” adds the USA Today article.
Wall Street bashes firms that cut their dividends. By choosing to repurchase stock rather than pay (or increase) the dividend, a firm can leave the impression that it is doing something for the shareholders — and avoid the long-term responsibility of dividend payments.
Mr. Bowser is not thrilled to see several of the stocks he follows embark on share buybacks. In one case, he notices that insiders are also selling stock.
Buybacks produce synthetic earnings, he concludes. Surely smaller firms can find a more fruitful way to spend their capital.
Some of the problems companies have are imposed by outside regulations, Mr. Bowser concludes, and some are self-inflicted.
But in either case, be careful. When the big operators announce they’re going to do something for the shareholders, the gift may turn out to be a little shopworn by the time it reaches your hands.
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