Effect of Accounting Flexibility on Earnings Management through Stock Repurchases

Abstract

Prior research (Taylor & Xu, 2012) finds that firms that attempt to increase EPS to meet analyst forecasts through stock repurchases give up the opportunity to time their buybacks to benefit from temporary undervaluation of their stock as is the case for firms that repurchase stock for other purposes. The current study explores a possible explanation for the costly behavior by investigating whether firms with constraints in their ability to inflate accruals are more likely to use stock repurchases as a means to manage earnings. The research question is tested using a logit regression model with quarterly data from 1992 to 2009, controlling for various previously documented factors that affect stock repurchases and/or earnings management. The empirical test results are consistent with the hypothesis that firms with lower accounting flexibility are more likely to manage earnings through stock repurchases. The study contributes to the earnings management literature by documenting the substitution effect of alternative means of earnings management. [PUBLICATION ABSTRACT]