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
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
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
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
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,"
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,"
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
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,
"To say [the focus on short-term gains]
is a result of Sarbanes-Oxley...is 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 http://ssrn.com/abstract=491627.