Improving Earnings per Share: An Illusory Motive in Stock Repurchases

Transcription

1 Inernaonal Journal of Busness and Economcs, 2009, Vol. 8, No. 3, Improvng Earnngs per Share: An Illusory Move n Sock Repurchases Jong-Shn We Deparmen of Inernaonal Busness Admnsraon, Wenzao Ursulne College of Languages, Tawan L-Hsun Wang * Deparmen of Inernaonal Busness Admnsraon, Wenzao Ursulne College of Languages, Tawan Key words: earnngs per share; sock repurchases; marke effcency JEL classfcaon: G14; G30; G11 1. Inroducon Improvng earnngs per share (EPS) has been wdely ced by fnancal managers o jusfy sock repurchases (Hrbar e al., 2006). Oher hngs equal, repurchasng socks reduces he number of shares ousandng and booss EPS. In pracce, fnancal analyss and oher marke parcpans are closely monorng and effcenly reacng o fnancal repors. If nvesors reac o he boosed EPS around repurchase announcemens, he posve correlaon beween he marke reacon and he changes n EPS should hen be observed. In hs noe, we fnd ha, n Tawan, nvesors do no reac o he boosed EPS. EPS s calculaed as he rao of he earnngs avalable o he number of common shares ousandng. Even f he number of common shares ousandng falls followng repurchases, clams ha hs booss EPS may no be warraned (Hrbar e al., 2006). For example, US frms mgh decrease her EPS f oo much annual earnngs are used for repurchasng. To solae he mpac on he numeraor, we use a Tawanese sample of frms ha, under regulaon, are requred o repurchase ousandng shares usng reaned earnngs. Ths specal regulaory requremen makes possble o mprove EPS followng repurchases and nuvely leads us o examne wheher nvesors reac o he boosed EPS. Frs we denfy wheher he EPS has been mproved n Tawan around he repurchase announcemens. Nex, we modfy he regresson model n Zhang (2002) * Correspondence o: Deparmen of Inernaonal Busness Admnsraon, Wenzao Ursulne College of Languages, 900 Mnsu 1s Road, Kaohsung 807, Tawan. E-mal: 97027@mal.wuc.edu.w. We apprecae helpful commens made by a board member.

2 244 Inernaonal Journal of Busness and Economcs o examne he relaon beween marke reacon and changes n EPS. We fnd ha Tawan s sock marke reacs slowly o repurchase announcemens and does no exhb sgnfcan response o he mproved EPS, whch seems o conradc expecaons of fnancal managers. Hence, mprovng EPS appears o be an llusory move n sock repurchases. 2. Daa and Mehodology Tawanese frms have been allowed o nae repurchases snce Augus In lgh of he nernaonal fnancal crss n 2007, we selec frms ha naed repurchases from Augus 2000 o July All daa are obaned from he Tawanese Economc Journal. Afer excludng frms ha made repeaed purchases, our sample conans 145 observaons. To confrm wheher EPS mproved followng repurchases, we compare he pre-even and pos-even EPSs of hose 145 frms. The pre-even EPS s defned as he EPS rao a he me before acual repurchase; he pos-even EPS s defned as he laes avalable EPS rao followng he repurchase. We use a pared -es and a Wlcoxon sgned-rank es o examne changes n EPS. To examne wheher nvesors reaced o he mproved EPS around he announcemen, we modfy he model of Zhang (2002). Zhang (2002) ndcaed ha an abnormal reurn a he announcemen s posvely relaed o a frm s announced repurchase percenage arge ( P ), whch s he percenage of s oal shares ousandng ha he frm sough o repurchase. Zhang used frm sze ( MV ), book-o-marke rao ( BM ), and pror prce performance ( CAR ( 60, ) as conrol varables n hs regresson model snce Ikenberry e al. (1995) found ha he announcemen reurn s relaed o boh frm sze and book-o-marke rao, whch could be he proxes for nformaon asymmeres. Moreover, based on he undervaluaon hypohess, whch assers ha fnancal managers underake sock repurchases prmarly because her shares are undervalued, he pror prce performance s deemed o be a proxy of undervaluaon. The calculaon on he pror prce performance excludes he 25-day perod durng whch he fnancal managers work on schedulng and carryng ou her repurchase plan rgh afer denfyng he undervaluaon. Therefore, we modfy Zhang s regresson model as follows: CAR( 1, n) = α + β MV + γ BM + θ CAR( 60, 25) + λ P + ϕ Δ EPS + ε (1) CAR( 1, n) = α + β MV + γ BM + θ CAR( 60, 25) + ϕ Δ EPS + ε, (2) where CAR ( 1, n) represens he cumulave abnormal reurns of frm from one day before o n days afer s buyback announcemen. Followng Zhang (2002), n can be eher 2 or 5. Therefore, he cumulave abnormal reurns for frm can be compued as:

3 AR, = 1 n Jong-Shn We and L-Hsun Wang 245 CAR ( 1, n) =, (3) where AR, represens he daly abnormal reurns of frm on day and s esmaed by he marke model: AR = R ˆ α + ˆ β R ). (4) (,, m, Here R, s he daly reurn of frm on day, R m, s he daly reurn of he marke ndex on day, αˆ s he esmaed nercep erm of frm, and βˆ s he esmaed slope coeffcen for he marke reurn. We esmae he marke model parameers for each repurchase frm usng daly reurns over he perod = 122 o = 3. The MV, BM, and P are respecvely he marke value, book-o-marke value, and he announced repurchase percenage arge of frm. Fnally, he Δ EPS represens he changes n EPS for frm, whch s calculaed as ( EPS EPS ) EPS. The EPS s he EPS rao a he me before acual, 0, 1, 1, 1 repurchase and EPS represens he laes avalable EPS number followng he, 0 repurchase for frm. Snce he announced repurchase percenage arge s closely relaed o changes n EPS, we also use he model (2) o nvesgae he marke reacon o changes n EPS. 3. Resuls The es sascs of he pared samples -es and he Wlcoxon sgned-rank es o he repurchase frms are (p-value ) and (p-value less han ). The resuls show ha he dfferenals beween pre- and pos-even EPS are posve and sgnfcan around he announcemen. We confrm ha Tawanese frms who repurchased shares usng reaned earnngs mproved her EPS around he announcemen. We hen use he modfed regresson model of Zhang (2002) o es wheher he nvesors reac o he mproved EPS n repurchases as fnancal managers would expec. Due o mssng daa for CAR ( 60,, only 127 frms are nvolved n hs regresson analyss. Resuls repored n Table 1 show ha nvesors do no reac o he changes n EPS around he repurchase announcemens. Ths fndng ndcaes ha fnancal managers may be msaken abou marke reacon o mprovng EPS. Resuls from he regresson analyss also show ha Tawan s marke reacs slowly o he repurchase announcemens. In he ( 1,2) wndow, none of he predcor varables are sgnfcanly relaed o he response varable. When we enlarge he wndow o ( 1,5), he announced repurchase percenage arge relaes sgnfcanly o he cumulave abnormal reurn. However, he posve sgns on he coeffcens of CAR ( 60, and book-o-marke ems are conrary o he undervaluaon hypohess, whch saes ha frms nae sock repurchases when hey perceve ha her shares are undervalued. Ths fndng sheds some lgh on he debae abou sock prce proecon n Tawan, snce he fnancal press ofen clams

4 246 Inernaonal Journal of Busness and Economcs ha Tawanese frms underake sock repurchases o preven share prces from connung declnes. Table 1. Marke Reacon o Changes n EPS CAR( 1, 2) CAR( 1,5) Inercep * * *** * (0.1739) (0.0031) (0.1247) (0.0504) (0.0001) (0.0556) CAR( 60, 25) * * * (0.5902) (0.5944) (0.6181) (0.0753) (0.0750) (0.0796) MV (0.8783) (0.9605) (0.8113) (0.6132) (0.4673) (0.6437) BM (0.6442) (0.9502) (0.9321) (0.7287) (0.6335) (0.6516) P ** ** (0.1350) (0.1410) (0.035) (0.0374) Δ EPS (0.4409) (0.4623) (0.7114) (0.7495) 2 R Noes: P-values are repored n parenheses. ***, **, and * represen 1%, 5%, and 10% sgnfcance levels, respecvely. 4. Concludng Remarks The man purpose of hs arcle s o denfy wheher he Tawanese marke reacs o mproved EPS afer sock repurchases. From he perspecve of nformaonal economcs, he marke should no reac o arfcal changes n EPS caused by sock repurchases. However, fnancal managers sll declare ha hey repurchase shares n order o mprove EPS. Ths noe fnds ha he cumulave abnormal reurns do no relae o he changes n EPS and argues ha he mprovng EPS s only an llusory move n sock repurchases. Our resul dffers from he fndng of Hrbar e al. (2006), whch suggesed ha nvesors on average dscoun repurchase-nduced EPS ncrease. Hrbar e al. (2006) repored ha managers n he US can use sock repurchases o mee or bea analyss EPS forecasng. The repurchase announcemen n he US s nformave, leadng nvesors o reac o he EPS ncrease. However, under Tawanese regulaon, frms are no allowed o cash ou her annual earnngs o do he repurchases. The repurchase-nduced EPS ncrease does no reflec a frm s curren earnngs n Tawan, ye hs explanaon helps nvesors smplfy he evaluaon of repurchase announcemens. Our fndng ends o suppor he effcen marke hypohess snce nvesors can recognze such arfcal mprovemen from fnancal repors and reac appropraely. Therefore, may be neresng o furher explore he nformaon conex under dfferen regulaory sysems governng repurchases.

5 Jong-Shn We and L-Hsun Wang 247 Furhermore, may also be neresng o nvesgae how he marke reacs o a frm ha booss s EPS usng repurchases from a long-erm perspecve. In pracce, frms can eher redsrbue or cancel her buybacks afer her repurchases. A redsrbuon reurns he number of shares ousandng o s orgnal level and a cancellaon decreases he number of shares ousandng permanenly. We beleve he markes should reac dfferenly o he ways a frm processes buybacks snce he evenual oucome conveys nformaon abou he frm s fuure EPS. References Hrbar, P., N. T. Jenkns, and W. B. Johnson, (2006), Sock Repurchases as an Earnngs Managemen Devce, Journal of Accounng and Economcs, 41, Ikenberry, D., J. Lakonshok, and T. Vermaelen, (1995), Marke Underreacon o Open Marke Share Repurchases, Journal of Fnancal Economcs, 39, Zhang, H., (2002), Share Repurchases under he Commercal Law n Japan: Marke Reacon and Acual Implemenaon, Pacfc-Basn Fnance Journal, 10,