What are the Characteristics of Firms that Engage in Earnings Per Share Management Through Share Repurchases?
Version of Record online: 14 MAY 2013
© 2013 John Wiley & Sons Ltd
Corporate Governance: An International Review
Volume 21, Issue 4, pages 334–350, July 2013
How to Cite
Farrell, K. A., Yu, J. and Zhang, Y. (2013), What are the Characteristics of Firms that Engage in Earnings Per Share Management Through Share Repurchases?. Corporate Governance: An International Review, 21: 334–350. doi: 10.1111/corg.12029
- Issue online: 7 JUN 2013
- Version of Record online: 14 MAY 2013
- Corporate Governance;
- Share Repurchase;
- Earnings Management;
- CEO Stock Ownership and Option Holdings
This study examines US firms' share repurchases during 1997–2006 to determine what factors are associated with firms that use share repurchases to manage earnings per share (EPS). Specifically, we analyze firm and governance characteristics associated with firms that engage in share repurchases that increase annual EPS by at least one cent in a given year and that had EPS less than or equal to annual EPS forecast prior to the share repurchase.
We find that growth firms are less likely to use share repurchases to increase EPS for earnings management purposes. We also provide evidence that firms with a more independent board, a separation of the roles of CEO and chairman of the board, or a low entrenchment index (E-Index) are less likely to engage in earnings management through share repurchases. Finally, we find evidence that high CEO share ownership restrains managers from using share repurchases as a mechanism to manage EPS.
Our empirical results support some of the best practices advocated by various shareholders groups regarding corporate governance. Also, strong shareholder rights can mitigate incentives to manage earnings, highlighting the importance of corporate governance mechanisms/provisions in ensuring the integrity of the financial reporting system.
This research is important to investors in the face of the growing popularity of share repurchases. In particular, our study suggests strong corporate governance, strong shareholder rights, and high percentage CEO stock ownership discourages repurchase-based earnings management.