How Executives Use Stock Market Manipulation For Personal Gain

In recent times, there’s been no shortage of stories about unethical and dishonest CEOs and executives, accused of stock and earnings manipulation. What persistent questions is not just why boards hire such people to begin with, but also, do boards select these individuals for these behaviors?

Definition and Examples of Stock Market Manipulation

Jeffrey Green, writing in The Balance, defines market manipulation as “an intentional effort to deceive and defraud investors by artificially affecting the supply or demand for a security and driving its price up or down. Those who orchestrate artificial price movements then profit from them at the expense of other investors.”

According to a story in the Washington Post, Company insiders are selling stock during buyback programs and making additional profits when stock prices jump. And it’s legal.

Gary Putka, writing in The Washington Post, describes the stock manipulation in the company Activision Blizzard by company insiders which was $1 billion program to buy back its own shares. A day after the company announced the buyback plan, Bobby Kotick, Activision’s CEO, sold nearly 4 million shares for $180.8 million. Putka reports: “The average share price of his sales was 15 percent higher than he would have gotten before the stock rose on the news. A total of five top Activision officials had sold shares totaling over $430 million, according to their filings with the Securities and Exchange Commission.”

The company insiders often sell during the short-term stock price jump that typically follow disclosure of new authorizations, or when the companies are involved in acquisitions. “The companies are doing so much purchasing they’re moving the stock’s price,” said SEC Commissioner Robert J. Jackson

A review by The Washington Post reported that at least 500 insiders sold their stocks during buyback programs at their companies in just one 15-month period in 2017 and 2018, according to The Post analysis of data compiled by the SEC as well as regulatory filings. More than 50 of the insider sellers were CEOs.

“While many executives have prearranged procedures to sell stock, these plans do not have to be publicly disclosed and can be changed,” Jesse Fried, a Harvard Law School professor who testified about buybacks at congressional hearings in October, said to the Washington Post. Fried added “They’re giving the market false information, then profiting from it by selling.”

Putka reports that over the past decade, “S&P 500 companies have spent a staggering $5 trillion repurchasing their own stock. Buybacks among the 500 surged 55 percent to a record $806 billion in 2018.”

Many insider sales via buybacks involve stock or stock options that executives receive in their pay packages. Putka cites the case of Home Depot, which has spent over $50 billion purchasing its own shares in the past 10 years. Putka reports: “On Feb. 21, 2017, the retailer announced a strong quarter and a $15 billion program to repurchase its stock. The next day CEO Craig Menear sold 140,372 shares of Home Depot stock as its price climbed.The options allowed him to buy the stock from the company at $26.84 a share, and to sell it the same day in the open market at prices averaging about $144.33, making a $16.5 million profit, according to Home Depot. The next day, Carol Tomé, then chief financial officer, sold 100,000 shares for $14.3 million. Both she and Menear benefited from the performance of the stock post-announcement.”

A much publicized and older case was that of Enron an American energy, commodities, and services company based in Houston, Texas. It was founded in 1985 as a merger between Houston Natural Gas and InterNorth, both relatively small regional companies. It became clear in 2001 that Enron was hiding portions of its liabilities off of its balance sheets. Most of its assets and earnings were doctored, which continued driving up its share price. By the end of the year, Enron filed for bankruptcy. An investigation of the scandal found that Lay had an active hand in inflating the company’s financial health. In 2006, CEO Kenneth Lay was found guilty of securities fraud and other charges. He died July 5, 2006, shortly before his sentencing.

Under CEO Bernard Ebbers’ stewardship, WorldCom became the second largest long distance company in the US, after it bought MCI in 1997 in a transaction valued at $37 billion. During the merger, Ebbers began to prop up the WorldCom results with the help of senior financial executives at the company, by falsifying financial documents, which resulted in inflating stock price. The tech and telecom downturn of 2001 began to undermine WorldCom’s earnings and over the next two years, the efforts to manipulate the company’s financial results became more aggressive. The SEC filed civil fraud charges against WorldCom, speculating that WorldCom had engaged in a concerted effort to manipulate its earnings in order to meet Wall Street targets and support its stock price. Additionally, it claimed that the scheme had been “directed and approved by senior management. In 2005 Ebbers was found guilty by a jury for fraud, conspiracy, and filing false documents with regulators. He was subsequently sentenced to 25 years in prison. However he was released in December 2019 due to declining health. Ebbers died February 2, 2020.

Some experts have argued that corporations in America are structured in a way to encourage CEO unethical and dishonest practices.

Influential economist Milton Friedman advanced the business philosophy that public corporations should focus exclusively on shareholders, ignoring the interests of other stakeholders including employees, customers, and the communities in which companies operate. The single-minded focus on maximizing shareholder value has caused companies to sacrifice long-term value for short-term profits and, ironically, enriched corporate executives at the expense of shareholders.

Bruce Bartlett, author of the book, The Truth Matters: A Citizen’s Guide to Separating Facts From Lies and Stopping Fake News in Its Tracks, argues in his article in The New Republic, argues “C-suite executives use share buybacks to manipulate stock prices for their own benefit, and no one else’s.”

Bartlett says this emphasis on profits to shareholders as the prime criteria for a CEO’s leadership success has morphed into a “shareholder revolution” which focuses on getting company profits by “aggressive use of share buybacks. The buyback policy reinforced the negative trends resulting from the doctrine of shareholder primacy — including a decline in labor’s share of national income, higher pay for corporate executives and greater income inequality, reduced corporate investment, and slower economic growth.”

He adds: “But as corporations focused more on generating profits to the exclusion of all else and managerial compensation increasingly took the form of stock options, the share price became the primary focus, with dividends falling in importance. Over time, share repurchases became a substitute for dividends.”

This strategy has led to manipulation of the stock market, and real company accounting methods. Bartlett says it this way: “ managers can control the timing of share buybacks, which they use to pump up stock prices around the time their stock options are vested.”

A study by Alex Admans and colleagues published by the National Bureau of Economic Research shows that “CEOs strategically time corporate news releases to coincide with months in which their equity vests. These vesting months are determined by equity grants made several years prior, and thus unlikely driven by the current information environment. CEOs reallocate news into vesting months, and away from prior and subsequent months. They release 5 percent more discretionary news in vesting months than prior months, but there is no difference for non-discretionary news. These news releases lead to favorable media coverage, suggesting they are positive in tone. They also generate a temporary run-up in stock prices and market liquidity, potentially resulting from increased investor attention or reduced information asymmetry. The CEO takes advantage of these effects by cashing out shortly after the news releases.” In effect, corporate executives use buybacks to manipulate stock prices for their own benefit.”

Former SEC Commissioner Robert Jackson warned that corporate executives frequently take advantage of buyback-driven spikes in stock prices to dump shares, thus capturing for themselves gains that belong to public shareholders. “The evidence shows that buybacks give executives an opportunity to take significant cash off the table, breaking the pay-performance link,” Jackson said in a 2018 speech. He added that SEC rules do not prohibit or even discourage such self-dealing.

In 1980, corporations repurchased just $6.6 billion of their own stock. By 2000, that amount had risen to more than $200 billion. In the 2000s, the percentage of corporate profits paid out as share buybacks sharply increased. Before the recent economic slowdown, they approached $1 trillion per year.

Disturbingly, there’s also growing evidence, as reported by John R. Graham, Campbell R. Harvey and Shiva Rajgopal, published in Financial Analysts Journal, that share buybacks come at the expense of long-term profitability and the economy as a whole, because “they lead managers to reduce or postpone investment spending for new projects, research and development, advertising and maintenance in order to meet near-term earnings targets. Buybacks also tend to raise corporate indebtedness and leverage, which can increase bankruptcies in an economic downturn. In other words, managers are literally destroying shareholder value as a routine way of doing business. This helps explain why non-residential fixed investment has fallen even as overall profitability has risen.”

Some experts argue that the Trump 2017 tax reduction for corporations appears to have led to an increase in share buybacks at the expense of federal revenue and corporate investment. Pressure to maintain corporate payouts may also be responsible for larger-than-necessary layoffs during the COVID-19 crisis.

Robert M. Daines and colleagues, writing in the Journal of Financial and Quantitative Analysis, show in their research “how some CEOs have manipulated stock prices to increase option compensation, documenting negative abnormal returns before scheduled option grants and positive abnormal returns afterward. These returns are explained by measures of CEOs’ incentives and ability to influence stock prices.”

“I was surprised, because it sounded too cynical at first,” says Daines, who teamed up with Grant R. McQueen and Robert J. Schonlau, “But we tested for all kinds of benign explanations and none of them fit the data. The unusual stock patterns happen so often, and they exactly fit with the self-interest of the CEOs and senior executives. Either the CEOs are incredibly lucky or they are manipulating stock prices.”

So how did CEOs manage to manipulate stock prices so adroitly?

Daines and his colleagues find evidence of several techniques, many of them tied to when companies decide to disclose important new information. One such technique, called “bullet-dodging,” in which a company temporarily depresses its stock price by releasing negative information before the option-grant date. Another technique is called “spring-loading,” in which a firm holds back on positive information until after the option date. Sometimes, Daines says, a company can do both things in the same cycle.

“This might actually be worse than the original backdating scandal,” Daines says. “The original scandal was bad because it suggested that executives might be overpaid, but this distorts stock prices for months. This gives executives an incentive to delay good projects, and that’s bad because you typically want to make good investments as soon as you can.”

In a study by Kathryn M. Bartol and colleagues published in the Academy of Management Journal, titled “CEOs On the Edge: Earnings Manipulation and Stock-Based Incentive Misalignment,” the authors argue “we found that CEOs were more likely to manipulate firm earnings when they had more out-of-the-money options and lower stock ownership. Our findings inform agency-based views by providing evidence that, under certain conditions, stock-based managerial incentives lead to incentive misalignment. Consistent with manipulated performance, we find significant abnormal stock returns in the months surrounding CEO departure for those with strong option incentives, which are reversed shortly after CEO departure. In the second category, executives directly manipulate corporate performance: by taking actions to temporarily elevate the company’s share value, executives maximize capital gains from exercising stock options at high share prices.”

Executives’ Dark Personality Traits and Likelihood of Stock Manipulation

According to new research in the Journal of Business Ethics, the “dark” personality traits — questionable ethical standards, narcissistic tendencies — that make a boss bad also make that person much more likely to go along with manipulating earnings and may be the reason they got the job in the first place.

Co-authors Nick Seybert , Ling Harris, Scott Jackson and Joel Owens studied the process of hiring executive management accounting candidates and its relation to the company’s earnings management practices — that is, a company’s tendency to inflate its income. Through several studies, they found that when a company needed to report earnings aggressively, experienced executives and recruiters tended to recommend hiring candidates with dark personality traits over candidates who sought input from others and believed in strong ethical foundations.

“Dark personality traits are often framed as an accidental byproduct of selecting managers who fit the stereotype of a strong leader,” says Seybert, an accounting professor. “However, our research found that this is often no accident.”

The research for “Recruiting Dark Personalities for Earnings Management” involved three experiments in which different actions were measured. In one experiment, for example, the participants were specifically asked to rate the candidates based on dimensions such as the candidate’s ability to manage people and relationships. The only dimension in which candidates with dark personalities were rated higher than their counterparts was in manipulation of ethical boundaries.

“A lot of people assume that these managers must have great self-presentation, promotion, people skills, or confidence” Seybert says. “But our research shows otherwise.” The basic idea behind this research is that these dark personalities can fulfill a specific nefarious purpose, says Seybert. When companies feel as though they need to inflate their earnings, people with dark personalities are more likely to get placed into positions of power to do exactly that. This results in candidates with potentially better management, organizational, and people skills being passed over for management jobs.

Seybert and his colleagues’ research is unique in that they recruited experienced executives and executive recruiters to evaluate the candidates in order to simulate the real business hiring environment. “Very, very few prior studies involved people who have experience recruiting for prior jobs,” says Seybert. “Our research involved a lot of time consuming and creative searching to find the right participants.”

Overall, Seybert says he hopes that this research will help candidates better evaluate companies during their job search. “The best takeaway for employees is to avoid companies that might have use for managers with dark personalities, and not to expect support from higher-ups when this is the case. The company might have picked a bad boss on purpose.”

In my book, Toxic Bosses: Practical Wisdom for Developing Wise, Moral and Ethical Leaders, I argue “Stephen Chen, writing in the Journal of Public Affairs, says misreporting of a firm’s financial performance increases the CEO’s confidence which in turn increases the need to misreport performance in order to feed an ever increasing ego. This growth can be fueled by statements by third party financial analysts and the press which praise their actions. And the actions are not restricted to financial data.”

I go on to say “Over the years, an exclusive focus on shareholder value has been used to justify cheating or deceiving customers, squeezing workers and suppliers, avoiding taxes and lavishing stock options on executives. Most of what people find so distasteful about American capitalism — the ruthlessness, the greed, the inequality — has its roots in this misguided and twisted notion that business only exists for financial gain for the shareholders (and greedy CEOs).”

We are unlikely to see the end of selfish, unethical CEOs who cleverly game the system legally because of its fundamental flaws in order to amass their wealth through the use of stock manipulation. And company boards willingly recruit and reward such CEOs for the “ends justifies the means” philosophy — company wealth and growth. Such a system only points to one of the fundamental flaws in free market capitalism in the U.S.

Read my new book: Toxic Bosses: Practical Wisdom for Developing Wise, Ethical and Moral Leaders