Shareholder/Option Holder Profit Splits on Stock Buybacks as a Measure of Liability (#10) - Summary of 11 Case Studies (AMAT, CSCO, CY, INTC, NSM, NVDA, ORCL, SNPS, SYMC, TXN, XLNX)

Abstract

The rapid growth of corporate stock repurchase programs raises questions pertaining to fiduciary responsibility for which the courts likely will be the ultimate arbiters. In the interim, some aspects of corporate liability can be gauged. For instance, if a company issues options equal to 25% of outstanding shares, then, in theory, shareholders/option holders to split future stock profits 80/20. Dividends, however, escape the contract and are paid exclusively to shareholders. To solve the dividend dilemma, corporations favor buybacks. Yet, buybacks tilt returns, too, but in favor of option holders. Measurement of the degree to which buybacks break the contract by delivering benefits skewed to option holders is one quantitative gauge of potential liability. In 11 case studies of companies that conduct $90.6 billion of buybacks in 2004-2007, the average company has an option plan that suggests shareholders and option holders will split future equity value growth 85/15 in favor of shareholders. However, the split from buyback benefits actually is 43/57 in favor of option holders. The 42 point excess return to option holders on average amounts to $1.013 billion per company. It is equivalent to a cost per share of 2.2% borne by shareholders. The capitalized cost to shareholders of the excess return to option holders from buybacks equals 13.7% of the average company's current stock price and is akin to a dividend paid by stockholders to option holders. Whether the skewed division of buyback profits is fair and reasonable depends upon the particular circumstances of each company.