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Short term real earnings management prior to stock repurchases

Lauren A. Cooper (), Jimmy F. Downes () and Ramesh Rao ()
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Lauren A. Cooper: West Virginia University
Jimmy F. Downes: University of Nebraska-Lincoln

Review of Quantitative Finance and Accounting, 2018, vol. 50, issue 1, No 4, 95-128

Abstract: Abstract This study examines whether firms engage in income-decreasing real earnings management before open market stock repurchases to reduce the cost of stock buybacks. In the short run, managers have the ability to underproduce inventory and increase discretionary expenditures, thus decreasing current period earnings. We find that managers engage in both of these activities before repurchasing their firms’ shares, especially the latter. Also, companies increase their discretionary spending before making repurchases to a greater extent following the passage of the Sarbanes–Oxley Act of 2002 as well as when they are financially healthy and have high marginal tax rates. Finally, we document that firms with the most income-decreasing real earnings management experience the largest positive abnormal returns during the subsequent period. Our findings highlight the importance of considering firms’ use of real operating decisions, as opposed to just opportunistic disclosure practices, around significant corporate events, such as the repurchase of their own stock.

Keywords: Real earnings management; Stock repurchases; Income-decreasing earnings management; Real operating decisions; Abnormal returns (search for similar items in EconPapers)
JEL-codes: G19 G30 M41 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1007/s11156-017-0624-2

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