Apple this week announced that it will be paying dividends. This has set off, or re-invigorated, some fascinating debates, at places such as Felix Salmon's wonderful blog, about the connection between dividends and stock prices.
Neither in theory not empirically is the relationship obvious. Yes, as Felix says, "if cash leaves the company and goes right into shareholders' pockets, the value of what's left behind goes down, not up." If you treat the payment of a dividend as a one-time event, it necessarily reduces the asset side of the balance sheet, thus also reducing the equity side.
Confirming that conclusion through evidence of actual stock price moves is tricky, though, simply because there are always a number of possible explanations for any given price move. But in 1986 the "Journal of Financial Economics" ran a study that looked at the value of options for stocks that pay dividends, and movements in the prices of those options around the announcement of a coming dividend. It found that a decline in the value of the underlying stock is implicit in options prices.
Dividend policy over time is another matter. It is intuitively plausible that a track record of paying dividends makes companies attractive, serving as a signal of their health and rewarding ownership with cash.
Apple hardly needs to signal that it is healthy these days. This leaves us with the question of the "reward" value of a cash payment. Without dividends, my reward for owning Apple is supposed to be the higher price, and my right to sell some of my shares to get the cash. Getting dividends is an easier sort of reward. It is as if a pigeon in a Skinner box no longer has to press the lever to get the pellet of grain -- the experimenter hands the pigeon the pellet. I suppose you'd get lazier pigeons, but over time that would become the more popular box, for pigeons with a choice.
Here's a link to a somewhat more sophisticated discussion of the economics of it.
Showing posts with label stock options. Show all posts
Showing posts with label stock options. Show all posts
24 March 2012
07 April 2011
Accounting issues
Some thoughts toward what will eventually become chapter 7 of my book, the chapter on Accounting and Valuation.
... The problem is not simply that the wrong accounting choices fool the tax authorities. The problem is not even that they fool investors. For our purposes in this book, the gravest difficulty is that the wrong accounting choice can prove a means by which management fools itself about the value of its company, its reserves of cash and other assets, and its strategic options. ["Big Oil's Accounting Methods" etc. 2006.]
Consider to understand this an accounting issue less obviously tied to inflation than the LIFO/FIFO imbroglio. Consider the question of the expensing of stock options.
In the dotcom-a-go-go years of the 1990s, neither the law nor accepted accounting principles required employers to recognize that in issuing stock options to their employees they had in effect expended enterprise wealth, i.e. stock options were not expensed.
Stock options were a critical part of the compensation package for many of the high-tech start-ups that give those years their distinctive flavor. The practices of not expensing such options allowed start-ups to show a profit sooner than otherwise would have been the case, and this in turn helped keep the original investors happy, while allowing start-ups to bring in new investors.
That was the argument -- when arguments came to be necessary -- for continuing to use stock options without calling them an expense. Yet it was also the argument for calling them an expense. For the obvious problem with the use of stock options was that they diluted the value of the company's equity. At some point some number of the options will be exercised and this increases the amount of stock outstanding -- there is a larger supply of that stock, then, capable of satisfying whatever the market demand may be.
For internal managerial purposes, too, it is important to know what is happening and what is likely to happen to the value of equity. It has a great impact on the company's ability to raise money quickly, on its ability to purchase other firms or to maintain its independence against those who would purchase it, and so forth.
Indeed, one could make an argument that the Financial Accounting Standards Board's politically motivated retreat from an expensing mandate was a signal -- something akin to a starter's pistol -- for the dotcom boom. In 1993 the FASB recommended a rule that would have installed expensing as part of the generally accepted accounting principles (GAAP) in the United States.
[My readers will want to know a bit about what the FASB is, if I have not already provided that info.]
Joe Lieberman (D-Conn.) a Senator from the state where the FASB has its headquarters, sponsored a Senate resolution declaring that the new proposed accounting standard would have "grave consequences" for entrepreneurs.
Indeed, on March 25, 1994, roughly 3,000 gathered at the San Jose Convention Center, in San Jose, California, protesting the threat posed by those distant Connecticut accountants to their beloved stock options. Kathleen Brown, the state treasurer, daughter of the once-and-future Governor Jerry Brown, addressed the crowd.
According to an account in FORTUNE, she shouted, "Give stock a chance," and the crowd loved it.
Lieberman and like-minded folks did manage to kick up enough of a fuss so that the FASB backed down, and continued to allow Silicon Valley and its favorite accountants to pretend that they were giving out something costless.
In face of political pressure, the FASB retreated. It said that in the main body of their books, companies could continue to pretend that options were, in effect, free. The retreat was not complete, though, because the FASB still required disclosure in footnotes.
This seemed like an awkward compromise to everyone, and unsurprisingly debate continued. By 1197 two analysts, Micahel L. Goldstein and Jonathan Freedman, had estimatef that the profits that corporations were showing about 5% the artifact of this rule and increased use of oiptions it encouraged.
The debates were kicked up several notches in intensity after the dotcom collapse. Heck, the debate was on The Simpsons. In an episode that aired in April 2002, ["I Am Furious (Yellow)"], Bart and Lisa were briefly employees of a dotcom company, paid in options. The company goes broke, and the siblings discover that their options are worth $0. But they have one million of them!
Bart to Lisa, "What's one million times zero?" then in a low growl he continues, "and don't tell me zero!"
... The problem is not simply that the wrong accounting choices fool the tax authorities. The problem is not even that they fool investors. For our purposes in this book, the gravest difficulty is that the wrong accounting choice can prove a means by which management fools itself about the value of its company, its reserves of cash and other assets, and its strategic options. ["Big Oil's Accounting Methods" etc. 2006.]
Consider to understand this an accounting issue less obviously tied to inflation than the LIFO/FIFO imbroglio. Consider the question of the expensing of stock options.
In the dotcom-a-go-go years of the 1990s, neither the law nor accepted accounting principles required employers to recognize that in issuing stock options to their employees they had in effect expended enterprise wealth, i.e. stock options were not expensed.
Stock options were a critical part of the compensation package for many of the high-tech start-ups that give those years their distinctive flavor. The practices of not expensing such options allowed start-ups to show a profit sooner than otherwise would have been the case, and this in turn helped keep the original investors happy, while allowing start-ups to bring in new investors.
That was the argument -- when arguments came to be necessary -- for continuing to use stock options without calling them an expense. Yet it was also the argument for calling them an expense. For the obvious problem with the use of stock options was that they diluted the value of the company's equity. At some point some number of the options will be exercised and this increases the amount of stock outstanding -- there is a larger supply of that stock, then, capable of satisfying whatever the market demand may be.
For internal managerial purposes, too, it is important to know what is happening and what is likely to happen to the value of equity. It has a great impact on the company's ability to raise money quickly, on its ability to purchase other firms or to maintain its independence against those who would purchase it, and so forth.
Indeed, one could make an argument that the Financial Accounting Standards Board's politically motivated retreat from an expensing mandate was a signal -- something akin to a starter's pistol -- for the dotcom boom. In 1993 the FASB recommended a rule that would have installed expensing as part of the generally accepted accounting principles (GAAP) in the United States.
[My readers will want to know a bit about what the FASB is, if I have not already provided that info.]
Joe Lieberman (D-Conn.) a Senator from the state where the FASB has its headquarters, sponsored a Senate resolution declaring that the new proposed accounting standard would have "grave consequences" for entrepreneurs.
Indeed, on March 25, 1994, roughly 3,000 gathered at the San Jose Convention Center, in San Jose, California, protesting the threat posed by those distant Connecticut accountants to their beloved stock options. Kathleen Brown, the state treasurer, daughter of the once-and-future Governor Jerry Brown, addressed the crowd.
According to an account in FORTUNE, she shouted, "Give stock a chance," and the crowd loved it.
Lieberman and like-minded folks did manage to kick up enough of a fuss so that the FASB backed down, and continued to allow Silicon Valley and its favorite accountants to pretend that they were giving out something costless.
In face of political pressure, the FASB retreated. It said that in the main body of their books, companies could continue to pretend that options were, in effect, free. The retreat was not complete, though, because the FASB still required disclosure in footnotes.
This seemed like an awkward compromise to everyone, and unsurprisingly debate continued. By 1197 two analysts, Micahel L. Goldstein and Jonathan Freedman, had estimatef that the profits that corporations were showing about 5% the artifact of this rule and increased use of oiptions it encouraged.
The debates were kicked up several notches in intensity after the dotcom collapse. Heck, the debate was on The Simpsons. In an episode that aired in April 2002, ["I Am Furious (Yellow)"], Bart and Lisa were briefly employees of a dotcom company, paid in options. The company goes broke, and the siblings discover that their options are worth $0. But they have one million of them!
Bart to Lisa, "What's one million times zero?" then in a low growl he continues, "and don't tell me zero!"
01 August 2010
Capital One
A passgae from Michael Lewis' book, The Big Short:
"Suddenly [in mid 2002] the market feared that Capital One wasn't actually smarter than anyone else in the industry about making loans but simply better at hiding losses. The regulators had discovered fraud, the market suspected, and were about to punish Capital One. Circumstantial evidence organized itself into what seemed like a damning circumstantial case, the SEC announced that it was investiogating the company's CFO, who had just resigned, for selling his shares in the company two months before the company announced its dispute with regulators and its share price collapsed."
Lewis cites this as a good example of the sort of situation in which a creative options play can flourish. A large move in stock price, one way or the other, seemed inevitable to Lewis' protagonists. With options, one can in essence bet against stasis, or against the minor incremental moves that cluster near the top of the Bell curve. One can bet in favor of one or the other tail of the curve, indifferent to which. This is precisely what Jamie Mai and Charlie Ledley did, quite successfully, in their alter ego as Cornwall Capital.
"Soon after Cornwall Capital laid their chips [pedantic editor -- "its chips"] on the table, Capital One was vindicated by its regulators, its stock price shot up, and Cornwall Capital's $26,000 options position was worth $526,000. 'We were pretty fired up,' says Charlie."
This is a small point within the big picture of Lewis' book, but one I thought worth preserving here.
"Suddenly [in mid 2002] the market feared that Capital One wasn't actually smarter than anyone else in the industry about making loans but simply better at hiding losses. The regulators had discovered fraud, the market suspected, and were about to punish Capital One. Circumstantial evidence organized itself into what seemed like a damning circumstantial case, the SEC announced that it was investiogating the company's CFO, who had just resigned, for selling his shares in the company two months before the company announced its dispute with regulators and its share price collapsed."
Lewis cites this as a good example of the sort of situation in which a creative options play can flourish. A large move in stock price, one way or the other, seemed inevitable to Lewis' protagonists. With options, one can in essence bet against stasis, or against the minor incremental moves that cluster near the top of the Bell curve. One can bet in favor of one or the other tail of the curve, indifferent to which. This is precisely what Jamie Mai and Charlie Ledley did, quite successfully, in their alter ego as Cornwall Capital.
"Soon after Cornwall Capital laid their chips [pedantic editor -- "its chips"] on the table, Capital One was vindicated by its regulators, its stock price shot up, and Cornwall Capital's $26,000 options position was worth $526,000. 'We were pretty fired up,' says Charlie."
This is a small point within the big picture of Lewis' book, but one I thought worth preserving here.
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