Exec Stocks: Selling the Right WayZoom inDownload PDF
No director wants to see his or her company cited in the newspaper for executivepay transgressions. Especially not on the front page of The Wall Street Journal. And especially when the reporter suggests stock sales from an executive-pay plan hurt shareholders. But that’s what happened on Nov. 27, in what might be called the Thanksgiving Surprise: CEOs of companies ranging from Big Lots to VeriFone Systems saw their photographs published for questionable trades of incentive stock.
The Journal did not say it had uncovered wrongdoing. But as its story detailed multiple sales of stock occurring just before the release of bad news, it gave a potent impression: Executives profited unfairly by trading on inside information. The story also bolstered the case that such sales can be taken as a signal to outsiders that good times have passed — and investors can use the information to bet against a company.
To be sure, history’s annals suggest there has been unfair profit taking from nonpublic information. And executives’ disposal of large blocks of stock may signal a good time for investors to sell. But can we conclude that such is the case generally? Research by Semler Brossy Consulting Group suggests not. In a study of executive stock sales in a sample of the 100 largest S&P 500 firms over the last five years, company shares actually outperformed the market 63 percent of the time in the 90 days after executives sold their stock. To put a finer point on it, we found that buying stock when a CEO was selling turned out to be a profitable short-term investment strategy. So much for the signaling of CEO stock sales.
This is counterintuitive. It suggests that news of executive sales has questionable value as market-moving information. The challenge remains for directors, however: Both they and executives need to devise a policy to support stock sales that are fair and above reproach.
Coming up with a policy remains pressing as investors and proxy advisors like Institutional Shareholder Services (ISS) and Glass, Lewis & Co. continue to demand that firms align executive pay with performance — and use stock and stock instruments to do so. It also remains pressing because investors increasingly advocate longer holding periods for stock. The desired period may be a year, several years, or even into executive retirement. Creating policy is complicated by regulations governing approved trading windows.
Our experience suggests that corporate boards can and should monitor stock holdings for senior executives, and they should encourage stock sales to enable the executives’ moderate, appropriate, and transparent diversification. Three factors should be incorporated into company policies:
- In compliance with insider trading rules. Directors should urge executives to draw up 10b5-1 plans (structured stock-sale plans allowed by the SEC since 2000 for the periodic and orderly sale of stock). Semler Brossy research shows that 20 percent of larger companies today disclose they have 10b5-1 plans for executives, although the disclosure of such plans is voluntary and the percentage of firms with them is undoubtedly higher. If appropriately structured, the plans protect against insider-rule violations and give executives many options for stock selling. Boards can help establish guardrails on how executives use the plans. For example, policy could require plans only be established, modified or canceled in “open windows” and during a time when both the executive and the Company can verify that material non-public information is not at hand.
- Transparent to investors. Executives and boards can avoid getting caught in a net of bad publicity with two policies. The first is a clear and publicly disclosed share-retention guideline. How long are executives expected to stay invested in the stock? The second is voluntary disclosure of the presence of 10b5-1 plans. Are executive stock sales following anything but executive whim? Investors and analysts can then readily see that company executives are committed both to holding a concentrated position in their firm and to diversifying their holdings in a regular way.
- Transparent to the board. More often than not, those most surprised by executive stock sales are board members. Directors know better than most the meaning (or lack of meaning) of executive stock sales. When the sales fall out of pattern, they can deduce more than outsiders. Some board members may hear about sales after the fact, or even after they have been reported from company filings. We advocate a board policy in which the board compensation committee is informed of potential or intended sales. Unusual or large sales — especially by the CEO or CFO — may warrant alerting the full board.
The crucial lesson is that directors should assure there is a policy to alert investors affirmatively, in advance, that executives will part with stock in an orderly way. With the right policy, stock sales will not be taken as signaling a weakening of confidence in the company’s future. They will simply give further proof that the board has done its job: It has explicitly balanced rewards, risks, and alignment with shareholder interests.
This article by Roger Brossy originally appeared in NACD Directorship.