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Review of Quantitative Finance and Accounting

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21.03.2019 | Original Research

Share repurchases and accounting conservatism

verfasst von: Gerald J. Lobo, Ashok Robin, Kean Wu

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 2/2020

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Abstract

The prior literature indicates that financial policy (e.g., payout policy) as well as accounting policy (e.g., conservatism) can be used to address incentive problems in firms but finds mixed evidence. We conjecture that stock repurchases, an increasingly popular form of payout, and conservatism are potential mechanisms to counter managerial propensity to engage in overinvestment using free cash flows. Consequently, we expect a negative relation between repurchases and conservatism as well as a stronger negative relation between these two mechanisms in firms with high levels of free cash flows. We find results consistent with these expectations. By contrast, we find a weaker negative relation between repurchases and conservatism when CEO tenure is higher, which confirms that more entrenched CEOs have less incentives to solve the overinvestment problem.

Vorheriger Artikel Investor learning, earnings signals, and stock returns

Nächster Artikel Lucky lots and unlucky investors

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One possible reason for divergent results is empirical design. First, Ahmed, et al. (2002) and Louis and Urcan (2015) use similar measures for dividends, but different measures for accounting conservatism. Second, Ahmed et al. (2002) use conservatism as the dependent variable, while Louis and Urcan (2015) use payout as the dependent variable.

The archival financial accounting literature identifies factors associated with specific accounting policies such as conservatism. For example, conservatism is negatively related to managerial optimism. More generally, the literature identifies factors such as CEO compensation, managerial style, board structure, taxes, and audit infrastructure. While there is considerable evidence on factors influencing policies or mechanisms such as conservatism, there is little evidence on exact methods and processes by which firms adopt and implement them.

To calculate this measure, we extract the purchase of common and preferred stock (Compustat items prstkcy) and subtract the decrease of redeemable preferred stock (Compustat item pstkr; use if change in pstkr < 0). We also consider the increase in treasury stock (Compustat item tstkc) as a lower bound: we replace the numerator with the increase in treasury stock if that value is higher. Finally, we consider the possibility that the numerator is negative in certain cases, and in those instances, we set the value to zero. Thus, this ratio is bounded between zero and one.

Using a raw measure of dollar value of actual repurchase (in the numerator of the formula in Eq. 3) yields qualitatively similar results.

We also replicate our test using measures of accumulated actual repurchase after announcement using Compustat quarterly data, following Bonaimé (2015). Non-repurchase firm-year observations are thus dropped in the test. The results are qualitatively similar to those presented in panel C from Tables 4, 5, 6 and 7 whether we accumulate repurchase activity over nine quarters or four quarters. We also find similar results when we accumulate annual data over 2 years.

For example, the announcement by Columbia Sportswear Company (Ticker: COLM) contains the statement “The repurchase program does not obligate the Company to acquire any specific number of shares or to acquire shares over any specified period of time.” Second, although the NYSE and NASDAQ require listed companies to issue a press release when a share repurchase program is initiated, the Securities Exchange Act doesn’t require such a disclosure (Banyi et al. 2008). On December 2003, the SEC modified Rule 10b-18 to require all repurchasing firms to report ex-post repurchases in periodic filings. Nevertheless, the announcement is not legally binding.

In untabulated robustness checks, we use alternative measures of conservatism, such as Basu (1997) and Ball and Shivakumar (2005) and find consistent results.

We find similar results when we use the conservatism measure contemporaneously, which is probably due to its stickiness. This further supports the substitution effect between conservatism and share repurchase.

Researchers also argue that conservatism represents an important aspect of accounting quality. Although we generate our prediction of a negative relation between conservatism specifically and repurchases, some of our arguments perhaps extend to the more general construct of accounting quality. To provide a preliminary examination of this possibility, in untabulated tests, we substitute accrual quality (our measure of accounting quality) for conservatism and re-estimate the models. We measure accrual quality using the approach in Dechow and Dichev (2002) and Francis et al. (2004). Results show a positive relation between repurchase and accrual quality. Thus, our results appear specific to conservatism as a measure of reporting quality, and do not generalize to other measures.

As in the Panel B, we also explore the contemporaneous relation between conservatism and actual repurchase, and find qualitatively similar results.

Although we measure conservatism at t − 1 (lag = 1) in our main tests and repurchase at t, we conservatively interpret the relation as an association rather than as causality. In this section, we examine other lag periods to explore the issue further. Specifically, we use contemporaneous data (lag = 0) as well as conservatism leading repurchases by one period (lag = − 1). The results are maintained for the contemporaneous specification but not for the leading specification suggesting that the decision to repurchase is conditional on conservatism and not vice versa.

It is also possible that the relation we document could be driven by the year effect, as discussed in Petersen (2009). To address this concern, we use the Fama and MacBeth (1973) two-step approach. These untabulated tests show a pervasive negative relation between repurchase and conservatism and confirm other reported results.

In untabulated tests, we examine two contemporaneous specifications for the association between conservatism and share repurchases. In the first model, we use Conservatism score as the dependent variable and stock repurchases as the independent variable, with both variables measured contemporaneously. Second, we use a Basu (1997) type model and interact the dummy for repurchases with the other independent variables. In both tests of contemporaneous association, we find a negative relation between accounting conservatism and share repurchases. Detailed results are available upon request.

We also use an alternative free cash flow measure following Opler et al. (1999) and find consistent results.

Because interacting two continuous variables may induce multicollinearity, we follow Aiken and West (1991) and subtract FCF_t−1 from its sample mean to get FCF_t−1^C, and then compute the interaction term FCF_t−1^C\(\times\)Conservatism score_t−1.

We also consider the possibility that repurchases are opportunistically used by managers to manipulate earnings per share through a reduction in the number of shares. The prior literature finds that firms may use accretive stock repurchases as a real earnings management tool to meet or beat analysts’ EPS forecasts (Hribar et al. 2006; Burnett et al. 2012). To address this issue, we eliminate accretive stock repurchases and find that our results hold.

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Titel: Share repurchases and accounting conservatism
verfasst von: Gerald J. Lobo
Ashok Robin
Kean Wu
Publikationsdatum: 21.03.2019
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 2/2020
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-019-00804-9

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