Imagine if you could sell all the stock you own in a company and get paid a bonus for doing so ? How great would it be if you could just look at a stock in your portfolio and say “I quit. Im tired of owning you. Pull me from the shareholder rosters im out of here ! Oh, by the way. I need to get paid to leave. I want you to cover my losses, and pay me a bonus, and of course, I need access to the company plane.”
CEOs can quit. Shareholders cant. CEOs have ridiculous exit packages. Shareholders have nothing but risk exit packages. There is no way on earth that any of the existing pay packages can say they align with shareholders interestswhen quitting means you hit the lottery.
Thats ridiculous and an insult to shareholders.
So i was pondering the question. What would work with executive pay ? How can an exec’s interests even somewhat lie with Shareholders ?
Well first, let me put out there that I am HUGELY bias to dividends. I loved MicroSofts special dividend, I think the huge buyback they just announced is the epitome of stupidity. You dont reward shareholders who sell. You reward shareholders who stay. Buybacks are a sign that the CEO and Board really dont understand shareholder return. Its a sign that they understand pressure from large shareholders who mark the price of their stock to market on a daily basis and what to see it get a bump and want an exit strategy they can sell into.
Dividends on the other hand, do just the opposite.
They send a message to shareholders that you want them to stay as shareholders and are rewarding them for their committment to your company. Its a reminder to shareholders that the business investments you have made have actually worked and the reward is that cash can be returned to shareholders . That profits are more important to shareholders over the long term than trying to convince wall street to increase your PE.
For boards that believe in the same dividend reward strategy then the solution to executive pay is very easy. Phantom Shares.
Phantom Shares in this case would be the equivalent of an Executive Tracking Stock.
Execs in a public company would be issues non-trading shares that would entitle them to only 2 financial opportunities.
1. They can be paid dividends equal to dividends paid to common shareholders – This way if Im a shareholder and I get paid a nickel per share per year. So does the exec. That is true alignment of interests.
2. The tracking stock is assigned a price equal to the price of the common stock on the day the exec is hired. If the company is sold, the tracking stock is “converted” to a common shareand the execis entitled to any premiumin thesale price of the stock above theassignment price on the day of employment.
With this approach, it doesnt matter if the CEO plays games toget the stock price higher, it doesnt help him or herunless the company gets sold. At which point there is certainly riskhe or she could play games with the stock and groom the company to sell it. However, given the sale of a company is something that shareholders have to approve far more often than not, it truly can be up to the shareholders to do the deal or not. They can control the financial destiny of their stock, the company and the executives involved compensation.
Its also possible that the board of a company could offer management far more shares of the tracking stock than some may deem reasonable. If the board did give a ridiculous number of tracking shares, they still would have to declarea cash dividend each quarter before the executives could benefit. The cash impact on operations from having to pay out to everyone would hopefully minimize this risk and prevent this from happening. (And yes i know that sleazebags everywhere will find a way to abuse this approach, but what that is, is not obvious to me right now)
So thats my idea to solve executive compensation issues. A phantom or tracking stock issued to execs that only pays them when shareholders are paid a cash dividend or when the company is sold. That is alignment with shareholders IMHO
Would it be difficult to attract top quality executive management to a company with this compensation program ? Hell no. if anything there is an excess of good management talent out there willing to work a job that challenges and interests them.
Its a very simple approach. Its one that would work.
Now whether any boards would do it, thats a completely different question
Ever read Good to Great by Jim Collins?
No high paid CEO has been worth the money according to research. High or low, salaries had nothing to do with performance, and more high paid CEOs did not lead their companies to perform greater than the market than did.
Comment by Jake Lockley -
As a startup CEO, I agree that CEO comp needs to align with shareholder interests. In a new startup, it’s pretty close to what you describe – the stock is completely illiquid and salaries are low, so the stock only provides meaningful compensation if we sell (or IPO). There’s always a line of people who want to do the job, so like you say, you don’t necessarily need a big package to attract talent.
For public companies, what do you think about EVA and its derivatives? It lets the CEO get rewarded for investing correctly in the business, as well as for a sale or dividend.
Comment by John Rodkin -
Good clarification Mr. Cuban, some of your points come out at me a little clearer now. Just a couple things:
MC- “The point I make and that you obviously dont grasp, is that if the primary motivation of your management is through the increase in the company’s stock price, the probability that a disproportionate amoutn of effort will be put into trying to juice the stock price is very high.”
DE- That will always be the primary motivation for 80% of public execs, no matter if you pay dividends as incentive or not. They talk about it openly on con calls to analysts, and their shareholders in shareholder meetings. Right or wrong, it is accepted that this is the strategy that makes everyone the most money. Do I think it’s wrong? Sure. I think a company should be growing themselves internally and closing their eyes to a stock price. If more time were spent managing the company, and less time spent managing stock price then lo and behold, those companies stock prices just might fare better. We agree, and I didn’t miss your point. I agree that the probability is higher, but then again as you mentioned several times, the option is there to not pay dividends, and chase capital appreciation anyway. As you stated the boards would have to decide which way to go, and I’m guessing the better choice of dividends (if available) still wouldn’t make the final cut. I’ll tell you why the motivation for short term market manipulation got big, and it’s not entirely why you think. It’s the damn media, and their hands on approach to the market analysts. Analysts for the majority of the big firms beat the mess daily out of C level execs when it comes to stock price. Why? Their firms are the biggest investors. Not because they want to show Sally and Joe why this is or isn’t a good stock, but because their firms own or have an interest in a ton of shares, and need the stock to go up. The media (CNBC et al) is all to willing to cover this spectacle on a daily basis, with all the sheep sitting in their living rooms nodding their heads. I don’t blame the sheep, I blame the media, sheep will be sheep, and that’s never going to change. The media has decided it’s great to cover these asshat analysts running around beating the mess out of C levels. Hell they have practically made a sport of it. Violence sells, and this is the closest thing to violence that armchair “wallstreeters” get.
That’s the majority reason for the efforts of short term stock gain. You cut that dog and pony show, you can get back to the roots. Then your dividend payments make sense.
You want some interesting juice for sharesleuth? Tie the stock anaylsts into the research Mr. Carey conducts. Look at each and every one of them, starting with the Dow stocks. I guarantee you will find as much dirt there as there is in the board rooms.
That’s not to say that there isn’t greed for the pure gain. It’s obviously alive and well, but at the very least it’s a two headed monster.
MC- Risks abound everywhere. had the stockmarket not gone crazy, most of the employees of broadcast.com would be working there for the salaries they earn, like those people who work for the millions upon millions of private companies who compete for employees every day.
Which leads to another point you miss. The 10k public companies are far from being the best companies. they just happen to be public, and nothing more. They attract and retain employees and compete against public companies every single day. So my proposal for a tracking stock may actually help boards weed out the shortsighted, hit and run execs that are creating the executive pay disparities we see today.
DE- No one said public companies are the best companies. BUT, they are where the fresh talent goes to. Not the only talent, not the best talent, but the most talent. The talent coming out of your top B schools is doing one of three things today:
1. Trying to start their own business.
2. Joining Big 4, Booz, Bain, McKinsey, Accenture or any other consulting firm that can get them.
3. Negotiating the highest salary they can at public companies with the “big names”.
That’s at least 70% if not much more of the talent leaving B schools today. Private companies get some, but not much of the talent. This is a generality; you may have succeeded at a higher rate. If I were leaving B school today, I would be happy to work at a company you own, in fact most kids would. It wouldn’t be to get a decent salary though, it would be to learn and take that knowledge somewhere I could make real money, unless you recognized my talent first. Or unless I thought you had a chance to go public.
Either of those options rarely happens. Most management doesn’t recognize the talent they have and most private companies don’t go public. So… I’d be off to the land of milk and honey. (I’m speaking in generalities here). You may recognize and retain the talent you have at the companies you run, I don’t know.
I knew you put more thought into it then what you typed. I just wanted to see it.
For the most part we absolutely agree. Only thing is I can’t help but think that there are a lot of private companies that take unnecessary risks with capital, the biggest one I can think of is Trump with his boom or bust mentality. It doesn’t affect shareholders, but it damn sure affects employees.
Comment by D. Echternach -
In general stock buybacks are done when companies have no clue how to make money from their operations. We have nothing better to do w/ our money so lets buy our stock.
CEO compensation has gone way out of balance. I believe in free markets. Free, TRANSPARENT, markets. Today’s shareholders have very little influence on the cronyism, stacking of boards, etc.. Annual reports are written to mislead. Annual reports are now a sales brochure for companies rather than a report card.
The audacity of some public companies to leave out executive compensation and option grants out of their annual report should be criminal.
I sold my company to a fortune 200 and witnessed all these shenanigans first hand. You wouldn’t believe the crap public companies do to make their short term numbers. They discount their product huge and load up the distribution channels “to make their sales numbers”. That does not sell more product. The next quarter the channel is loaded w/ product and the company is much less profitable on those discounted sales.
The problem is public companies get caught up in running their businesses in 90 day chunks between their quarterly reports. Gearing a multibillion dollar business to run in 3 month spurts is hardly strategic. If a CEO trying to do the right thing came out and said my company XYZ is in a long term strategic restructuring that will take 2-3 years is basically committing career suicide. The system needs to be changed somehow to align and reward those who truly add value instead of “manufacturing” value by playing accounting games and other short term band aids.
We find ourselves trying to legislate morality and honesty. I think there are solutions that will help keep compensation more aligned but it is a very difficult road. The real key is to empower the shareholders so they really have good information and feel like they have real input into a company.
There are many crappy public companies that announce restructuring after restructuring, similar to a sports team that has been rebuilding for 10 years! Show me a CEO that does that and I’ll show you someone who isn’t worth a dime.
Sure the “free market” guys say you dont have to buy the stock or you are free to sell it. That is fine. I just don’t get the part that says you are free to fleece shareholders while they do own your stock.
Comment by Steven -
What about providing phantom shares or other funds (pension plan) that can’t be touched until retirement age w/out significant penalty? Seems like another alternative method, already used in some companies, to align shareholder interests w/ comp plan and also improve long-term employee retention.
Comment by Jonathan Alexander -
Sounds good. Do you have plans to introduce this in the companies that you control? Start the ball rolling and it could catch on…
Comment by Dustin Sacks -
I never understood why CEOs were paid so much money in the first place. What is it that they do that deserves such a high salaries?
I think teachers and mothers should have the higher salaries.
Moreover, going back to the NCAA, I think athletes should be paid too.
Comment by Antonio Howell -
I knew i was going to get a response like #6 from Mr Ecthernach, and Im glad I did so i could respond
1. Companies in a finiancial mess won’t pay out or they or cancel didvend payments if they are already paying them.
MC-Of course they wont. Not every company should. Just because mgmt is rewarded with dividends doesnt mean they have to pay them. No does it mean the board would approve if a CEO was shortsited enough to try to do so when a company was losing money on an ongoing basis.
Him: These are the comapnies that often times turn over management that could not get the job done. What does this mean? They have to attract new talent. Under your system the way to attract that talent is to pay a healthy dividend, more than your competitor. Not feasible when you have financial difficulties. Theefore the companies that need the talented execs the most, get the short end of the stick. There goes your turnaround pros that come to fix a company as well.
MC>Not true at all. You sound like Silicon Valley did when options were to be expensed. If a company has a future, a good exec can be rewarded in any number of ways. Including the tracking stock, salary, the opportunity to purchase stock on the open market or from treasury stock. The point I make and that you obviously dont grasp, is that if the primary motivation of your management is through the increase in the company’s stock price, the probability that a disproportionate amoutn of effort will be put into trying to juice the stock price is very high.
Plus, if the exec is worth a damn, then he/she is coming on for the challenge of turning around the company with the upside being not only the results, but also the generation of cash by the company over the LONG haul that can be returned to shareholders, or in the sale of the company. If the execs are coming on with a short term reward horizon, then you just hired the wrong person.
Take my word, headhunters have a long list of very, very qualified people who want the challenge of being the CEO of a public company. Its shortsighted boards that think that only the ones that ask for huge lockins are the qualified ones.
Him> Side point, BCST had a 98 Q4 loss of $5.18 million. Could you have afforded to pay a dividend? Should you have to worry about your management seeking jobs to your competitors because they could have (assume they could)? Let’s say that Real Networks could have paid a dividend. Your top talent just left Broadcast.com. Out the door to RNWK where they will be compansated each quarter. Say what you want about them jumping ship, and all the drama about being a visionary and your ability to retain them. The reality is you coudln’t have, and your business would have suffered HUGE. In that competitive of an arena, you might as well have kissed your ass goodbye, if you aren’t acquired.
MC>Risks abound everywhere. had the stockmarket not gone crazy, most of the employees of broadcast.com would be working there for the salaries they earn, like those people who work for the millions upon millions of private companies who compete for employees every day.
Which leads to another point you miss. The 10k public companies are far from being the best companies. they just happen to be public, and nothing more. They attract and retain employees and compete against public companies every single day. So my proposal for a tracking stock may actually help boards weed out the shortsighted, hit and run execs that are creating the executive pay disparities we see today.
him >. If you are in the business of innovation, ie GOOG, YHOO,(BCST back in the day) what makes more sense? Pay out sorely needed R&D money, or payout shareholders?
MC:Of course not. Just because the reward is in dividends, as I said before doesnt mean you have to pay them. If you can grow the company so that at somepoint in the future you can make a bigger payout, do it. thats good business.
Him> Some companies actually do a good job of reinvesting earnings, and turning that into real profit.
MC>Yes they do. SOME being the operative word. Most dont. Most run out of things to re invest in that are related to their businesses at some point. When that happens, CEOs being CEOs and wanting that stock price ot increase, start increasing the risk and making acquisitions or worse yet, buying their own stock. I know everyone disagrees, but I assure you that history will look back on stock buybacks as the single most stupid thing corporations did during the 1990s and 2000s. What could more ridiculous than not only rewardnig those who get out of the stock, but taking on the risk of the stock market with corporate funds. That money that was used to buy company stock by Sun, OSTK and others at prices that were significantly higher look real smart right now dont they ? And MSFT makes an announcement of a big buyback at a time when the market is high and the competition is tougher than its been. is it conceivable that MSFT could be 5 or more points lower ina year ? Of course it is. Its conceivable that any stock could go significantly lower. Why would any company introduce that market risk to their corporate investments ? Its the equivalent of having a pension fund with only 1 stock, or a portfolio of 1 stock. Would any prudent advisor suggest that as a smart approach
Him >
I suggest you read Berkshire Hathaways’s owners manual.
Here’s a quote from Buffet when asked about the policy of dividend payments at Berkshire:
“We will either pay large dividends or none at all if we can’t obtain more money through re-investment (of those funds). There is no logic to regularly paying out 10% or 20% of earnings as dividends every year.”
MC> Good for warren. Warren does a good job of running his insurance businesses which require huge amounts of cash. If he can keep growing his business, more power to him. If he can keep buying companies and operating them more efficiently and getting a return. Great.
Unfortunately for his shareholders, the stock is around the same range today as it was in early 1999. Warren comes out all the time and says he cant find good places to invest. His shareholders just sit with a 70k to 90k dollar stock that can bounce around a thousand dollars a day. I bet they would love to have a dividend. The good news is that Warren would take the job whether you gave him a tracking stock or options. And my guess is that he doesn load up the CEOs of the companies he buys with BH options either. Do they quit and run off.
what i proposed isnt the perfect solution, but it works and is certainly a better than way than stuffing a CEO with options and exit strategies.
Him>Not that I don’t applaud the thought behind the idea, but I can tell there wasn’t much thought (or the right thought) put into it.
Comment by mark Cuban -
While the approach and theory is good there are a couple points you probably did not think about:
1. Companies in a finiancial mess won’t pay out or they or cancel didvend payments if they are already paying them. These are the comapnies that often times turn over management that could not get the job done. What does this mean? They have to attract new talent. Under your system the way to attract that talent is to pay a healthy dividend, more than your competitor. Not feasible when you have financial difficulties. Theefore the companies that need the talented execs the most, get the short end of the stick. There goes your turnaround pros that come to fix a company as well.
Side point, BCST had a 98 Q4 loss of $5.18 million. Could you have afforded to pay a dividend? Should you have to worry about your management seeking jobs to your competitors because they could have (assume they could)? Let’s say that Real Networks could have paid a dividend. Your top talent just left Broadcast.com. Out the door to RNWK where they will be compansated each quarter. Say what you want about them jumping ship, and all the drama about being a visionary and your ability to retain them. The reality is you coudln’t have, and your business would have suffered HUGE. In that competitive of an arena, you might as well have kissed your ass goodbye, if you aren’t acquired.
2. If you are in the business of innovation, ie GOOG, YHOO,(BCST back in the day) what makes more sense? Pay out sorely needed R&D money, or payout shareholders? If you start paying out divs, you could very easily lose the innovative edge because you have no free capital to work with. Their cash is better spent innovating products and keeping ahead of the game.
3. Some companies actually do a good job of reinvesting earnings, and turning that into real profit. I suggest you read Berkshire Hathaways’s owners manual.
Here’s a quote from Buffet when asked about the policy of dividend payments at Berkshire:
“We will either pay large dividends or none at all if we can’t obtain more money through re-investment (of those funds). There is no logic to regularly paying out 10% or 20% of earnings as dividends every year.”
Not that I don’t applaud the thought behind the idea, but I can tell there wasn’t much thought (or the right thought) put into it.
Comment by D. Echternach -
Mark –
Clarity and simplicity will go hand in hand on this issue. Let’s cut out (through the tax code) the plethora of long term incentive plans, executive pension plans, perquisities (i.e., plane travel, country clubs, car allowances, etc) not available to ordinary employees … note that this mechanism already exists for 401-K plans.
If there are only three ways to make money off of the comapny – 1) current period salary and bonus, 2) savings plan (401-K or pension) and 3) options / phantom stock – then you’ll actually be able to figure out how much is getting paid out.
BTW, your plan would actually encourage the long-term, value-creating employee with a reasonable cash income to quit. How am I supposed to put my kids through college? Granted, that issue isn’t the ‘excesses’ you are worried about but, since these things flow downhill, is actually the more common situation in the long run.
dg
PS: Please go talk to your tax advisor. Unless you’ve moved to Hong Kong, you really do care about the difference between ordinary income and capital gains.
Comment by DG -
Very well said Mark. The stock market shouldn’t be a game.
Comment by Port Orange MLS -
A payment plan for execs that only pays on a company sale or payment of dividends would also mismatch incentives. There is already an unhealthy emphasis on short term results. Paying execs on dividends would exacerbate the problem at the cost of long term investment.
Even a mature industry (where the value is primarily producing dividends, not planning for the future) needs to maintain that investment in the future.
Interesting ideas as always, but I think this one needs to be refined a bit to make it work.
Comment by Bob Russell -
Stock options reduce the incentive to pay dividends. This is bad for mature companies that should be paying substantial dividends. The phantom stock would create an incentive to pay high dividends. This would be bad for companies that shouldn’t be paying high dividends, such as rapidly growing small firms with poor access to the capital markets.
I think that a cash bonus bank based on some measure of performance like EVA is the best one size fits all solution available. However, stock options may still be a good solution for some firms and the phantom bonus is an interesting idea that may be worth looking into for some of the more mature firms.
Comment by Pat L -
What would the shareholders’ tax planners have to say about dividends instead of buybacks? Don’t dividends count as income, while buyback-induced stock price increase counts as capital gain?
How is holding the stock of a company with a buyback plan different from holding the stock of a company that pays dividends, then reinvesting your dividends?
Another way to handle the exec. compensation thing: your options vest on your hire date and expire the same day, so you have to buy in. The company will loan you the money needed to exercise the options, but you’re only allowed to sell a small fraction of the stock per year as long as you work there.
Comment by Don Marti -
Shareholders can quit – It’s called selling the stock.
Comment by nascar -
I remember reading an article way back in 1999 about a guy who never entered a business executive position without making sure he had a parachute on his back – a golden one – in case an exit needed to be made.
Comment by Glen F. -
Or… you can simply choose to not own a particular stock where management is receiving egregious compensation.
Comment by Eddie -
Max,
You seem to have a strong preference for cash over stock. You’d prefer to have a company’s earnings returned to you as a cash dividend, even though it reduces your stake in the business, rather than having the company use the same earnings to increase your ownership share tax-free. In fact, your preference for cash over investment is strong enough that you don’t mind paying taxes immediately rather than deferring them, just to achieve the certainty of realized gains.
The natural question, then, is why you invested in stocks to begin with? If you prefer realized gains you can just sell your stock today. You say a dividend that decreases the value of your stock by X while giving you X in cash is a good thing. So, if you want more of a good thing, I recommend you call your broker now and request an immediate 100% dividend. If you’ve held the stock for a year you’ll get the 15% qualified dividend rate (though your silly accountant will call it a long term capital gain).
This comes right back to my points. 1) Investor preference for dividends is irrational. 2) Investors who actually want to continue investing in a company for the long term prefer buybacks over dividends.
Incidentally, buybacks do have transaction costs, but they are lower than the costs of issuing a dividend and forcing many of your investors to reinvest them a few shares at a time. Economies of scale – it’s cheaper for the company to buy the stock all at once than for each investor to execute individual purchases.
Comment by Sparohok -
I don’t know a thing about business, your idea sounds good but never underestimate the power of greed. They WILL find a way to exploit the system.
On the positive side, this is a free market and it is going to take a while but you will see companies, through the power of investor’s influcence, moving away from these golden parachutes for management.
Comment by spectro -
Sparohok> Taxes. Buybacks permit investors to continue deferring taxation, which is always good. Dividends force most investors to incur taxes immediately. Advantage: buybacks.
You forget that capital gains are not guaranteed, so it’s incorrect to say that buybacks are “deferred taxation”.
Sparohok> Transaction costs. This is very minor, but dividends may incur transaction costs if reinvested. Advantage: buybacks.
Wow! And why are transaction costs magically do not apply to buybacks?
Sparohok> Psychology. Investors like dividends, because of the “cold hard cash” factor that someone mentioned. This is an illusion, because the cash dividend decreases the value of the stock you own by precisely the amount of cash you are paid. Advantage: dividends, but only if you’re irrational.
Huh? Let’s retrace – the value of the relatively illiquid security decreased by X, while I get paid X in cash, and somehow it is BAD?
Comment by Max -
Mark, I respect your business savy. However you are an intellectual THIEF. A while back I posted the idea of PHANTOM SHARES. You gave me no acknowlegement. Shame on you!
http://www.blogmaverick.com/entry/1234000040073585/#c687799
Comment by jason clark -
Mark, I respect your business savy. However you are an intellectual THIEF. A while back I posted the idea of PHANTOM SHARES. You gave me no acknowlegement. Shame on you!
http://www.blogmaverick.com/entry/1234000040073585/#c687799
Comment by jason clark -
If a company seems to be gearing its policies towards large and agressive shareholders, such as buybacks for the purpose of giving the stock a temporary jump, the little guys should run. Get set with a company that pays stable and increasing dividends and has some potential for capital appreciation.
Comment by Power -
With the rise in executive pay and outrageous bonuses (even for companies that fail to perform well), I find it surprising that no political party is even willing to discuss the pay some executives get.
In Japan there used to be an unwritten rule that the most you could earn was 12-13 times the AVERAGE salary within the company. This means that big-buck lawyers could rake in high dollar, but also meant that car company execs would be less able to do so.
Maybe 12-13 times the average is too low, maybe it should be 50, 100, etc. However, it is a shame it cannot be discussed… If either political party said that CEOs can only get 50 times the average salary, would that be too much or too little? Could either party justify saying that an executive deserves 100 tims the average salary?
I think not. I’m not sure whether there is a right/wrong answer here, but it’s a shame no one asks the question.
Comment by Mark Bollobas -
New reader here. Just a few points.
Buybacks and dividends are economically identical except for the following factors:
1) Taxes. Buybacks permit investors to continue deferring taxation, which is always good. Dividends force most investors to incur taxes immediately. Advantage: buybacks.
2) Transaction costs. This is very minor, but dividends may incur transaction costs if reinvested. Advantage: buybacks.
3) Psychology. Investors like dividends, because of the “cold hard cash” factor that someone mentioned. This is an illusion, because the cash dividend decreases the value of the stock you own by precisely the amount of cash you are paid. Advantage: dividends, but only if you’re irrational.
MC theorizes that dividends also send a message that the company wants to keep its shareholders for the long term. In fact it does precisely the opposite. A dividend returns some of the company’s cash flow to shareholders, forcing shareholders to either reinvest or accept a smaller stake in the company (less dollars, the same share). Whereas an equivalent buyback keeps investors fully invested (the same dollars, greater share). A committed, long term shareholder prefers buybacks, and a company that wants that sort of investor should prefer buybacks as well.
Finally, DJG says: “A company buying shares back is no different than anyone else buying shares; it’s a good idea and value creative to remaining shareholders, if the stock is cheap, and a bad idea if the stock is expensive.”
In fact, they’re completely different. When a company buys back shares, this decreases outstanding supply, and the equilibrium price of the remaining shares goes up. This may create or destroy intrinsic value depending on the future discounted earnings of the company relative to the current stock price. On the other hand, when anyone else buys shares, there is not necessarily any change in equilibrium price and certainly no change in the intrinsic value of the shares to other shareholders. Economically, these scenarios couldn’t be more different.
Comment by Sparohok -
cubes i agree 100% with the buybacks opposed to dividends. the problem with dividends from a ceo’s standpoint is it comes out of the stock price and lowers the market cap.
btw i used to trade bcst and made over 100k in it one day in 1999! thanks bro, i’ll always love you for that. even tho im a heat fan.
Comment by nick -
I would be not at all surprised if announced share buybacks were followed by increased executive selling.
Comment by Cup -
It’s been proven that very simple approaches(especially ones that would work for the people, in this case shareholders) would never be allowed by the powers that be. This is a world of have and have nots. If history has taught us anything, it’s taught us that it’s been this way since recorded history. If history truly tends to repeat itself then we will see more of the same. The only way to NOT see more of the same is to force change through revolution or uprising. If that sounds drastic, prove me wrong.
Comment by Brandon Piddington -
Mark,
I like your points about aligning shareholder interests with executive interests through dividends rather than through share buybacks.
I should point out that I’m very much a proponent of the market system. For this reason, I have a hard time sympathizing with shareholders when they generally have the option of selling their shares and no longer being affected by that organization’s decisions. If a company seems to be gearing its policies towards large and agressive shareholders, such as buybacks for the purpose of giving the stock a temporary jump, the little guys should run. Get set with a company that pays stable and increasing dividends and has some potential for capital appreciation.
As for executive “exit” packages. I understand your points about this not being in the interests of the shareholders. At the same time, you must view these exit packages for what they are- decisions of the corporation. Some executives, Jack Welch being a star example, deserve their buyout packages. He brought his company from a $15 to $400 billion market cap during his tenure. If you view the exit packages in terms of the progress made by the company under their tenure, sometimes those pay packages don’t look so crazy. It’s kind of like paying A-Rod $25 million a year. It seems nuts, but if he can perform even 2% better than the second best player, he just might deserve the extra $20 million that come along with that. Had to throw a little sports analogy in there…
Thanks!
Russell Bailyn
Comment by Russell Bailyn -
Dividends are always better for the stockholders than buybacks. Capital gains are not guaranteed; cold, hard cash is. More importantly, the stockholder has the power to do what they want with the dividend. A buyback tells the world that the company thinks they are the best investment out there, which is ludicrous 95% of the time. Microsoft’s share price would have gotten a much bigger long term jolt if they announced a doubling of the dividend instead of a stock repurchase. It would have held them over nicely (in terms of positive pub) until Vista comes out. Instead, all the focus in on Vista.
Unfortunately, I don’t think we’ll see enough turnover in boards and companies to hire CEOs who think for the long term. Far too many people are seduced by the cash and golden parachutes. I think compensation overhauls like the Coke board made will be few and far between.
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Comment by admin@monitorinvest.com -
This might work if the gain could happen from dividends or an increase in stock price. Use the moving average of the stock price or let the stock price a year after the CEO leaves determine his gain.
Comment by Al Brown -
Share buybacks are often vastly superior to dividends or any other use of capital. This is not even a debateable issue if you understand it.
The proper use of excess capital is a function of the price of the stock vs. its value vs. other investment opportunities.
If a stock is undervalued, it is more tax efficient to buy back shares than pay a taxable dividend that the shareholders might want to reinvest. If the stock is undervalued enough, buybacks are often a better use of capital than investments in the business.
A reduction of shares leads to an increase in EPS which eventually leads to a higher stock price creating much more value.
The debates about options dilution and share repurchases tied to them and buybacks at foolish prices in an attempt to prop up a stock are different issues than whether repurchases make sense at depressed prices.
Warren Buffett has been encouraging share repurchases at the companies he has owned for decades (long before they became popular) because he understood this.
Comment by W.C. -
MC, the comment about Microsoft was quite myopic, don’t you think? Don’t forget there are 2 sides to every story unless you sat down with their CFO and got to the root of why they made the move and realized, “Yeah, this guy’s smokin’ some ganja.” 😉 Why don’t you just ask him?
You’re phantom stock idea is quite a Utopian viewpoint! I would never have guessed that someone that made billions by cashing out would suddenly decide it was a bad thing.
Ah, yes, phantom stock. Love the idea. Just remember, though, that the Board gets compensated via cash & options for sitting in the big leather chairs in the Board room, too. Remember who is typically the chairman? You got it, the CEO. Would you do this with your company if it was publicly traded? Nice idea, but too ideal and practical and too big a bite into their pockets. It just won’t fly. And please don’t tell me that you cheered the latest SEC ruling (FAS123R) to implement expensing of stock options to “create a level playing field.” That’s horseshit. Just a bunch of pencil-necked FASB jagoffs that have sour grapes ’cause they’re not in the game and can’t have any pie. (Not to mention pressure from the ALCOA’s of the world that have seen their stock flatline like A-Rod’s defense.)
Besides, like athletes that are paid millions, why shouldn’t CEO’s? Much like fans keep paying for high-dollar tickets, so, do stockholders keep buying stock to pay the comp. I just don’t like the idea of the company having to continue shelling out cash to pay this guy or gal — if the stock went up, then it’s ’cause the public decided he/she was doing a good job and, therefore, they should be entitled to cash in. With all the reward, they bear the risk. Unlike athletes who merely get ridiculed in the press when their game takes a dive, CEO’s get taken to court in our litigious-happy community.
Comment by Enrique -
DJG…You only make money when you SELL a stock for profit. Last time I checked, my grocery store won’t take my unrealized cap gains as payment! Your example is fine if everyone can cash out at the new higher price. Try dumping the entire float on the market and see what happens to your $70 price. The only way to get out would be sell the company at a premium to current stock price. I would be not at all surprised if announced share buybacks were followed by increased executive selling.
Comment by Steven -
DJG…You only make money when you SELL a stock for profit. Last time I checked, my grocery store won’t take my unrealized cap gains as payment! Your example is fine if everyone can cash out at the new higher price. Try dumping the entire float on the market and see what happens to your $70 price. The only way to get out would be sell the company at a premium to current stock price. I would be not at all surprised if announced share buybacks were followed by increased executive selling.
Comment by Steven -
Actually Legg Mason has an excellent piece that shows that dividends and buybacks are exactly the same in the long run. Buybacks are smart at some prices and dumb at others. They do increase future earnings/dividend potential to remaining long term shareholders. I do agree with you that the heads I win, tails you lose nature of options and pay is insane.
Comment by Hance West -
Mark – I disagree with your comments about dividends vs buybacks. Remaining shareholders benefit hugely more than ones selling into a buyback with one key assumption: that the stock is cheap, or at least that they think the stock is cheap. A company buying shares back is no different than anyone else buying shares; it’s a good idea and value creative to remaining shareholders, if the stock is cheap, and a bad idea if the stock is expensive.
Envision a company that has 100 shares, of which you own 10, and they trade at $50 per share, then the market cap is $5000; let’s assume the company has no debt, so the value of all of the capital (the enterprise value) is $5000. If the company thinks the stock is cheap, they might go borrow $2500 and buy back 50 shares ($2500/$50 = 50 shares). Then the company has 50 shares left that trade at $50 per share, so a market cap of $2500, along with $2500 of debt, makes the same EV of $5000.
Let’s say you thought the shares were cheap (and the company obviously did because they just bought a bunch of shares), and you were right — so the value of the entire enterprise goes up by, say, 20% from $5000 to $6000. Take off the $2500 of debt, and the market cap has gone from $2500 to $3500, or from $50 to $70 per share, or 40%. So, for a 20% move in the EV the share price moved 40%.
Buying back shares when they are cheap rewards remaining shareholders, because they benefit dramatically more from any increase in the value of the entire company than they would have prior to the buyback.
Comment by djg -
Dividends are always better for the stockholders than buybacks. Capital gains are not guaranteed; cold, hard cash is. More importantly, the stockholder has the power to do what they want with the dividend. A buyback tells the world that the company thinks they are the best investment out there, which is ludicrous 95% of the time. Microsoft’s share price would have gotten a much bigger long term jolt if they announced a doubling of the dividend instead of a stock repurchase. It would have held them over nicely (in terms of positive pub) until Vista comes out. Instead, all the focus in on Vista.
Unfortunately, I don’t think we’ll see enough turnover in boards and companies to hire CEOs who think for the long term. Far too many people are seduced by the cash and golden parachutes. I think compensation overhauls like the Coke board made will be few and far between.
Comment by csr -
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Comment by Wadim -