Abstract
This study examines the change of the demand for accounting conservatism surrounding share repurchases for a sample of US listed firms between 2003 and 2013. We find that the extent of accounting conservatism decreases significantly post share repurchase, consistent with the view that share repurchases reduce excess cash and information asymmetry, and consequently the agency-cost demand for conservative accounting decreases. Further analysis finds this result holds only for financially unconstrained firms and firms with low or no financial distress risk, but there is no significant decrease in accounting conservatism for financially constrained firms or for firms with high financial distress risk. This suggests that share repurchases in these firms might result from other motives such as manager hubris, earnings management, or false signals to mislead investors, and thus cannot reduce the agency-based demand for accounting conservatism. Our results add further evidences to the literature on accounting conservatism and firm financial policies.
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Notes
We start our sample post Sarbanes–Oxley period to avoid confounding effects from the change in legal and regulatory requirements.
We thank the anonymous reviewer for this point.
If the Z-score is greater than 3.0, the firm is unlikely to default, between 1.8 and 2.7 there is a good chance of default and less than 1.8, the firm is viewed as failing.
They use the increase in common treasury stock if the firm uses the treasury stock method for repurchases. If the firm uses the retirement method instead and this manifests as zero (or missing) in treasury stock in the current and prior year, we measure repurchases as the difference between stock repurchases and stock issuances. If either of these amounts is negative, repurchases are set to zero.
Our overall results are qualitatively similar when the cutoff point of KZ index is top 20% or top 10%.
We also use 1.8 as the cut-off point of Z-Score to define firms with high financial distress risk. The results are qualitatively similar.
We also control for industry fixed effects by including industry dummies, Industry, in the regression estimation, Eq. (7). The results after controlling for the possible effect of industry are qualitatively similar to the baseline results (available from the authors on request).
Literature also uses skewness (difference between the skewness in operating cash flows and earnings) as a proxy for conservatism. Skewness is estimated over several periods and is not a firm-year measure. Our sample and research design do not have enough observations to estimate skewness and skewness may capture the effect of repurchase over the estimation period. Therefore, we do not use skewness as an alternative measure.
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The authors thank the valuable comments from the associate editor and the two anonymous reviewers.
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Li, W.X.B., He, T.T., Marshall, A. et al. An empirical analysis of accounting conservatism surrounding share repurchases. Eurasian Bus Rev 10, 609–627 (2020). https://doi.org/10.1007/s40821-019-00145-6
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DOI: https://doi.org/10.1007/s40821-019-00145-6
Keywords
- Accounting conservatism
- Share repurchases
- Agency cost
- Information asymmetry
- Financial constraint
- Financial distress risk