The Accounting Choice to Record Share Repurchases

Abstract

This paper examines U.S. firms’ accounting for share repurchases and the accounting choice provided to Delaware-incorporated firms between the treasury and retirement methods. This accounting choice does not affect income, cash flows, or net assets, but it nevertheless affects financial reporting transparency and the allocation of equity between retained earnings and contributed capital. According to Generally Accepted Accounting Principles (GAAP), the accounting choice to record share repurchases should reflect management’s intended disposition of the repurchased shares. First, using a sample of U.S. public companies, we examine whether firms use the treasury stock account consistent with GAAP. We find the average treasury firm repurchases shares and reduces shares outstanding more frequently than the average retirement firm, a result which seems contrary to the underlying economic differences we expect under GAAP. Next, we compare characteristics of Delaware-incorporated treasury and retirement firms and find that the choice between the two methods is not random; rather, this choice is related to a number of firm characteristics, including idiosyncratic risk, leverage, firm growth, and industry membership. Finally, we find that a firm’s accounting method has explanatory power in predicting share repurchases.