The Unintended Effect of FAS 123R on Firms’ Stock Repurchase Activity

• In Event: Financial Accounting and Reporting II

Abstract

We investigate whether or not FAS 123R affects stock repurchase activity. Prior research has shown that the dilution effect of stock options on earnings per share (EPS) decreases the value of stock options. Therefore, firms tend to use stock repurchases rather than dividends to return cash to shareholders (dividend substitution effect). Also, prior research shows that stock repurchases are used to manage earnings. FAS123R increases the potential dilution to EPS and return on assets as firms record stock-based compensation at fair value. Therefore, we hypothesize and find that FAS 123R is associated with increases in stock repurchases overall. We further find that this effect is greater with increased levels of management stock options and earnings pressure incentives. Our study fills a gap in research on the potential effect that FAS 123R might have on how firms decide to return cash to shareholders. Further, we provide evidence on unintended economic consequences of the change in accounting for stock-based compensation.

Authors

• Joanna Golden, Florida Atlantic University - Boca

• Mark Kohlbeck, Florida Atlantic University - Boca