Harvard Business Review Condemns Buybacks (Almost)
I make a habit of reading the Harvard Business Review to check on the current degree of moral ambiguity being washed into the brains of future business leaders at America’s leading MBA factory.
The September 2006 issue of the Harvard Business Review featured a lead article, “Ten Ways to Create Shareholder Value”, by Alfred Rappaport, Professor Emeritus at Northwestern Univerity’s Kellog Graduate School of Management.
Professor Rappaport also authored the best seller, “Creating Shareholder Value: A Guide for Managers and Investors”.
In the Harvard Business Review article, Professor Rappaport says,
“Value-conscious companies repurchase shares only when the company’s stock is trading below management’s best estimate of value and no better return is available from investing in the business. Companies that follow this guideline serve the interests of the non-tendering shareholders, who, if managements’ valuation assessment is correct, gain at the expense of the tendering shareholders.”
Professor Rappaport’s view is in line with Warren Buffett’s recent criticism of buybacks (See: “Warren Buffett Attacks Buyback-Option Schemes“) and a growing willingness among more progressive business thinkers to question the wisdom of the trillion dollar stock buyback movement that has so distorted the equity market for over a generation.
Of course, Professor Rappaport’s comparison of stock buybacks to a tender offer is not at all accurate. Buybacks are conducted on the open market under rules of secrecy. Selling shareholders have no idea whether a particular transaction is part of a buyback program or not.
Since most stock buybacks in recent years have been executed at prices considerably higher than any reasonable estimate of corporate value, based on management’s desire to boost value of their stock options, it follows that if corporate America were to take Professor Rappaport’s advice to heart, the major buying force supporting equity prices today would be removed and the stock market would crash.
The Ethics of Screwing Your Own Shareholders
Now, Professor Rappaport’s forgiving attitude of a company gaining “at the expense of the tendering shareholders” would not at all have been condoned by Benjamin Graham, Warren Buffett’s personal guru and the father of value investing.
Benjamin Graham and David Dodd in the investment classic, ‘Security Analysis’, opposed buying back stock on the market, even when done at less than intrinsic value, as shown in this quote:
During the 1930-1933 depression repurchases of their own shares were made by many industrial companies … The stock was bought in the open market without notice to the shareholders.
This method introduced a number of unwholesome elements into the situation. It was thought to be ‘in the interests of the corporation’ to acquire the stock at the lowest possible price.
The consequence of this idea is that those stockholders who sell their shares back to the company are made to suffer as large a loss as possible, for the presumable benefit of those who hold on.
Although this is a proper viewpoint to follow in purchasing other kinds of assets for the business, there is no warrant in logic or in ethics for applying it to the acquisition of shares of stock from the company’s own stockholders.
The management is the more obligated to act fairly towards the sellers because the company itself is on the buying side.
In other words, Professor Rappaport’s conditioned condoning of buybacks that cheat selling shareholders might be compared to John Ehrlichmann’s famous phrase from the Watergate era, — it is a “modified limited hangout” — a symptom of ethical ambiguity.
Whatever happened to fiduciary responsibility?
In any event, the Harvard Business Review article implicitly condemns most of the reasons used to justify stock buybacks during the 1990s (See: “The Great Misleading“), and in this way reminds me of the old joke about three lawyers at the bottom of the ocean — it’s a good start.
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