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Friday, January 13, 2006

Tech Co Buybacks Only Mask Option Issuance (aka Whatever happened to Caveat Emptor?)

Finally! The financial journalism community clues into shareholder abuse -- sort of. This article in BusinessWeek discusses how many stock buybacks aren't really reducing the number of shares, they're just counteracting the cashing out of options by company employees.
This is one of the great travesties of the public markets. The people who really have insider information, company employees, are selling in droves while the public blithely continues to buy at significant valuations. The article actually gets the perspective wrong in my humble opinion because what they should be doing is looking at massive options issuance. Whether a company decides to buyback shares to counter it is really a red-herring. As I discussed in my post regarding options expensing, most people don't understand the concept that options are about dilution, not expenses. In other words, in managing a business I would keep track of how much cash I push out the door to keep it running (the expenses) and then think about how much of the company I own (dilution).
The problem with public companies today is the classic "agency problem". I learned about this in undergrad business 101. The agency problem refers to the inevitable tension/friction that builds between a company's owners and its managers when they are separate people. Managers may want to do different things with a company than its owners would like, but since managers are running the business on a day-to-day basis, owners can find themselves left out in the cold.
Couple this tension with a rising trend of mutual funds, ETFs and hedge funds and this means that investors don't even think they own shares anymore -- they own an interest in investment vehicles. Therefore the general public is now two steps removed from their control over the assets they own.
And make no mistake, when you buy shares in a company, you own it.
What this means is that public company managers have figured out that as long as they publicly trumpet their share buybacks while doling options out the back door, they know that shareholders won't say a word. At least in an up market. Unfortunately, American investors are a retributional crowd. If share prices begin a period of sustained decline, then they'll start looking at issues like this and howling like mad. They'll say they were never informed of the level of greed, etc... What they don't understand is that their current: "If it ain't broke, don't fix it" policy is what allows the problem to fester and grow in the first place. Kind of like that whole investment banking research scam that didn't become illegal until the market tanked. I hope the public appreciates the free reach back claw option they got on that one.
There is a rising trend of hedge funds and other institutional matters that are starting to exert their influence. See Knight-Ridder for further details. You'll see more of this in the future, but the basic point that I'm working from at the moment is that the tech markets are frothy and tech co employees are cashing their options in like madmen.
That's when it becomes clear to me to start working on developing short ideas. Maybe not today, but soon.


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