Real earnings management around open market share repurchases

Abstract

This thesis investigates real earnings management behaviors in the context of open market share repurchase. I use three proxies developed by Roychowdhury (2006) to measure real earnings management behaviors, including abnormal cash flow from operations (DCFO), abnormal production costs (DPROD) and abnormal discretionary costs (DDISX). In comparison to existing literature that documents the impact of accrual earnings management on post-repurchase performance, this thesis endeavors in investigate thoroughly both methods of earnings management. I find that repurchasing firms not only engage in accrual earnings management as is documented in Gong, Louis and Sun (2008) but also engage in real earnings management. Empirically, repurchasing firms have significant positive DCFO and negative DPROD in the year of announcements, both of which are earnings-reducing real activities. Repurchasing firms do not exhibit significant evidence of earnings-reducing DDISX in the year of announcements, but they experience earnings-reducing DDISX in all the three years prior to announcements. As predicted, the operating performance and stock performance of a repurchasing firm can be explained by pre-announcement earnings-reducing accrual manipulations and pre-announcement earnings-decreasing real earnings management. Specifically, the pre-repurchase downward DPROD makes the most important explanatory variable in both repurchasing and actual repurchasing samples whether controlling for DACC or not. The pre-repurchase upward DCFO is most relevant in determining the post-repurchase stock performances.