Economic Cost of Earnings Management Through Stock Repurchases

Abstract

The current study examines whether firms that attempt to increase EPS to meet analyst forecasts through stock repurchases tend to pay a relatively higher price for their stock than firms that repurchase stock for other purposes, such as to benefit from temporary undervaluation of their stock. The research questions are tested using a tobit regression model with quarterly data from 1992 to 2001, controlling for various previously documented factors that affect stock repurchases and/or earnings management. The empirical test results are consistent with the hypothesis. In addition, the study finds that the cost associated with earnings management through stock repurchases varies with certain firm characteristics such as PE ratio. The study contributes to the earnings management literature by documenting substitution of alternative means of earnings management and by examining one of the economic consequences of earnings management through stock repurchases.