January 29, 2020

High & Low Finance: Dell’s Ups and Downs With Options

Now, nearly 25 years after it went public, Dell Inc. is reported to be considering leaving the public arena by going private in what would be the largest leveraged buyout in years. The company is no longer viewed as a leader, and its share price is less than it was a decade ago.

For most of its history, Dell appears to have followed advice from investment banks — advice that ill-served long-term shareholders to the benefit of corporate executives. The company paid out billions of dollars to buy back stock, and only last year began to distribute some of the money to shareholders who chose to stick with it rather than bail out.

It has spent more money on share repurchases than it earned throughout its life as a public company. Most of those repurchases were at prices well above current levels.

Here’s the breakdown so far: Cash paid by the company to shareholders who were bailing out: $39.7 billion. Cash paid in dividends to shareholders who chose to hold on to their shares: $139 million. Current market value of the company: about $22 billion.

Along the way, profits for Dell executives from stock options soared to amazing levels, and Michael S. Dell, the founder, chairman and chief executive, evidently concluded he had erred by not taking options during the company’s early years.

In 1994, the company’s proxy stated “Mr. Dell does not participate in Dell’s long-term incentive program because of his significant stock ownership.” That changed in 1995, and in 1998 he received more than 20 percent of the options the company issued. His options eventually produced profits of more than $650 million for him.

This column is not about Dell’s business successes and struggles, which have been well covered elsewhere. It instead looks at the company as an example of financial management and mismanagement — and at the impact foolish accounting rules can have on corporate policies and behavior.

The primary accounting rule involved here was for stock options, but the general rule that companies do not need to record profits or losses on transactions in their own stock also played a role, allowing companies to routinely sell low and buy high without ever reporting a loss.

Until 2005, companies could pretend that stock options they handed out to employees and executives were worthless, and therefore not show them as an expense, as they would if they paid the employee in cash or even in shares of stock. The logic to the rule was that since the options would in the end be valuable only if the share price rose, there was no need to record an expense when the options were issued. Anyway, the companies said, this was a cashless expense. The company would not have to pay a penny, so why record an expense?

Accountants realized years ago that made no sense, and in the 1990s the Financial Accounting Standards Board, which sets American accounting rules, moved to change the rule. Companies, particularly technology companies, reacted as if capitalism itself were under attack. Make them account for options, they said, and people would stop buying their shares and America’s technological innovation would come to an end.

That argument did not persuade the accountants, but it — and a lot of campaign contributions — had more impact on Capitol Hill. In 1994, the Senate voted 88 to 9 in favor of a resolution threatening to put the accounting standards board out of business if it did not back down. The board surrendered, and it was another decade before it recovered its nerve.

One trouble with the argument that no cash was involved was that in practice it was far from true. Many companies, Dell among them, sought to reassure shareholders that they would suffer no dilution through the issuance of stock options, vowing to buy back as many shares as they issued through options.

Floyd Norris comments on

finance and the economy at nytimes.com/economix.

Article source: http://www.nytimes.com/2013/01/18/business/how-dell-became-entangled-in-options.html?partner=rss&emc=rss

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