Shareholder Proposal Pros and Cons

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By RodgerRafter
October 18, 2002

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Thanks to everyone who participated in last weeks broad discussion:

I'd like to narrow the focus a little for another discussion this week before we get down to writing the actual proposal or proposals.

Topic: Pros and Cons to writing a proposal.

As shareholders, we are the owners of the company, and have a right to determine how things are run. The board of directors are our elected representatives and they have the power to hire and fire top management. We can also write and vote on proposals that can direct management toward a specific course of action. The questions arise: When is involvement by shareholders is a good thing, and when is it meddling that impedes the daily operation of the company?

My own answer is that management should generally be trusted to run things properly until they demonstrate actions that clearly go against shareholder interests. If that happens, shareholders need to speak up to protect themselves. While I think management has done an excellent job in constructing and executing on a business strategy, to the benefit of all, I believe that they've taken other actions that have directly and unfairly enriched themselves at shareholder expense. In these areas, I think it is important for shareholders to speak out and try to change management's behavior.

#1. The Board of Directors is composed almost entirely of current and former corporate executives who have a natural bias toward executive overcompensation, especially with regards to stock options as compensation. I'm not accusing them of being dishonest or corrupt. I'm saying that humans are naturally biased and that in this case, the bias of the board has worked against shareholder interests. As shareholders I think we should try to reconstitute the board with a majority of members who operate from a long-term shareholders perspective.

#2. I believe that the quantity of stock options granted to top executives has been out of line with the value of their contributions to the company, for reasons relating to #1 above. Additionally, the pattern and size of the stock options grants creates short-term motives for managers that go against the long-term interests of shareholders. Example: The top VPs have been receiving grants of around 1,000,000 shares worth of options roughly every 2 years. They are due for their next grants early next year. It is in their personal interest to have the stock price be as low as possible at the time of their grants, as it was for the big repricings in 1997, as well as the large grants in 1999 & 2001. It's also important for them that the stock price is as high as possible when they are ready to exercise them, which may have led to abuse of the share repurchase program in the past and use of insider information that isn't available to the rest of shareholders. It also creates a strong temptation to move revenues and profits from quarter to quarter as a way of manipulating the stock price. While understanding the cycles in the stock price and how they relate to executive options grants has helped me make money personally, the cycles tend to work against the interests of the majority of shareholders.

#3. The shareholder repurchase program has been used poorly in the past. From an old post of mine:

"During 1999 and 2000, Apple fired up their own share repurchase program and bought back 5.05 million shares at an average price of $37.82. This, of course, was a bad use of the program that ended up driving up the price so that managers could make handsome profits on their options. Former VP Mitch Manditch skipped town with over $30 million in profits after only 3 years service to Apple."

Yet, now, with the stock trading barely above the value of Apple's cash in the bank, management appears reluctant to make additional purchases at a fraction of the price. (One possible reason for this is that management doesn't want to move the share price up before the next round of options grants.)

With over $4 Billion in cash and short-term investments, Apple has great potential for manipulating the price of AAPL stock. This can be done to create a gradual increase in price that satisfies shareholders long-term goals, or it can be used to create short-term fluctuations that benefit management and insiders.

Through a proposal, we could conceivably create a policy where Apple was required to repurchase shares along a given uptrend (say 20% minimal increase in Apple stock per year, starting at $14 today).

For example: Apple will spend up to $100,000,000 per month buying shares with limit orders. The bid price will start next week at $14, and increase by 0.35% each week.

If investors recognize that Apple is a pretty safe bet to return 20% per year, Apple would probably not have to use much cash on the repurchase program, and it's highly unlikely that 7,000,000 shares would be sold to them in a given month. To prevent the repurchase program from totally draining the treasury, or to drive up the share price too quickly, other constraints could be added: No repurchases are to be made when Apple's share price exceeds 2 times book value per share.

Of course it's unlikely that Steve and Fred would like to have their hands tied via shareholder proposal. On the other hand, they may have accumulated enough options by the time a shareholder proposal went into effect that their long term interests would be more inline with our own. What do the rest of you think?


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