It was only Bart Demosky's 18th day on the job as Canadian Pacific's (NYSE:CP) new executive vice president and chief financial officer, but he found himself in an enviable position as the company prepared to announce strong fourth-quarter results.

It was a cold, snowy day in January, but at Canadian Pacific's Calgary head office the atmosphere was anything but chilly. The railroad was coming off one of its best years ever: record revenue, an all-time low operating ratio, and improved productivity across the board. It was sitting on a lot of free cash, too... $530 million to be precise.

During the conference call with investors and analysts, Demosky noted on several occasions that the railway expected strong free cash generation to continue. Unwilling to provide official guidance, Demosky did suggest it would be in the range of $1.0 billion-$1.5 billion for 2014.

Hunter Harrison, Canadian Pacific's chief executive officer, was noncommittal on how the company would allocate the additional capital, other than to say a share buyback program, dividend raise, or both would be considered.

Share buyback
It didn't take long for Harrison and the other members of the board to agree on how to spend some of that money.

Just last month, Canadian Pacific unveiled a share buyback plan to purchase up to 5.3 million shares, or about 3% of the total outstanding, over the next year. Based upon the company's current share price on the New York Stock Exchange of $145, the value of the program could reach nearly $770 million.

Unfortunately, the case for share buyback programs increasing shareholder value is a difficult one to make.

First of all, there is the issue of timing. It is often the case that boards decide to repurchase shares when times are good, they have lots of free cash, and not coincidently, the company's stock is doing exceedingly well. With its stock approaching an all-time high, now may not be the most prudent time to begin buying in the name of creating shareholder value.

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There's also the issue of who benefits. A new research paper written by William Lazonick of the University of Massachusetts Lowell noted that in 2012, the 500 highest-paid executives in the United States received an average pay of $24.4 million -- 52% from stock options and 26% from stock awards.

By reducing the number of outstanding shares and increasing various per-share measures, including earnings per share, share buyback programs often provide a boost to the value of stock-based pay.

"The more one delves into the reasons for the huge increase in open-market [share] repurchase since the mid-1980s, the clearer it becomes that the only plausible reason for this mode of resource allocation is that the very executives who make the buyback decisions have much to gain personally through their stock-based pay," Lazonick said.

Dividend increase
Opting first for a share repurchase program has little to do with retail investors, and much more with large, U.S. institutional investors that pay more tax on dividends from Canadian companies than their counterparts north of the border do.

The railroad last raised its quarterly payout to $0.35 per share in April 2012. In terms of returning cash to shareholders, Canadian Pacific is a laggard compared to other Tier 1 railroads. Today, Canadian Pacific offers investors a dividend yield of just 0.80%, whereas most competitor's stock provides a yield of around 2%, with the most generous being Norfolk Southern (NYSE:NSC) at 2.2%.

Foolish bottom line
Despite the size of the share buyback program, which is larger than most analysts were expecting, it's likely that Canadian Pacific will announce a dividend increase when it releases its first-quarter results on April 22.

Unfortunately, the dividend raise will likely be small. This suggests that Canadian Pacific's board of directors places the interests of large institutional investors and senior management above the average retail investors.