1. Kamin v. American Express (accounting vs. investment value) Law & Valuation Spring 2005

2. Valuation in corporate decision-making Board decision on “maximizing shareholder value” –Board choice in Kamin v. American Express –Accounting treatment of DLJ disposition –Accounting value vs. economic value Judicial response –Business judgment rule –Deference to market irrationality

3. Kamin v. American Express Management wants to dump bad DLJ investment. Why? Presents options to board: Option 1: Declare special dividend of DLJ stock to AmEx shareholders. Option 2: Sell DLJ stock at corporate level, sustaining capital loss but realizing tax savings. How account?

4. Purchase of DLJ stock (1972) DebitCredit Investment29.9 Cash29.9 Balance sheet AssetsLiabilities Cash (29.9) Investment 29.9 Equity

5. Option 1: Dividend distribution DebitCredit Dividend paid4.0 Retained earnings25.9 Investment29.9 Balance sheet AssetsLiabilities Investment (29.9) Equity Retained earnings (29.9)

6. Option 1: Dividend distribution Income Statement Revenue-- Expense-- Gain / Loss-- Tax-- Net income--

7. Option 2: Sell DLJ stock DebitCredit Cash4.0 Other income (loss)25.9 Investment29.9 DebitCredit Income tax payable8.0 Income tax expense8.0

8. Option 2: Sell DLJ stock Balance Sheet AssetsLiabilities Cash 4.0 Investment (29.9) Tax liability (8.0) Equity Retained Earnings (17.9)

9. Option 2: Sell DLJ stock Income statement Revenue -- Expense -- Gain / Loss(25.9) Tax (31%) 8.0 Net income(17.9) Cash flow statement Inflow from sale 4.0 Tax savings 8.0 Net cash flow 12.0

10. Kamin v. American Express Compare Option 1 and Option 2 Option 1: Distribute DLJ stock and avoid $17.9 million reduction in net income Option 2: Sell DLJ stock and reduce taxes by $8.0 million Why did board choose Option 1 – the economically inefficient, but market- friendly distribution of DLJ stock?

11. Kamin v. American Express Team 2: “Board’s attempt to smooth earnings by avoiding a short-term hit seems to be an attempt to protect shareholder value.” Team 6: “Courts will not interfere unless [board] powers have been illegally or unconscientiously executed … or fraudulent or collusive and destructive of the rights of the stockholders.” Team 9: “In today’s dollars, AmEX could be subjecting the company to a potential shareholder value loss of $344.2 million. … If Kamin disagrees he should sell. Team 12: “More likely AmEx did not have capital gains sufficient to absorbed the entire $25.9 million in long- term capital losses … would have been carried back to tax years 1972-1974. Total $12 million in savings may have actually been less in PV terms. In 1975.

12. Kamin v. American Express

13. Did the reviewing court, which deferred to the board, make the right decision?

14. Kamin v. American Express Team 2: “The board seems justified in its decision to focus on the market value of AMEX stock.” Team 6: “The board exchanged sound business judgment [creating positive cash flows of $12 million] for short term accounting solution.” Team 9: “Managers use accounting tricks to “smooth earnings” and add value to a firm, increasing shareholder wealth. Until the manipulation is unveiled, the company enjoy rewards from the market with steady earnings and meeting estimates. Team 12: “Under current accounting rules, AmEx would have had to show the dividend transaction in footnotes to its financial statements and accrued depreciation on the investment as a loss. … 1975 accounting seems to have been designed to defraud both current and potential investors.”

15. Kamin v. American Express Any suggestions to make markets more rational, efficient?

16. Kamin v. American Express

17. VJG: “… maybe regulation by the SEC or federal law could replicate institutional investors valuing companies not based on accounting tricks” BH: “AmEx could have avoided dispute had accountants properly “marked to market” DLJ stock.. Loss can’t be changed by magic in accounting” FG: “ We would have sent case to trial, not decide on SJ, to get more information on board decision” NB: “Buffet has lost confidence in EPS: “primary test of managerial performance is high earnings rate on equity capital employed … and not EPS.” JM: “Shareholders pay the board … and must life with the decisions … or take action”

18. Kamin v. American Express In the end, who should decide value?