Whose interests do directors put first?

Friday, 22nd September 2017 13:00 - by Eric Chalker

It is common for directors to ask shareholders for authority to buy back company shares.  For many private investors this is anathema, because they rarely if ever see any benefit.  Worse, when directors actually use the authority it tends to be at the top of the market, not when the share price is low.  Worst of all, perhaps, is when directors seize upon a share price fall to buy shares for themselves, but not for the company itself so that all shareholders benefit.

In January this year, following a profit warning, the share price of Braemar Shipping Services (in which I have held shares since 2011) dropped to a multi-year low.  This prompted the CEO and three non-executive directors (including the chairman, who previously held none) to buy for themselves a total of 141,057 shares at an average cost of 248p.  At the time of writing, they are enjoying a 20 per cent gain.  The chairman has since assured shareholders that the shares were bought “as a vote of confidence in the future of the (company).”

How nice.  But why did the directors not also use the authority given to them at the previous AGM to buy back shares for the company itself?  To that question there has been no good answer.   If the directors had enough confidence in the company to invest for their own benefit over £200,000 in its shares, why did they not enable all shareholders to enjoy the expected bounce by reducing the number of issued shares?  Why else ask for the authority to do buy-backs?

Shareholders’ interests are not served

This is not the first time I have come across a failure to use the buy-back authority when the share price is low.  One notable example was Barratt Developments.  In December 2008, its share price fell to just over 50p, a catastrophic fall from nearly 1250p less than two years previously.  The balance sheet at the end of June 2009 showed net current assets of almost £3bn, with a current ratio of 4.4.  Cash flow was positive.  The board had authority to buy back shares, but it had not done so.  At the AGM, I asked why not, but the chairman could offer no explanation.  If not in those circumstances, I asked, what conceivable circumstances would trigger a buy-back?  Silence.

If ever the buying back of a company’s shares could be justified, the situation faced by Barratt Developments in 2008/9 was certainly one example, yet the directors failed to act.  The reason may be that they simply didn’t think about it but, whatever the explanation, it shows how little thought goes into preparing AGM agenda.

Unfortunately for those who use their own money to buy shares, it is also foolish and costly.  When the times are good, a buy-back authority makes directors vulnerable to pressure from brokers and others on the inside track to make use of it.   It is not so long since this is what happened at Rolls-Royce and Aberdeen Asset Management (neither of which I owned at the time), when the more those companies bought back their own shares the more the price fell.  They deprived themselves of the full equity cushion they originally had, which did nothing for those still holding the shares, yet left the directors less able to deal with the downturn in business which was why the share price fell.

Dixons’ directors rush to buy, but only for themselves

In 2007, when I was a shareholder in Dixons International, the directors used their authority to buy back shares at the top of the market.  It was a gross mistake.  Shareholders suffered.  By the end of the year, the company had run out of money, the dividend was cut, the pension deficit got worse and the share price sank well below what the board had paid.  That was buying at the top.

The reborn company, Dixons Carphone, has now suffered a 30 per cent fall in its share price, following a profit warning.  It is of course too soon to say whether this is the bottom, but the directors clearly think so, because they quickly spent £400,000 of their own money to buy 224,884 shares.  They will say, of course, this is just to show confidence in the company, but it is difficult to believe there is no element of self-interest, even though not yet apparent. 

There is nothing wrong about that, of course, but as they have so much confidence in the company, why have they not taken action to benefit all shareholders, by reducing the number of shares in issue?  Did the directors have authority to buy back the company’s shares?  Yes.  Did they do so?  No.  Before I became aware of the directors’ share purchases, I wrote to the chairman, Lord Livingston, to urge him to use the buy-back authority to add value to investors’ holdings by reducing the number of shares in the market; the reply, sent on his behalf, simply sidesteps the matter. 

Is it dereliction of duty?

When shareholders, at the behest of the board, have given directors authority to buy back shares but directors don’t do this when the share price has collapsed while the business is still viable, could it be called dereliction of duty?  It is certainly shocking, especially when directors have shown by their own share purchases that a buying opportunity exists.  It also exposes the robotic manner in which resolutions are put before shareholders, year after year, with no evidence that their purpose has been properly thought through.

Prior to 1985, it was illegal for companies to finance the purchase of their own shares: what was the argument that persuaded Parliament to change this law and did its members even know what they were doing?  It certainly appears that company directors do not know what they are doing, when they ask for the authority, use it when share prices are high and fail to use it when they are low. 

Eric Chalker, UK Shareholders’ Association Policy Co-ordinator & Director, 2012-2016

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.