An increase in share repurchases by firms that would otherwise have a small
negative earnings per share is associated with significant real changes in other
corporate policies. Such firms tend to decrease capital expenditures,
employment, and R&D in the four quarters subsequent to the quarter in which
they undertake the share repurchase.
The authors examine the real consequences of share repurchases driven by earnings
management considerations. Firms that would have just missed the earnings per share
(EPS) forecast in the absence of a share repurchase are more likely to repurchase
their shares than firms that just beat the EPS forecast. This behavior creates a
discontinuity in the probability of a share repurchase around the zero earnings
surprise level. The authors use this discontinuity to assess the causal effect of
such repurchases on other corporate policies using a regression discontinuity
They find that firms that repurchase shares subsequently reduce employment and
investment in capital. They also find that the stock market reacts positively to EPS
forecasts that are met by using share repurchases at the time of the earnings
announcement. On average, this market reaction is not different for firms that just
meet their earnings targets. But the share price reaction is lower for those firms
that reduce real variables, such as R&D and employment, to help finance
How Is This Research Useful to Practitioners?
The research adds to the literature that examines share repurchases. The authors make
the argument that EPS-driven repurchases cause firms to reduce investment,
employment, and R&D. They also examine the impact of such EPS-driven repurchases
on the valuation of the purchasing firm. The authors note that the interpretation of
their analysis of the impact on valuation is complicated because firms endogenously
choose how to finance EPS-motivated share repurchases. Nevertheless, their analysis
indicates that a number of firms in their sample are willing to sacrifice valuable
investments to finance EPS-motivated share repurchases.
The research enriches the existing framework for assessing share repurchases.
Specifically, it provides a more nuanced approach to assessing the impact of share
repurchases for firms that just meet EPS expectations. Two key groups of
practitioners will find the research very useful. First, investment analysts may be
able to refine their assessment of the impact of share repurchases on investment
returns. Second, management can use the framework to refine the assessment of their
share repurchase financing options and the way markets react to their repurchasing
How Did the Authors Conduct This Research?
The authors test the causal effect of repurchases on investments including capital
expenditures, employment, and R&D. They regress changes in investment on share
repurchases, instrumented with an indicator of whether a firm would announce a
negative EPS surprise without a repurchase.
The regressions compare firms that just miss the EPS consensus forecast (treatment
group) with firms that just beat the consensus forecast (control group) and the
relationship between changes in dividend policy (dependent variable) and stock price
changes (independent variable). To ensure that the discontinuity in the likelihood
of share repurchases is properly identified, the authors limit the sample to a small
window around zero pre-repurchase EPS surprises.
The authors use Compustat as their main data source. They start with all firm-quarter
observations in the database between 1988 and 2010. They exclude all utility firms
and financial services firms as well as all firm-quarters with missing or
nonpositive assets. They end up with about 390,000 firm-quarter observations. They
merge these observations with stock-level data from CRSP and analyst forecast data
There are currently high levels of cash on corporate balance sheets, especially in
the United States. Such companies have faced pressure from activist shareholders,
institutional investors, the government, and media for them to put their cash to
use. Shareholders want cash returned through dividends or share repurchases or
invested in high-return ventures. The government would like to see the cash invested
in the real economy to help stimulate economic growth. With this context, the
research is very timely. The analysis used is well structured and can be replicated
by practitioners. The key insights are mostly intuitive and accessible to a whole
range of readers. Nevertheless, as the authors admit, by focusing on firms that just
miss or just beat their EPS expectations, the applicability of the insights is
constrained. This constraint presents an opportunity for further research to be done
to refine our understanding of the impact of share repurchases on real outcomes.