WFU Law School
Law & Valuation
3.4.2 Cash Flows

Kamin v. American Express Co.

Kamin v. American Express Co.
383 N.Y.S.2d 807 (Sup. Ct. 1976),
aff'd, 387 N.Y.S.2d 993 (App. Div. 1976).

Professor Elliott Weiss explained the remarkable decision of the Ameridca Express board to forego tax savings in pursuit of the appearance of earnings:

In 1972, American Express bought almost two million shares of Donaldson, Lufkin & Jenrette, Inc. ("DLJ") common stock for about $ 30 million. Three years later, when the stock price had declined to about $ 4 million, American Express announced that it would distribute the stock to its shareholders as a dividend.

Two American Express shareholders urged the company to sell the DLJ stock, rather than distribute it as a dividend. They pointed out that if American Express sold the DLJ stock, it could reduce otherwise taxable capital gains by an amount equal to the roughly $ 26 million loss it would incur on the sale of its DLJ stock and thus save approximately $ 8 million in federal income taxes. On the other hand, by distributing the DLJ stock as a dividend, American Express would lose this potential tax saving and would provide no significant tax benefits to its shareholders. Put differently, if the board wanted to pay a dividend to shareholders, by selling the DLJ stock it would be able to distribute $ 12 million (the sale price plus the tax savings) in cash, which shareholders surely would prefer to receiving DLJ stock worth $ 4 million.

The American Express board of directors considered the shareholders' argument and then rejected it. The board had previously been advised by American Express's CPAs that if American Express distributed the DLJ stock as a dividend, instead of selling it, American Express could account for the transaction by reducing its retained earnings by the $ 30 million it had paid for the DLJ stock--the value at which American Express continued to carry that stock on its books. The advantage of this treatment, from the board's point of view, was that it allowed American Express to avoid reporting a loss of $ 26 million on its investment in DLJ and reducing its reported earnings by a like amount. The board was concerned that reporting such a loss, and a resulting reduction in American Express's income, would have a serious negative effect on the market value of American Express stock.

The dissident shareholders then sued to enjoin payment of the dividend. The court responded by dismissing their complaint, reasoning that, absent evidence of bad faith or a dishonest purpose, the board's decision was entitled to the protection of the business judgment rule.

Kamin illustrates the power of the business judgment rule. [It represents] a holding that, once the plaintiffs had conceded that the American Express board considered the tax advantages of selling the DLJ stock before deciding to distribute that stock as a dividend, no questioning of the board's demonstrably foolish decision would be entertained. The court was not moved at all by the fact that it did not serve the interests of American Express's shareholders for the board to forego $ 8 million in tax savings so as to avoid reporting American Express's loss on its investment in DLJ, especially since any investor interested in American Express would have found it very easy to learn that American Express had in fact incurred that loss, since information on both American Express's investment in DLJ and the decline in value of its DLJ stock was publicly available.

[C]orporate managers often "massage" financial data in order to present to the world the financial picture that they wish to present. It apparently was worth $ 8 million (in shareholders' money) to the board of American Express to avoid reporting the loss occasioned by their investment in DLJ.

Elliott J. Weiss, Teaching Accounting and Valuation in the Basic Corporation Law Course, 19 Cardozo L. Rev. 679 (1997) (Prof. Weiss is Charles E. Ares Professor of Law, University of Arizona College of Law). For discussion of management attitudes toward paying dividends, see Bauman, Weiss & Palmiter - Chapter 9 (West Group 2003).

BNA Corporate Accountability Report - February 13, 2004
By Andrew M. Ballard

Majority of Companies Will Sacrifice Value To Meet Earnings Expectations, Survey Finds

Three-quarters of surveyed corporations would knowingly sacrifice shareholder value to meet earnings expectations, according to a study released by Duke University and the University of Washington Feb. 9.
According to "The Economic Implications of Corporate Financial Reporting," financial executives are focused on short-term results and are willing to sacrifice long-term value to achieve them. The study also found that the short-term focus stems, in part, from unintended consequences of the Sarbanes-Oxley Act of 2002.

John R. Graham, professor of finance at Duke's Fuqua School of Business and one of the authors of the study, told BNA that he and the other study authors were surprised at the large percentage of companies willing to take or delay real economic action instead of making legal accounting adjustments. Graham said he also was surprised that financial executives were willing to admit that attitude during surveys and interviews.

Graham and the other study authors surveyed 401 financial executives and asked them about their attitudes regarding the reporting of earnings, motivation to manage earnings, and their choice of techniques to manage earnings. Graham said in-depth interviews were conducted with an additional 20 financial executives on those issues.

According to Graham, 78 percent of the surveyed executives said they would knowingly sacrifice some value in exchange for smooth earnings. And 55 percent of those surveyed would delay starting a project to avoid missing an earnings target, even if it meant sacrificing value, he said.

Tilt Toward Economic Decisions, Rather Than Accounting Choices

The surveyed executives were "leery of making perfectly legal accounting choices" and instead were more willing to make economic decisions that were less optimal for long-term value, Graham told BNA. He said the discomfort with using accounting to adjust earnings reported stemmed from Sarbanes-Oxley.
Sarbanes-Oxley was enacted following a number of high-profile accounting scandals. The law imposed additional requirements on financial reporting and corporate governance. Missing earning targets or reporting fluctuating earnings generally reduces stock prices because investors and analysts "hate uncertainty," according to Graham. "If you miss a target, your stock price will get punished," he said.

In addition, "missing an earnings target is seen as an indicator of more widespread problems," according to Graham. It is "like seeing one cockroach, you know there are 100 behind the wall," he said.

Steady earnings also tend to build a firm's credibility in the financial market, Graham told BNA.

According to Graham, although "you can't totally put the blame on Sarbanes-Oxley," firms are changing their accounting numbers less often since its enactment. Graham also said he believes companies are sacrificing value more now, but does not have the historical survey information to assert that.

Regarding Sarbanes-Oxley, Graham said lawmakers and regulators need to realize that "when you put in one set of rules, there can be a negative reaction."

Graham said the short-term focus on earnings is driven by investors in and analysts of the nation's financial markets and "I don't know exactly what you can do about it."

Although the study authors are likely to conduct additional research on the issue in the future, none is planned at this time, Graham told BNA. Graham was joined in authoring the study by Campbell R. Harvey, a Duke business professor and analyst with the National Bureau of Economic Research in Cambridge, Mass., and Shiva Rajgopal, a business professor at the University of Washington in Seattle.

Nothing New, Carlton Says

According to Alfred P. Carlton Jr., a corporate and finance attorney with the Raleigh law offices of Kilpatrick Stockton and immediate past president of the American Bar Association, the findings of the study are "nothing new." Under Carlton's watch at the ABA, the association released task force recommendations aimed at improving corporate governance in the wake of corporate scandals and the enactment of Sarbanes-Oxley.
Publicly traded corporations have long focused on short-term gains at the sacrifice of long-term value, Carlton told BNA. The pressure to do so was one of the primary causes of corporate misstatements of earnings that led to the Sarbanes-Oxley law, he said.

"To say [the focus on short-term gains] is a result of sort of disingenuous," according to Carlton. "While it may continue to encourage that [focus], it certainly isn't, in my thinking, the cause of it," he said.

Copies of the study are available from the Social Science Research Network's Web site at


3.4.2 Cash Flows

©2003 Professor Alan R. Palmiter

This page was last updated on: March 24, 2004