Every stock market investor is on the lookout for the early signs that stock might fly or dive, and plenty of stock watchers will religiously follow the buying or selling habits of directors as a portent of future confidence or lack of.
So the argument goes: If the directors are buying then they are likely to exceed expectations, if they’re selling it’s likely that they’ll disappoint. An extension of this approach favour stocks where the board have a significant shareholding, rather than those who have less "skin in the game".
In reality this theory is a false indicator and worse, it shines a light on a very peculiar problem which can be summed up with the following question: when can a CEO sell shares without selling shareholders short?
The answer from most is “never, and why should they? If they believe in the business they should never want to sell and should actually be out buying more to encourage other investors to do the same. Sure, it’s OK for them to share in a progressive dividend, or to be increasingly wealthy on paper, but to actual realise any of these returns the humble CEO can only do so on exit, be it a trade sale or a takeover.”
Selling, of course, is anathema and doing so is a clear sign that the directors have no confidence in the future of the company. Yet, with the new EU-wide Market Abuse Regulations in place to crack down on insider dealing why would a director even risk selling share ahead of bad news?
Far more likely is that the sale is taking place because the director needs to settle a tax bill, or has decided to buy a new house or a house of their offspring, or as part of a divorce settlement, or perhaps even wants to cash for other business ventures. It seems that the normal rules of investment don’t apply to the board: there is no opportunity to take profits, and how dare you attempt to balance your own portfolio (don’t forget for many smaller AIM companies the CEO may have all of his entire wealth in this business and these maybe the only shares they own).
Sadly, when companies put out RNS announcements heralding director share sales they don’t explain why they need the money, nor would they welcome an obligation to do so – although that said, I do remember investors welcoming the openness of one of my clients who on nearing retirement sold some of his shareholding and explained that he was co-investing in his son’s new restaurant in California.
But if the criticism of selling wasn’t bad enough, there’s also the cynicism around acquiring shares, particularly as few directors increase their shareholding through a market purchase. The debates over incentive plans and options packages are legion, but what also animates shareholders is participation of directors in discounted placings, giving the lucky few a chance to buy in at the usual 10 per cent discount to market, but leaving the vast majority of investors out in the cold.
I know from experience that this hits retail investors hard as they understand the Institutional Investors wanting their pound of flesh, but to see the directors join in whilst they have to pay market price to top up is particularly hard to stomach. Directors are pulled both ways as often the Institutions insist on seeing some director participation to show their commitment.
The best solution I’ve seen so far is for the directors to pass on the discounted placing but provide a commitment that they will buy shares, but only after the placing is completed and they will do so in the open market like any other shareholder.
This is a far more honourable approach and shows solidarity with the smaller shareholders. Perhaps if more directors did this investors might be more forgiving if they do need to sell some of their shares at a later date?