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Wall Street Journal, June 4, 2009 article


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JUNE 4, 2009

Executives' Stock Deals Preceded Price Drops


New research suggests complex stock-sale arrangements designed to protect executives from declines in their company share holdings often are struck not long before such declines occur.

The deals have long been criticized as opaque and hard for investors to understand. Now, a new study, which jibes with other recent research, shows that after executives strike these favorable deals, share prices tend to decline disproportionately.

The contracts "appear to be used opportunistically because they are followed on average by a share decline and unusual levels of negative corporate events," said Carr Bettis, chairman of Scottsdale, Ariz., research firm Gradient Analytics and co-author of a recent report on the subject.

Known as prepaid variable forward contracts, the arrangements are usually made between an executive and a brokerage firm. The executive typically agrees to deliver to the brokerage a number of shares at a date several years in the future in exchange for upfront cash often equal to between 75% and 90% of the shares' value at the time of the agreement.

If the share price falls in the contractual period, the brokerage absorbs the loss. If it rises, the executive shares in the gains up to a point.

In any case, the executive locks in some value, minimizes losses and retains a shot at some gains, all while maintaining voting rights for a time.

Researchers say they have no specific evidence that executives who use such deals are motivated by knowledge that isn't public.

The New York attorney general last year sought information from some companies that permit the arrangements and looked at how they were disclosed. To date, investigators haven't brought any charges or given any public indications of suspected securities fraud at any of those companies.

[Variable Performance]  

One trend that could help explain the results: Executives often enter such deals when their company's stock has been rising, research suggests, and so may be due for a fall. But researchers say they accounted for that phenomenon and concluded the price declines in these cases were statistically significant.

A report by Gradient, released to clients in April and reviewed by The Wall Street Journal, showed that shares of companies whose executives entered into these hedging contracts fell about 8% more than a peer group of similar companies about a year after the contracts were entered into. The report covers 474 contracts spread over 363 firms from 1996 and 2006.

Gradient's Mr. Bettis, a professor at Arizona State University, has pursued the research for years with colleagues at Portland State University and Southern Methodist University.

A 2007 study of about 100 contracts by Stanford University finance professor Alan Jagolinzer and two colleagues also found correlations between weakness in companies' shares and the contracts.

Some companies, such as Pitney Bowes Inc., have banned the arrangements. "We think it is inappropriate for senior employees to, in effect, bet against the company," said Johnna Torsone, Pitney's chief human-resources officer. The company instituted the ban about three years ago.

The contracts have been used by roughly 400 publicly traded companies, according to Gradient, and aren't as common as share sales as a way for executives to reduce their exposure to their company's fortunes.

Supporters of the contracts say they help executives with concentrated exposure to company stock diversify while retaining voting rights for the shares until the contract ends.

Another way for executives to diversify share holdings is to sell shares on the open market. It is transparent, but can draw the attention of shareholders, and also costs executives voting power.

The tax treatment of the contracts has also come under scrutiny from the Internal Revenue Service, since executives are allowed to cash out their share holdings, but defer capital-gains taxes for years on that cash.

Several years ago, the SEC looked into disclosure issues surrounding the contracts. The IRS didn't comment and the SEC didn't respond to a request for comment.

One company that saw a steep decline after its chief executive entered into one of the contracts is shipping company Horizon Lines Inc. In November 2006, Chief Executive Charles Raymond entered forward contracts in which he committed shares at a price of about $27, according to regulatory filings. In exchange, he was given $5.3 million. By the time the contracts matured in early 2009, the stock had fallen to below $5 a share.

A company spokesman said he wanted to diversify "holdings without losing out in the anticipated growth of the company."

Write to Scott Patterson at and Serena Ng at


Printed in The Wall Street Journal, page C1


Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved




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