Add a new wrinkle to the longstanding debate about the wisdom of share-repurchase programs: claims of a conflict of interest.
Companies cite many good reasons for buying back shares: the practice boosts earnings per share, it sends a signal that the company
considers its shares undervalued, and it finds a use for some of that vast cash horde many firms have. Companies could, of course, pay a dividend, but many prefer the flexibility of buybacks because they are occasional events (the issuance of a dividend usually creates an expectation of regular payouts).
But what happens when a company buys back its shares at the same time that executives are selling theirs? There are no laws to prohibit officers and
directors from selling company stock while the company is buying. But at a time when investors and regulators are hypersensitive to even the appearance of
conflicts of interest, some critics are asking whether officers and directors who promote and authorize massive stock-buyback programs should also be taking
the other side of those trades.
“In our view, there is an inherent conflict of interest when insiders are using the stockholders’ money to buy back shares on the theory that they are undervalued,
and at the same time are unloading their own shares,” argues plaintiff’s attorney William Lerach of Lerach Coughlin Stoia Geller Rudman & Robbins LLP in San Diego. “We believe it to be an inherently bad practice. Certainly, when we evaluate whether to bring suit against insiders for securities fraud, it’s something we look for, and when we see it we view it to be very incriminatory.”
Three years ago, Lerach helped negotiate a settlement of shareholder litigation with Sprint Corp. (now Sprint Nextel Corp.) in which Sprint agreed that it
would no longer allow insiders to sell Sprint shares while the company was buying them. A Sprint spokeswoman says the prohibition applies only under “certain limited circumstances,” but declined to elaborate. Lerach says it is a reform other corporations ought to embrace voluntarily.
Few have, at least in part because both buybacks and stock options as a form of compensation are relatively recent phenomena. In 1980, for example, the value
of stock buybacks exercised by S&P 500 companies equaled just 10 percent of the value of the dividends issued, according to Scott Weisbenner, a finance professor at the University of Illinois who studied the issue while serving as an economist at the Federal Reserve Board from 1999 to 2000. By the late 1990s, however, companies were spending more on repurchases than on dividends. And the boom continues: in the second quarter of this year, buybacks
outpaced the same period a year ago by 43 percent, while dividends accounted for just 32 percent of cash paid out to shareholders, down from 51 percent as recently as the second quarter of 2001. Weisbenner also found that between 1994 and 1998, the use of stock-options programs by S&P 500 companies grew by more than 40 percent.