Another symptom of equity-market distress. And the New York Times also provides an interesting discussion of the behavioral implications of corporate officers borrowing against their holdings:
When executives own big stakes in the companies they run, investors can rest a little more easily at night, knowing those managers have the shareholders’ best interests at heart.
Except when maybe they don’t….
Already this month, there have been about $1 billion in sales by company insiders dumping stock to meet margin calls, as lenders’ demands for the stock sales are known. According to Equilar, an executive compensation research firm in Redwood Shores, Calif., executives at three dozen companies have disclosed such sales since October….
Under Securities and Exchange Commission rules, executives are typically required to disclose insider sales within two days of making them and indicate why they were sold, including as a result of a margin call. But experts say there are no rules requiring that the public be told ahead of time that an executive has pledged stock in a margin loan or how the borrowed money is being used. It might be a loan to buy more shares of the company’s stock — which would indicate a vote of confidence in the shares. Or it might be a loan to buy some other company’s stock or something else altogether — possibly a sign that the executive thinks there are better places to invest.
“The disclosure rule is vague,” said Ben Silverman, director of research at InsiderScore, which tracks the buying and selling of company insiders.
Over the last 25 years or so, investors have come to take on faith the need for executives to own significant amounts of company stock, as a way to make sure the interests of the people running a company are aligned with those of the shareholders. But the ability to use the shares as collateral for a loan may change that dynamic, said Charles M. Elson, a corporate governance expert at the University of Delaware.
“It may be at certain levels de-aligning,” he said. Although individual circumstances may not require public disclosure of an executive’s decision to pledge the stock, Mr. Elson said, he argues that the boards of directors should be told.
Paul Hodgson, a senior analyst at the Corporate Library, a governance research group, says it is too easy for investors to be misled when executives are not holding the stock outright. “The disclosure is a problem,” Mr. Hodgson said. Most investors will look at the executives’ holdings in the proxy statement, he said, and say, “ ‘They own a lot of stock — they are really committed.’ ”
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I don’t quite agree with the thesis in the NY Times article that executives who margin their shares have misaligned their interest with other shareholders. These executives have in effect borrowed to fund their stake, in effect applying leverage to their position. However, they are still long the equity, and would benefit when share prices go up, and therefore, their interests are still aligned with minority shareholders.
“the ability to use the shares as collateral for a loan may change that dynamic, said Charles M. Elson, a corporate governance expert at the University of Delaware.”
Simply borrowing against shares doesn’t undercut equity ownership. Executives that borrow against shares have every incentive to keep their company’s stock up so that they won’t lose money in order to cover borrowings.
What undercuts equity ownership is when executives have hedges of their equity positions, through put forward sales, options, equity swaps, etc. Those things should be disclosed, especially if coupled with borrowings from the counterparty, such that they’ve hedged risk and gotten cash in hand.
I think $1 billion may be underestimate. McClendon and Simpson (CHK and XTO) alone are more than $1 billion. I guess it depends on where the stock was sold:
Chesapeake CEO Forced to Sell All His Stock (and implications for NG
I have to counter this premise of “They own a lot of stock — they are really committed” since I’ve encountered that attitude in quite a few people. I’d say the real problem is that stock prices are decoupled from the overall company performance they are meant to reflect. It’d be more accure to say that the execs are committed to jacking the numbers so that the stock’s doing well just in time for their options to be exercised. Then crashed when it’s time to be gifted more shares.
As for the premise of the article, I agree that the disclosures are too few and too vague to be of help to the avg shareholder. I’m a big fan of cash accounting, no intangibles, no booking future sales ahead. I feel the CEOs job is to get the productivity of the company up, not to play accounting tricks. I’m not very popular with the MBAs at parties…
I agree with anon-6:34.
Merely borrowing against your stock holdings doesn’t necessarily undercut your incentive, since you still want that stock to improve in value, and you will still be materially affected by future movements in the stock price.
But my understanding is that many, many CEOs and other executives with stocks execute hedges and other arrangements so that they can essentially “sell” their stocks (i.e. get cash based on current price, with no further gain or loss based on future movements in the share price) without actually selling them so as to avoid having to disclose that insiders are dumping their stock. This is the real travesty, and should be required to be reported. Unfortunately, I’m not sure how the SEC can require reporting since most of these hedges are private arrangements.
Exactly. Pledging something as collateral doesn’t decrease your exposure in any way. The real question is, are executives required to disclose short positions they hold in the company stock (or bonds)?