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Keywords:

  • Corporate Governance;
  • Share Repurchase;
  • Earnings Management;
  • CEO Stock Ownership and Option Holdings

Abstract

Manuscript Type

Empirical

Research Question/Issue

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.

Research Findings/Insights

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.

Theoretical/Academic Implications

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.

Practitioner/Policy Implications

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.