Research: Prior Earnings Deflation May Create Positive Performance After A Stock Repurchase
The positive returns and reported improvement in operating performance that accompany many stock repurchases may be the result of downward earnings management leading up to the repurchase, according to new research from Penn State's Smeal College of Business.
Research: Prior Earnings Deflation May Create Positive Performance After A Stock Repurchase
UNIVERSITY PARK, PA (February 28, 2007) – The positive returns and reported improvement in operating performance that accompany many stock repurchases may be the result of downward earnings management leading up to the repurchase, according to new research from Penn State's Smeal College of Business.
Guojin Gong, Henock Louis, and Amy Sun, assistant professors of accounting at Smeal, examined financial data from 1,720 companies that made open-market repurchases between 1984 and 2002.
Their results show that managers deflate earnings around announcements of open-market repurchases. This suggests that both the abnormal stock returns and the reported improvement in operating performance following a repurchase are at least partly due to this downward earnings management, rather than actual growth in profitability.
After controlling for the effect of the earnings management, the researchers find no evidence of performance improvement or abnormally positive returns after a buyback, providing further evidence that the post-repurchase superior stock performance is associated with the pre-repurchase downward earnings management.
Other findings of the study include:
• The extent of the downward earnings management increases with the number of shares bought back.
• The extent of the downward earnings management increases with the equity holdings of the chief executive officer.
• Downward earnings management is only observed at companies that actually have a repurchase—there is no evidence that firms that make announcements but do not buy back shares deflate their earnings.
"Earnings Management and Firm Performance following Open-Market Repurchases" will be published in a forthcoming edition of the Journal of Finance.
REPORTERS & EDITORS: For more information, please contact Wyatt DuBois in the Smeal College of Business Media Relations Office at 814-863-3798 or wed112@psu.edu.
Penn State's Smeal College of Business offers highly ranked undergraduate, MBA, executive MBA, Ph.D., and executive education opportunities to more than 5,500 students at all levels. Featuring academic departments of accounting, finance, marketing, insurance and real estate, management, and supply chain and information systems, the college is also home to major research centers such as the Center for Supply Chain Research, the Institute for the Study of Business Markets, the Center for Digital Transformation, the Farrell Center for Corporate Innovation and Entrepreneurship, the Center for Global Business Studies, and the Center for the Management of Technological and Organizational Change.
