DirectorsatWork 217the smartest way to allocate the company’s capital. Indeed, options
create incentives to borrow money for stoc krepurchases that boost
earnings per share and return on equity. That poses a major risk, as
a smaller equity base in a crisis can push a company closer to bank-
ruptcy, severely damaging shareholder interests (as well as the inter-
ests of others).
In contrast to the occasional wisdom of stoc krepurchases is the
universal folly of stoc ksplits. Stoc ksplits have three consequences,
none of them beneficial to the stockholders. They increase trans-
action costs by promoting high share turnover; they attract share-
holders with short-term, market-oriented views who unduly focus on
stoc kmar ket prices; and, as a result of both of those effects, they
lead to prices that depart materially from intrinsic business value.
With no offsetting benefits, splitting a stoc kis nonsense. Nev-
ertheless, most companies do it, including GE, Microsoft, and Am-
azon.com. Berkshire Hathaway is one of the handful that don’t. After
going public in mid-1997, Amazon.com split its stoc kthree times
from June 1998 to September 1999! GE split its stoc konly nine times
in its hundred-plus-year history, though three of those splits oc-
curred in the last six years of the 1990s.
The only meritorious argument favoring stoc ksplits is that they
reduce the per share price of stoc kand thus enable a wider investor
group to participate. If no U.S. company in history had ever split its
stock, the per share price of some of the best companies would be
in the tens of thousands of dollars (as is the case at Berkshire Hath-
away, for example). That price level is prohibitive for many investors.
This argument does not justify the high frequency of stoc ksplits,
however, which are used to keep prices below a couple of hundred
dollars—an amount that is affordable by all investors.
CHECKING UP
As Chapter 10 showed, for accounting information to be valuable,
users must have justifiable confidence in its integrity. Forces that
jeopardize integrity are often intractable: Business innovation, evo-
lution, and complexity, coupled with the formal nature of accounting
rules inevitably create a substantial zone of managerial discretion in
financial reporting.
Integrity in financial reporting is promoted through internal con-
trol systems and by external auditor certifications, both of which can