The New York Times | Market Watch, January 18, 2004 article: "Buybacks Aren't Always a Good Thing" [Questions raised about use of stock buybacks to benefit executives]

Source: The New York Times | Market Watch, January 18, 2004 article

MARKET WATCH; Buybacks Aren't Always a Good Thing

By GRETCHEN MORGENSON JAN. 18, 2004

FEW shareholders of NVR Inc., a large home builder and mortgage lender, have grumbled about the compensation of Dwight C. Schar, its chief executive. Sure, he made $94 million in 2002, mostly by exercising options. But stockholders have become rich alongside Mr. Schar, who bought an interest in the Washington Redskins last year.

A closer look at NVR, however, indicates that management's rewards may come at a higher cost than shareholders may realize.

Like many other home builders, NVR has dazzled as interest rates have dropped. In the last two years, the stock has more than doubled; it closed Friday at $440.

But a decline in interest rates is not all that's driving NVR. So is the company's aggressive share buyback plan.

Since 1993, when the company that would become NVR exited bankruptcy proceedings, NVR has acquired 16.4 million shares for $900 million. Shares outstanding fell to 7.1 million last October from 12.1 million in 1999.

As the stock soared, so did NVR's buyback costs. In 2002, when the company generated $381 million in net cash from operations, it paid $400 million to buy back shares. And in the first three quarters of 2003, cash from operations totaled $280 million while $240 million was spent on buybacks.

So determined is NVR to repurchase its stock that in 2001 and 2002 it paid $7 million in so-called consent fees to get debt holders' permission to buy more shares than its bond covenants allowed. Interestingly, NVR did not deduct this $7 million as a cost when it was paid; rather, it was amortized over the years that the debt will be outstanding, reducing any earnings hit.

Shareholders benefit from NVR's buybacks, of course, because they put a floor on the stock and even propel it. But Carol Bowie, director of governance research services at the Investor Responsibility Research Center, says investors are growing more suspicious of buybacks because they can mask big transfers of shareholder wealth to managers.

NVR's buybacks enrich its executives two ways. First, when executives sell shares, buybacks using shareholder funds relieve selling pressure on the stock.

Given the stock's stunning rise, it is no surprise that insider selling at NVR has been torrid. Through the first nine months of 2003, as the company bought 644,000 shares, insiders sold around 563,000 shares. From May to November, Mr. Schar reduced his liquid holdings by around 40 percent. William J. Inman, president of NVR Mortgage Finance Inc., sold half of his liquid holdings, and Paul C. Saville, chief financial officer of NVR Inc., cut his stake by 27 percent.

But buybacks also bolster Mr. Schar's compensation because some of his incentive pay is based on earnings-per-share growth.

If his compensation were based on aggregate earnings growth, NVR's buybacks would have little effect on his pay. But the buybacks have cut NVR's shares outstanding, increasing earnings per share greatly.

In the first nine months of 2003, for example, NVR's earnings rose 16 percent. But on a per-share basis, they jumped 23 percent.

''If insiders have been selling a lot of stock and the company has been buying a lot of stock, that presents the potential for conflict of interest,'' said Paul Hodgson, senior research associate at the Corporate Library, a governance research company in Portland, Me. ''I don't think it is a particularly good use of net cash flow, and neither does it seem particularly wise to choose a long-term performance target that could be so influenced by management actions.''

A spokesman for NVR declined to comment. To be sure, its shareholders have not protested. Maybe they should start.