Stock Buybacks, Stock Prices, & Full Disclosure: continued
The Boeing Buyback
The force that drove stock prices upwards was not better financial ratios. Rather it was a colossal stock buyback program in the years 1998-2001, when the company spent over nine billion dollars to take twenty-five percent of company equity off the market.
In September 1998, the board had approved the repurchase of one-hundred forty-five million shares on the exchange – fifteen percent of equity.
In 2000, the directors expanded the buyback program by authorizing the purchase of an additional eighty-five million shares – a further ten percent of equity.
The $9.1 billion needed to pay for this mighty stock play came from retained earnings, working capital, and new borrowing.
Since the amount spent was more than thirty-times the average daily trading volume of Boeing on the New York Stock Exchange – more than the central banks of many developing countries have to defend their currencies against incursions of hedge fund traders – it is not surprising that the price of Boeing stock doubled.
Transitory Benefits of Stock Buybacks
Although the buyback program succeeded in temporarily jacking up stock prices, the results were not lasting, and prices quickly fell from highs of more than sixty dollars per share back to thirty dollars by 2002.
The audited reports do not show the amount that executives and other option holders made on this price rise, nor how much insiders gained by cashing in as buybacks forced prices upwards.
When directors authorize a buyback program, the undertaking is indefinite, and the timing is unclear.
A repurchase scheme may be cancelled, accelerated, or curtailed.
Anyone on the inside, who knows whether a program will continue and when it will finish, can benefit from this knowledge.
The annual reports of Boeing during the buyback period tersely mention the program, without explaining the intent.
The Schwab Interview
However, in a published interview with a representative from the brokerage house, Charles Schwab, on March 17, 2020, Philip Condit, the Boeing Chairman and CEO, described the first tranche of the program (15% of equity) as follows:
We had an authorization [sic] to purchase up to fifteen percent of the outstanding stock. We are into that process. And we will probably be continuing that program. Again, in a mode of value creation, where we find the kind of opportunities to expand our business, like the aircraft service business, we will.
Those are things we are going to make the investment in, because we think we can produce more value that way. To the degree that we can produce excess cash, we want to return it to the shareholder in the most efficient fashion, and share repurchase is one of those ways.
(‘Charles Schwab CEO Series’ Teleconference transcript, Philip Condit, Chairman and Chief Executive Officer, The Boeing Company, March 17, 2020, published on the Internet.)
It is interesting that this response came late into an hour-long interview conducted by Mr. Thompson, Senior Vice President of Charles Schwab Corporation and a member of the board of the U.S. Securities and Exchange Commission Consumer Advisory Council.
The interview entailed thirty questions, some from the stockbroker, and some from investors in the audience and e-mails.
The question on stock buybacks was e-mailed by an investor and was number twenty-seven out of thirty queries, receiving one of the shortest answers of the interview, with no follow-up from the moderator.
Less Than Full Disclosure
Clearly, stock buybacks, even when absorbing a major chunk of equity, were not a subject on which Wall Street wished to shine much light.
This is particularly curious in the case of the Schwab-Boeing interview, since the multi-billion dollar pressure of buybacks caused the price of Boeing stock to double in the next nine months.
A year later, when the fifteen percent buyback tranche was completed, Mr. Condit was quoted in the media as saying:
We committed [sic] to finishing up the 1998 share repurchase program this year, and that's what we did.
Our goal is to enhance shareholder value, and we see our share repurchase programs as an excellent way to provide immediate current returns, as we position the company for greater valuation over the long term.
(‘Boeing Completes 15 Percent Share Repurchase Program’, Journal of Aerospace and Defense Industry News, December 29, 2020, published at http://www.aerotechnews.com/)
We note that management’s view of the buyback program changed over the months from a mere ‘authorization’ of the board to a ‘commitment’.
If the buyback program was a ‘commitment’, to whom was the promise made, and what was the quid pro quo?
Buybacks: 'A Mode of Value Creation'
Mr. Condit’s explanations were consistent with the logic for buybacks advanced by many other CEOs during the Great Bubble.
He considered that buying back a major portion of equity was “a mode of value creation” with a goal of “enhanc[ing] shareholder value”, providing “immediate current returns”, and “position[ing] the company for greater valuation over the long term.”
He claimed that the buyback program was a way to return “excess cash” to shareholders in “the most efficient fashion”, although it would have been faster, cheaper, and more equitable to simple declare a cash dividend.
Since the majority of Boeing shareholders seem to have been institutional beneficiaries, with stock held in retirement plans benefiting from deferred taxation, even the weak argument of ‘tax efficiency’ was untenable.
More candidly, AeroWorldnet quoted an unnamed Boeing source in 1998, at the time the buyback program was authorized, as saying that that the company hoped to use excess cash to “buoy its lagging stock price.” (From the Internet: http://www.aeroworldnet.com/5in09078.htm )
The Market Provides Excuses
The beauty, in the eyes of corporate executives, of an asset-lite, buyback strategy is that after the stock run-up is over, the market will provide excuses that absolve management from responsibility for a subsequent fall in prices.
There were at least four reasons for the collapse in Boeing stock prices in the second half of 2001.
A Shortage of Money. Having increased its debt and drained working capital, Boeing eventually ran out of money with which to continue to repurchase stock in the volumes needed to influence prices.
Other Stocks Were Falling. The Great Stock Bubble had already been pricked in 2000, and there no longer was a bull market to sustain a buyback program. Buyback programs depend on general market trends for success.
The War on Terror. By flying commercial airplanes into the World Trade Center on September 11, 2020, terrorists dealt a deadly blow to an already sick and over-extended airline industry, including many of Boeing’s prime customers, thereby degrading the company’s prospects.
Changes in Accounting Rules. The fall in stock prices triggered the recursive effect of SFAS Rule 145, which became effective in January 2001, requiring Boeing to write-off $2.5 billion dollars of goodwill posted in earlier mergers and acquisitions, with negative consequences on the company’s financial presentation.
Boeing’s asset-lite management thinking was in tune with its ambitious stock repurchase scheme.
The application of this philosophy in the last years of the Great Bubble produced a short-term boost in stock prices, a weakening of the company’s financial position, and a diversion of corporate assets from long-term shareholders.
The temporary increase in stock prices was beneficial to stockbrokers, fund managers, and company executives with compensation plans linked to stock prices.
Was Executive Pay Justified?
Boeing’s five top executives were paid ninety million dollars (Boeing Company proxy statement 2002) in the three years, 1999-2001, a period in which the company’s return on assets did not exceed 6.3% (Standard & Poor’s report May 2003).
In the same years, an unsophisticated investor could have earned a five percent annual return (Derived from Morningstar published indices) on six-month bank certificates of deposit, with greater safety of principal and liquidity.
Managers of closed-end bond funds gave their shareholders much higher returns on assets, receiving far more modest remuneration.
Boeing shareholders earned an average dividend yield of only 1.3%.
If the buyback money had been used to pay dividends, the cash yield to investors would have been over six percent!
ROE, Buybacks, and Dividends in Perspective
From the Boeing example, we see that ROE is an imprecise and fuzzy indicator of performance.
The numerator (income) and denominator (equity) are determined by management by guessing at income and expense, by borrowing, and by acquiring stock in order to reduce equity.
Two accounts in the financial reports, however, are not subject to doubt: the money spent on buybacks and the cash paid as dividends.
Both are audited outlays and are more important to investors than the nebulous figures of earnings and ROE.
These accounts show how much money had been taken out of the company by shareholders – in the case of dividends by all shareholders, fairly, and, in the case of buybacks, by only some shareholders, unfairly.
In the Boeing example, the company paid $11.3 billion dollars to shareholders as buybacks and dividends in the five years 1998-2002, but only 20% of this was distributed proportionately and equitably to all shareholders as dividends.
In other words, long-term investors received $2.7 billion while speculators, executives, and shareholders who were permanently selling out, received $9.1 billion.
For every dollar that permanent shareholders received as dividends, stock flippers and speculators received four dollars. This represented a huge disincentive to long-term Boeing employees, clients, suppliers, and permanent shareholders.
The company was a jewel in the nation’s industrial tiara, but long-term investors were not first in line to be rewarded.
Tricks with Treasury Stock
One of the enduring holes in accounting logic, is that money used in the purchase and sale of a company’s own shares (treasury stock), is never reflected in profit and loss accounts.
If, in order to benefit Executive X, a company agrees to sell him company shares for ten dollars, and to then repurchase the same shares for twenty dollars, Executive X’s ten dollar profit will not be accounted for as a loss (expense) to the company, although Executive X will have a capital gain subject to tax.
Since the company will not be able to claim a loss for tax purposes, this method of hiding expenses would normally not be used by a non-public company, unless there was a strong advantage to someone who had the authority to approve such a trade.
In the case of Boeing, in line with long- and widely-accepted practice in American capital markets, executives used the sale and repurchase of treasury stock to fortify their options.
Stock buybacks give value to executive options.
However, the link between the sale and purchase of treasury stock is blurred, complex, and subject to many rules and conditions.
For example, the company may not simply trade the stock with an executive at two different prices on the same day.
Both trades must take place on the stock exchange at ‘fair market’, which, in effect, means that there must be a delay between the sale and the repurchase, since stock prices do not normally double in a single day.
Companies have learned that money that otherwise would be tied up during this delay, can be finessed by giving an executive the option to buy stock at a price that is expected to be lower than the market at the time of repurchase.
Executive Options: A Free Ride
The executive holds this option at no cost for months, or years, until the market rises. He then exercises this free call — buying the stock from the corporation, often with money borrowed from the company — and re-sells the stock on the market for a profit.
The problem with this strategy is that there is no assurance that stock prices will rise.
The executive overcomes this difficulty by using company funds to buy stocks from other investors on the exchange, reducing the supply, and forcing prices upwards, eventually cashing out for a profit.
The SEC conveniently condones this practice, granting an exemption from rules against stock manipulation and insider trading.
The SEC training manual teaches investigators to spot ‘pump and dump’ schemes of small-time stock manipulators, while ignoring multi-billion dollar buyback programs of blue chip corporations.
The cost of using company funds to manipulate stock prices is charged directly to the capital accounts – in accordance with the time-honored, treasury-stock loophole in accounting rules.
The trusting, long-term shareholder, whose proportionate claim on assets has been diverted to others, is soothed by Wall Street analysts and, ignorant of this subtle ploy, is blissfully unaware that his pocket has been picked.
Directors have fiduciary responsibility to shareholders, but corporate governance codes do not specify what this means. 
