Accretive Share Repurchases Versus Accrual/Real Earnings Management: Complements or Substitutes?

Abstract

This paper seeks to address whether managers use accretive repurchases in conjunction with or to the exclusion of other earnings management tools. Prior literature has shown that managers use accretive repurchases to meet or beat analyst forecasts of earnings per share (EPS). However, whether such planned and aggressive repurchasing of common shares outstanding is used as a complement or substitute for traditional tools of earnings management remains unexplored. I find a complementary relationship between accretive repurchases and income-increasing discretionary accruals, a complementary relationship between accretive repurchases and abnormal discretionary expense cuts, and a substitutional relationship between accretive repurchases and abnormal operating cash flow reductions. In addition, I find that the likelihood to use income-increasing discretionary accruals in conjunction with accretive repurchases is significantly driven by the number and dollar amount of stock and stock options awarded to the firm’s CEO in the previous year. I also find that firms with a CFO who is co-opted by the firm’s CEO are more likely to use accretive repurchases than firms in which the CFO is not co-opted by the CEO. This suggests that a CEO likely influences the CFO to make capital allocation decisions that benefit the CEO, but may not be in the best long run interests of the firm. Finally, I find that transient investors strongly predict whether a firm uses accretive repurchases, suggesting that managers use this tool to avoid price pressures imposed by not hitting quarterly forecasts of EPS.