Letter to Financial Journalist

Please don't take what I'm going to write here personally. Rather it is a feeble attempt to inform. Everything you wrote in the story is true. However, I am more concerned about what you left out. I think it is very important for financial journalists to make a distinction between buybacks that shrink the share count and buy backs that do nothing to shrink the share count. No doubt, the latter concept is foreign to you, because how can a share buyback do anything but shrink the share count.

Let me explain: FASB, the SEC, Congress, the accounting profession and corporate America conspired to institute a system whereby company's can pay employees with stock options. I like to call it "coupons." The rules devised by these parties, determined that wages paid with coupons are not an expense. Interestingly, when employees cash in the coupons on NASDAQ, employers are allowed to claim as a tax deduction the economic value of the exercised options (coupons), that is, the difference between the market value of the stock and the strike price. In plain English, management got the green light from the gatekeepers to inflate earnings by omitting a material compensation expense. At the same time, the IRS gave management the green light to expense a stock-based compensation expense, even though management strongly opposed any moves to bring the same expense into the income statement. I'm not making this up.

So, visualize the following situation: An employee receives redeemable coupon as wages, goes to NASDAQ and redeems these coupons, which has the effect of inflating the share count. Management then takes hard-earned cash to buy back these shares to bring the share count back to where it was before it issued the stock to the employee in lieu of cash wages. This "we'll-pay-with coupons-at-the-front-door-and-redeem-it-at-the-back-door" approach to compensation achieved three objectives, all of which ensured that a handful of insiders picked up compensation packages of such magnitude that would make the Royal Household of Saudi blush or go green with jealousy. The side effect of all this largesse that nobody wants to talk about is that after having received the billion of dollars in ill-gotten wages, the companies of these "forty thieves" imploded and the American worker who had his/her retirement funds invested in these entities bore the brunt of the losses.

The first objective was to inflate earnings by the omission of a material compensation expense. The second objective was to gain a material tax deduction for stock-based compensation that actually did not result in any cash outflows - well, not at the time when the options were exercised, but eventually the cash outflows do occur. This brings us to the third objective, which is when the cash flows do occur they are not shown as the settlement of a deferred compensation liability, but rather in the financing section of the cash flow statement as a capital allocation.

The point I'm making is, when a company buys back the stock it issued to its employees, it can in no way be described as a stock buyback in the conventional sense of the word. The accounting rules and disclosures conspire to make it look like a conventional stock buyback, but you and I should be smarter than to fall for such deceit.

Don't think like an accountant (sadly, I'm a CPA), think like an economist or, better still, like fifth grader. If you pay someone's wages in kind and you then buy back the item in kind, surely that repurchase, once you cut through the noise, is nothing more than just a wage-related expense.

You are correct when you write, "The flood of dividends and share buybacks is a direct result of record US corporate profits…" You are correct, but for the wrong reason. These profits are illusionary. They do not include the stock-based compensation that companies deduct for tax purposes. If you cross the border to Canada, you have to expense the cost you claim as a tax deduction - no such "record" profits in Canada. Either stock-based compensation is an economic expense or it is not, a national border should not be the deciding factor.

To prove that these profits are illusionary one can first point to the tax deduction, i.e., taxable income is much lower. To hide the fact that a company's taxable income is so much lower that its "record" pre-tax profits, FASB allowed companies to put through a bogus journal. (This is for another day.) Secondly, and this is my point, these record profits evaporate when you deduct the cost of stock buybacks, which we have established above are disguised compensation payments.

Don't get conned by stats showing that companies reduced their share count this year. Go back to the days when they issued stock to employees like confetti. They are still buying back stock they issued to employees in past years. So, Cisco bought back 350 million shares this year and spent $11 billion in doing so, more than they made in two years. Guess what? Cisco has another 1.3 billion shares coming down the pike from stock option exercises. These stock buybacks that we see today are mere wages in disguise. Financial journalists at respected publications like the Wall Street Journal should expose the deceit, not go along with it. Don't take this personally, but your story totally missed this crucial point.

Albert Meyer