Post on 07-May-2023
Electronic copy available at: http://ssrn.com/abstract=1972680
Accelerated Share Repurchases, Bonus Compensation, and CEO Horizons
Carol Marquardt
Associate Professor
Baruch College – CUNY
Zicklin School of Business
Stan Ross Department of Accountancy
55 Lexington Ave
New York, NY 10010 USA
Carol.Marquardt@baruch.cuny.edu
646.312.3241
Christine Tan
Assistant Professor
Fordham University and Financial Accounting Standards Bard
1790 Broadway
New York, NY 10019
ctan@fordham.edu
Ph: 646 312 8213
and
Susan M.Young
Associate Professor
Fordham University
1790 Broadway
New York, NY 10019
Syoung16@fordham.edu
Ph: 646 312 8245
November 2011
We thank Bo Zhang for research assistance and John Graham for providing marginal tax
rate data. We also thank Monica Banyi, Mary Ellen Carter, Victoria Dickinson, Valentin
Dimitrov, Peter Easton, Nicole Thorne Jenkins, Joshua Livnat, Patricia O‘Brien, Joshua
Ronen, Richard Sloan, Tom Stober, Christine Wiedman, and workshop participants at
Notre Dame, Indiana, USC, Waterloo, Edinburgh, Fordham, the Columbia-NYU-Baruch-
Rutgers Joint Accounting Conference, the Seventh Annual University of Utah Winter
Accounting Conference, and the 2007 AAA Annual Meeting for helpful comments and
suggestions. An earlier version of this paper was entitled, ―Managing EPS through
Accelerated Share Repurchases: Compensation versus Capital Market Incentives.‖
Electronic copy available at: http://ssrn.com/abstract=1972680
2
Accelerated Share Repurchases, Bonus Compensation, and CEO Horizons
Abstract
We examine whether short-term financial reporting objectives related to executive compensation
and employment horizons affect managers‘ decisions to undertake accelerated share repurchases
(ASRs) versus open market repurchases (OMRs). In an ASR, the firm repurchases borrowed
shares and simultaneously enters into a forward contract with an investment bank. This structure
provides potential financial reporting advantages over OMRs in that earnings per share (EPS)
benefits are recorded immediately (i.e., the reporting effects are ―accelerated‖) while the actual
share repurchases and potential costs associated with the forward contract are deferred to a future
date. Consistent with this short-term focus, we find that firms are more likely to choose ASRs
over OMRs when the repurchase is accretive to EPS, when annual bonus compensation is
explicitly tied to EPS performance, when CEO horizons are short, and when CEOs are more
entrenched. These results are robust to controlling for endogeneity in the decision to repurchase
shares. In addition, we find no evidence that compensation committees adjust executive pay for
the effects of the ASR. Overall, our results suggest that short-term financial reporting benefits are
a significant determinant of decisions to undertake ASRs, consistent with theories of managerial
myopia.
Key words: Accelerated share repurchase, compensation, voluntary turnover, horizon problem
Electronic copy available at: http://ssrn.com/abstract=1972680
Accelerated Share Repurchases, Bonus Compensation, and CEO Horizons
1. Introduction
While stock repurchases have recently soared in popularity and now represent the
dominant form of cash payout (see Skinner, 2008), they have also come under increasing
criticism in the financial press (e.g., Morgenson, 2006; Shaw, 2006; MacDonald, 2007).
The main thrust of the criticism relates to their use in boosting short-term earnings per
share (EPS). More pointedly, a report by Audit Integrity (2007) argues:
―The most consistent benefit is that they tend to be good for management
by producing the appearance of earnings growth where none may exist,
while providing management with additional bonuses and compensation at
those companies which reward executives for increased EPS.‖
In this paper, we empirically examine whether short-term financial reporting
incentives related to executives‘ compensation contracts and employment horizons affect
firms‘ decisions to undertake an innovative new form of stock buybacks – accelerated
share repurchases (ASRs). In an ASR, the firm repurchases borrowed shares and
simultaneously enters into a forward contract with an investment bank. This structure
provides potential financial reporting advantages over typical open market repurchases
(OMRs) in that earnings per share (EPS) benefits are recorded immediately (i.e., the
reporting effects are ―accelerated‖) while the actual share repurchases and potential costs
associated with the forward contract component of the agreement are deferred to a future
date. These transactions thus provide a powerful setting in which to examine whether
assertions linking managerial myopia to repurchase decisions are valid.1
1 For example, Maremont and Ng (2006) have criticized the increasing use of ASRs because they can be
used to obtain short-term EPS increases but potentially damage shareholder value in the long run due to the
2
Using a sample of actual stock repurchases from 2004 to 2006, we empirically
examine the determinants of ASRs using a two-stage Heckman (1979) procedure that
corrects for any self-selection bias related to the repurchase decision. In the first stage,
we follow Dittmar (2000) and model the repurchases as a function of firm cash levels and
cash flows, market-to-book ratio, leverage, dividend payout, firm size, stock price
performance, and option usage. In the second stage, which is our primary focus, we
model the decision to execute the repurchase as either an ASR or an OMR and include
the Inverse Mills Ratio (IMR) from the first stage analysis to control for potential
endogeneity problems.
Consistent with the ―accelerated‖ reporting effects on EPS associated with ASRs,
we find that short-term financial reporting incentives related to executives‘ compensation
contracts and employment horizons are significant determinants of the decision to
undertake ASRs. As expected, we find that firms are more likely to execute an ASR
when the reporting effects are accretive to EPS and when firms‘ bonus compensation
contracts explicitly reward executives on EPS performance. We also report evidence that
short CEO horizons are a determinant of repurchase decisions -- voluntary CEO turnover
in the year following the repurchase is significantly higher for the firms that choose ASRs
over OMRs. We also find that the ASR firms have CEOs that are more entrenched than
the OMR firms, as measured by the frequency with which CEOs also hold a dual position
as chairman of the board. These results are robust to controlling for alternative
motivations for repurchases, as well as other determinants of compensation structure and
CEO turnover. Our findings suggest that the basic premise of the criticisms offered by
guaranteed nature of the repurchase agreement. Some analysts hold similar views (e.g., McConnell, Pegg,
Senyek, Mott, and Calingasan, 2006).
3
the financial press – that repurchases are often motivated by short-term reporting effects
– has validity. More particularly, our results show that managerial myopia is more
clearly linked to ASRs than to OMRs, consistent with our expectations.
We also present additional analyses. First, we examine whether compensation
committees adjust reported EPS for the effects of the ASRs when determining cash
compensation levels. Using a model similar to Healy et al. (1987), we find no evidence
that compensation committees adjust reported EPS in setting executive pay, which is
consistent with our finding of greater CEO entrenchment for firms that choose ASRs over
OMRs.
Second, to address the issue of whether ASRs might impair firms in the long run,
we examine quarterly operating performance over a six-quarter window, beginning with
the quarter before the repurchase and ending four quarters after the repurchase. Using
unadjusted data, we find that ASRs significantly underperform OMRs in every quarter;
however, this finding does not hold when we adjust for industry and size. We thus
cannot conclude that the use of ASRs damages the firm in the long run. This finding is
consistent with those of Bowen, et al. (2008), who link managerial opportunism to poor
corporate governance, but are unable to document a deterioration in future firm
performance.
Finally, we examine whether firms with performance-contingent supplemental
executive retirement plans and that also use EPS as a performance metric for bonus
determination are more likely to choose an ASR over an OMR. We do not find evidence
to suggest that these firms are more likely to choose one form of share repurchase over
another.
4
This paper contributes to the accounting literature in several ways. First, we
extend the literature on the use of stock repurchases as a potential earnings management
tool. While prior work by Bens, et al. (2003) and Hribar, Jenkins, and Johnson (2006)
have shown that benchmark-beating is a significant determinant in the decision to
undertake OMRs, we show that different incentives related to EPS reporting are at play in
the decision to undertake ASRs. This finding is important in that it deepens our insight
into managers‘ motivations behind basic financing decisions that affect the firm.
Our results also contribute more broadly to the literature that links executive
compensation to corporate financing decisions. Compensation policies have been shown
to affect firms‘ leverage ratios (Smith and Watts, 1992; Berger, et al., 1997), convertible
debt choices (Marquardt and Wiedman, 2005), and the agency costs of debt (Duru, Mansi
and Reeb, 2005). While prior literature has also related compensation policies to stock
repurchases, this stream of research has tended to focus on the use of repurchases to
offset potential dilution from stock option grants (Bens et al., 2003; Dittmar, 2000). In
contrast, we document that the reliance on short-term EPS-based bonus contracts is a
significant determinant of repurchase decisions.
In addition, our research contributes to the literature on managerial myopia. A
number of studies have investigated the associations between short-term horizon
incentives and suboptimal investment decisions (see, e.g., Narayanan, 1985; Dechow and
Sloan, 1991; Bebchuk and Stole, 1993; Bushee, 1998), as well as accrual management
(see Pourciau, 1993; Murphy and Zimmerman, 1993; Reitenga and Tearney, 2003). Our
evidence complements and extends these findings by documenting that stock repurchase
decisions are associated with CEO employment horizons.
5
The remainder of this study is organized as follows. The next section describes
ASR agreements in greater detail. We develop our hypotheses in Section 3 and discuss
our research design in Section 4. Section 5 describes our sample selection process. We
present results in Section 6 and conclude with Section 7.
2. Background on accelerated share repurchases
An ASR is an arrangement in which a company purchases a block of borrowed
shares and simultaneously enters into a forward contract with an investment bank. The
investment bank buys the company shares back in the open market over time, generally
six months to one year, to replace the borrowed shares (see Figure 1). The forward
contract is typically settled at the volume-weighted average price (VWAP) over the
contract period.
For financial reporting purposes, an ASR is treated as two separate transactions.
First, when the agreement is initiated, stockholders‘ equity is decreased by the number of
shares repurchased times the current share price, and cash is decreased or a liability is
increased by an equal amount; this affects EPS calculations (on a weighted-average basis)
for the current period. In addition, any fees charged by the investment bank are
expensed. Second, because the firm typically has the choice to settle the forward contract
in either cash or shares, they are not required under current reporting standards to mark
the forward contract to market.2 Thus, there are no reporting effects associated with the
2 The implicit assumption behind the lack of mark-to-market accounting for the forward contract is that the
company intends to settle the forward contract in shares and therefore need not consider the change in the
fair value of the forward contract in the calculation of net income. In reality, most ASR forward contracts
are settled in cash.
6
forward until the settlement date, at which point the firm will deliver to (or receive from)
the investment bank the difference between the VWAP and the stock price at the
initiation date of the ASR. At settlement, the accounting treatment is to decrease cash (or
increase liabilities) and to decrease equity, assuming the price of the company‘s stock has
increased. The repurchased shares may be kept in treasury or retired (see the Appendix
for a numerical example of the accounting treatment for ASRs).3
A key difference in accounting treatments between ASRs and OMRs is the timing
of the recognition of the decrease in shares outstanding. In an OMR, this decrease is
recorded when shares are actually repurchased, while in an ASR, the financial reporting
effects are based on the repurchase of borrowed shares, preceding actual share
repurchases. Therefore, one advantage to ASRs is the accelerated financial reporting
benefits. The disadvantage is that cash must be provided up front, and the firm must pay
the average share value over the life of the contract regardless of the increase in share
price. Firms do not have an option to discontinue repurchasing shares once the ASR has
been entered into as they would with an OMR program.4
One likely reason for the increased frequency of ASR agreements since 2004 is
related to the issuance of Statement of Financial Accounting Standard (SFAS) No. 150,
―Accounting for Certain Financial Instruments with Characteristics of both Liabilities and
Equity.‖ SFAS 150 became effective for interim periods after June 15, 2003. Prior to
SFAS 150, firms commonly wrote put options on their own shares to hedge against price
3 Dickinson, et al. (2008) examine whether the current accounting for ASRs is representationally faithful
and document significant differences in the value relevance of the assets and liabilities of ASR firms versus
an industry-matched sample. 4 In fact, Lie (2005) shows that almost 25 percent of firms that announce an OMR plan do not repurchase
any shares at all in the announcement quarter.
7
increases. SFAS 150 requires that firm use mark-to-market accounting on puts and
forward options, reducing the benefit to the firm by requiring changes in value to be
recorded as increases or decreases to net income. However, as noted above, the forward
contracts associated with ASRs are not required to be marked-to-market when the firm
has the option of settling the contract in cash or shares. An additional discussion of
accounting for ASRs can be found in EITF 99-7, ―Accounting for an Accelerated Share
Repurchase Program.‖
3. Hypothesis development
The unusual structure of ASRs, as outlined in the previous section, has piqued the
interest of academic researchers. Chemmanur, et al. (2008) explore the determinants of
the decision between executing an ASR versus an OMR, with a focus on testing various
corporate financing theories of repurchases, and Akyol, et al. (2009) ask whether ASRs
are used to deter takeovers, finding no evidence consistent with this motivation.
This paper differs substantially in focus from the concurrent work on ASRs in that
we concentrate on the role that financial reporting objectives play in the choice between
an ASR and an OMR. In particular, we rely on two aspects of the ASR agreement in
developing our hypotheses: 1) the financial reporting benefits are ―accelerated‖ relative
to OMRs in that the effect on EPS is recorded prior to the actual repurchase of shares in
the open market over time; and 2) any cost associated with settlement of the forward
contract is shifted to a future period and is recorded directly in equity, bypassing the
income statement.5 We predict that these features will make ASRs relatively more
5In an untabulated analysis, we examine final settlement costs for 45 ASR firms in our sample that
disclosed this information. On average these firms make an additional cash payment to the investment bank
8
attractive to ―myopic‖ managers, i.e., those with strong incentives to increase EPS in the
short run. Our hypotheses below all relate to this basic tenet.
3.1 Accretive EPS Effect
We predict that managers are more likely to choose ASRs over OMRs when the
impact of the repurchase is accretive to EPS. One main advantage to an ASR is that the
reporting effects are ―accelerated‖ relative to the actual repurchase of shares. If the net
effect of the repurchase does not increase reported EPS, the manager arguably has less to
gain in choosing the ASR structure. While, in theory, OMRs could be sized such that
they would have reporting effects equal in magnitude to ASRs, in practice, the vast
majority of OMRs are not accretive to EPS. For example, Hribar, Jenkins, and Johnson
(2006) find that only 9% of OMRs in their sample increase reported EPS by one cent or
more.6 Our first hypothesis is thus as follows:
H1: Accretive EPS effects are positively associated with the decision to
undertake an ASR versus an OMR.
at the end of the contract period that represents 5.7% of the original ASR cost. Further, the pattern of settlement strongly suggests that ASR firms are concerned with the financial reporting effects of the
forward contract. We discuss this further in the results section. 6 The relatively small effects of OMRs on reported EPS suggest that OMRs are well-suited as an EPS
management tool when firms fall just short of an earnings benchmark – indeed, Hribar et al. (2006)
empirically show that firms exploit OMRs‘ inherent flexibility by strategically timing OMRs when they
―need a penny‖ to make an analyst forecast. While it is possible that firms also use ASRs to meet or exceed
analyst forecasts, it is a relatively straightforward exercise to adjust expected EPS for the effects of the
repurchase because the number of shares repurchased is known in advance with certainty; further,
anecdotal evidence shows that managers themselves explicitly disclose the reporting effects of the ASR on
future EPS, and analysts adjust their forecasts accordingly. For example, Rockwell Collins issued a press
release on September 29, 2006, announcing an ASR of 4.7 million shares at an initial cost of $257 million.
The press release also included the following statement: ―With the execution of this agreement, the
company now expects fiscal year 2007 earnings per share in the range of $3.10 to $3.20, a 5 cent increase
over the previously announced guidance range of $3.05 to $3.15.‖
9
3.2 EPS-Based Bonus Compensation
Prior research shows that the use of EPS-based bonuses affects firms‘ financing
decisions. For example, Marquardt and Wiedman (2005) find that firms are more likely
to structure convertible bond transactions to increase EPS when manager bonuses are
based on reported EPS figures.7 In addition, there is practitioner evidence relating stock
repurchases to executive compensation. In their recent report from The Center for
Financial Research and Analysis and The Corporate Library, Lehman and Hodgson
(2006) examine firms in the S&P 500 with negative cash flows prior to or during share
repurchase programs and found that a greater percentage of the CEOs for these firms
were rewarded on ―per share‖ performance metric (43.11 percent) compared to S&P 500
firms as a whole (27.85 percent). They also found that bonuses were more likely paid out
to the CEOs of these firms—88 percent of these CEOs received annual bonuses versus 78
percent of the S&P 500 firms and 37.5 percent received cash bonuses versus 22.2 percent
of CEOs in the S&P 500. The authors conclude that share repurchase programs may be
used to generate higher levels of EPS and EPS growth in order to increase payout of
incentives.
We predict that firms with bonus compensation contracts that are explicitly based
on EPS performance will be more likely to choose ASRs over OMRs. The immediate
boost to EPS and the deferral of contract settlement costs to a future period makes ASRs
a more attractive than OMR when executives are explicitly rewarded on short-term EPS
performance. In addition, prior research has linked OMRs to firms‘ reliance on stock
7 On a related note, Altamuro (2006) finds that firms are more likely to use synthetic leases, which increase
reported earnings, when bonuses are tied to net income.
10
option compensation (see Bens et al., 2003; Kahle, 2002; Dittmar, 2000), which tends to
be negatively associated with cash-based compensation (see Bryan, et al., 2000).
Our second hypothesis is therefore as follows:
H2: The use of bonus compensation contracts that explicitly reward EPS
performance is positively associated with the decision to undertake an ASR
versus an OMR.
3.3 Voluntary Turnover and the Horizon Problem
Prior research finds that executives make opportunistically-motivated decisions as
their employment horizon decreases. For example, Dechow and Sloan (1991) find that
CEOs invest less in R&D expenditures in their final years in office in an attempt to
increase their earnings-based compensation, and Reitenga and Tearney (2003) report
evidence of accruals management in the last two years of CEOs‘ employment.
Because part of the cost associated with an ASR is shifted into future fiscal
reporting periods (typically the following year) through the forward contract component
of the agreement, this repurchase structure is likely more attractive to executives with
very short employment horizons. Specifically, we hypothesize that CEOs would most
profit by timing an ASR for the year prior to their departure. We focus on CEO turnover
in the year following the repurchase because Yermack (2006) documents that separation
payments (also known as ―golden handshakes‖) are common when the CEO leaves the
firm, either voluntarily or through dismissal; further, the large majority of these payments
are awarded on a discretionary basis by the board of directors and not according to the
terms of an employment agreement. CEOs could benefit from the reporting effects in the
year of the repurchase, and the additional costs of the ASRs that would be recognized in
11
the year of departure would likely have little impact on the departing CEO‘s separation
package, particularly if the CEO is entrenched.8 Our third hypothesis is stated as follows:
H3: Voluntary CEO turnover in the year following the repurchase is positively
associated with the decision to undertake an ASR versus an OMR.
3.4 Managerial Entrenchment
We hypothesize that CEOs will be best able to benefit from the accelerated
financial reporting effects of an ASR if they have sufficient managerial power (Bebchuk,
et al., 2002) to influence board decisions and compensation arrangements. Bebchuk et al.
(2002) argue that managers can influence all facets of the pay-setting process, including
the appointment or reappointment of directors who are less likely to challenge his/her
compensation. Consistent with this theory of managerial power, Davila and Penalva
(2006) find that firms with more entrenched executives are more likely to have
compensation contracts that put more weight on accounting-based measures of
performance, which are arguably easier to manipulate, than on market-based performance
measures.
We also observe that compensation committees shield CEO pay from a variety of
factors, including accounting choices related to inventory and depreciation methods
(Healy, et al., 1987); restructuring charges (Dechow, et al., 1994); accounting losses
(Gaver and Gaver, 1998); strategic expenditures (Duru, et al., 2002); merger and
acquisition activity (Grinstein and Hribar, 2004); and recurring operating expenses
8 There is also evidence that compensation committees pay special attention to earnings management that
occurs in a CEO‘s final year of employment, after the executive‘s decision to leave the firm has been
revealed (see, e.g., Cheng, 2004, or Huson, et al., 2006).
12
(Comprix and Muller, 2006).9 It is therefore not unreasonable to expect that boards might
similarly ignore the effects of stock repurchases in determining executive compensation,
particularly if managers are more entrenched. Our fourth and final hypothesis is thus
stated as follows:
H4: Managerial entrenchment is positively associated with the decision to
undertake an ASR versus an OMR.
4. Research design
We examine whether financial reporting objectives related to short-term executive
compensation contracts and employment horizons affect stock repurchase decisions using
a two-stage Heckman self-selection model. In the first stage, we model the manager‘s
decision to repurchase shares; in the second stage, which is our main focus, we model the
decision to execute an ASR versus an OMR after controlling for the effects of self-
selection bias.
4.1 First stage analysis: Repurchase decision
We first estimate a tobit model of the decision to repurchase shares similar to
Dittmar (2000):
REPt = αt + β1CFOt-1 + β2CASHt-1 + β3MKBKt-1 + β4PAYOUTt-1 + β5SIZEt-1
+ β6RETURNt-1+β7LEVt-1 + β8DILUTIONt-1 + εt (1)
where REPt is the dollar volume of repurchases, defined as Compustat data item
Purchase of Stock minus any change in preferred stock from t-1 to t, divided by the prior
9 In contrast to these findings, Jackson et al. (2008) find that when a firm has losses or decreases in
earnings, accounting fundamentals can explain changes in CEO bonuses. They conclude that compensation
committees do rely on accounting fundamentals in setting CEO bonuses when earnings are negative or
decreasing.
13
year-end market value of equity and truncated at 1%; CFO is operating cash flows,
divided by assets, at t-1; CASH is cash and cash equivalents, divided by assets, at t-1;
MKBK is the ratio of the market value of equity plus debt to the book value of assets at t-
1; PAYOUT equals cash dividends divided by net income before extraordinary items at t-
1; SIZE equals the log of total assets at t-1; RETURN is the one-year stock return from
year-end t-2 to year-end t-1; LEV is defined as the difference between a firm‘s net debt-
to-asset ratio (where net debt equals debt minus cash) and the median net debt-to- asset
ratio of all firms with the same two-digit SIC code at t-1; and DILUTION equals the
difference between the shares outstanding used to calculate diluted earnings per share and
basic earnings per share, divided by the latter at t-1.10
Consistent with findings in prior
research, we expect repurchase activity to be positively associated with CFO, CASH,
SIZE, and DILUTION and negatively associated with MKBK, PAYOUT, RETURN, and
LEV. Following Heckman (1979), we include the Inverse Mills Ratio (IMR) from
equation 1 in our second-stage analysis to control for endogeneity in the decision to
repurchase stock in our main tests.
4.2 Second stage analysis: ASR vs. OMR
Our main focus is on the manager‘s decision between executing an ASR versus an
OMR. We use a probit regression model to test H1-H4, where the dependent variable,
10
Dittmar‘s (2000) model includes an OPTIONS variable, defined as the percentage of shares outstanding
held in reserve to cover stock options, as reported by Compustat. This variable is not available after 1998;
we therefore include our DILUTION variable as an alternative measure of stock option reliance. One
advantage of using this variable to measure dilution is that it includes the effects of all potentially dilutive
securities on stock price, not only stock options. Dittmar (2000) also includes a takeover variable for a
portion of her sample period. While we do not explicitly include takeover attempts in our model, we note
that firm size, growth opportunities, and leverage, all of which are represented in equation 1, have been
found to be negatively associated with the probability of takeover (see Palepu, 1986). In addition, Akyol, et
al. (2009) find no evidence that ASRs decrease a firm‘s attractiveness as a takeover target.
14
ASR, equals one if the firm chooses to undertake an ASR and zero if the firm chooses an
OMR.
To test H1, where we predict that accretive EPS effects are positively associated
with the ASR structure, we estimate the impact of the repurchase on diluted EPS for the
fiscal quarter in which the repurchase occurs. We follow Hribar et al. (2006) and compare
reported diluted EPS with an ―adjusted‖ EPS that removes the effects of the repurchase.
Specifically, we add back (on a weighted-average basis) the shares repurchased to the
denominator and after-tax interest charges to the numerator of diluted EPS. If this
―adjusted‖ EPS measure is less than reported EPS, the repurchase is accretive to EPS.
We create an indicator variable, ACCRETIVE, that equals one if the repurchase is
accretive to EPS and zero otherwise. We use this general measure of reporting impact
because managers of the repurchasing firm do not know actual diluted EPS for the
quarter at the time repurchasing decisions are made, but are likely able to determine
whether a repurchase will be accretive or dilutive to reported EPS. We allow for this
uncertainty by using an indicator rather than a continuous variable to estimate reporting
effects. We expect a positive estimated coefficient on ACCRETIVE.
To proxy for compensation incentives related to EPS performance (H2), we
follow Marquardt and Wiedman (2005) and create an indicator variable, BONUS, which
equals one if EPS is explicitly mentioned as a determinant of annual bonuses in the firms‘
proxy statement, and zero otherwise. We believe that this is the most direct measure of
whether a manager is compensated based on reported EPS.11
If managers of ASR firms
11
We hand-collect this information from the ―Report of the Compensation Committee‖ within firms‘ proxy
statements. This report typically outlines the general compensation philosophy and provides details about
the CEO‘s compensation more specifically.
15
are motivated by short-term compensation contracts, we expect a positive estimated
coefficient on BONUS.
To test H3, we create an indicator variable, TURNOVER, which equals one if the
CEO of the repurchasing firm voluntarily leaves the firm in the fiscal year following the
repurchase, and zero otherwise. Using a procedure similar to Huson, et al., (2001), we
classify turnover as ―forced‖ if a search of Factiva reveals that the CEO was fired, forced
from the position, or departs due to policy differences; we classify all other turnover as
voluntary. We expect a positive estimated coefficient on TURNOVER.
To test H4, we create an indicator variable, COB, which equals one if the CEO is
also the chairman of the board (COB), and zero otherwise. We choose this measure as it
is well-documented in prior research that duality in CEO and COB leadership rules
reflects managerial entrenchment and power. For example, Brickley, et al. (1997) find
that dual roles are associated with longer tenure and higher compensation levels. Ryan
and Wiggins (2004) find that CEOs who are also COB use their position to influence
directors‘ compensation, potentially interfering with effective monitoring. Grinstein and
Hribar (2004) find that M&A bonuses are positively related to shared CEO and COB
roles – i.e., CEOs who also serve as COB receive significantly higher bonuses and
engage in larger M&A deals. In addition, they find that compensation committees do not
appear to adjust bonuses for the performance of the deal. To the extent that the duality in
CEO and COB roles reflect managerial entrenchment, we expect a positive estimated
coefficient on COB.12
12
We use COB as our primary measure of managerial entrenchment because it is the most commonly used
in the prior literature. However, in sensitivity tests, we also use CEO age and CEO tenure as additional
measures of managerial entrenchment (see e.g. Berger et al. 1997; Davila and Penalva 2006). Results are
qualitatively similar.
16
We also control for other firm characteristics that might affect the choice between
an ASR and an OMR. For example, it is possible that the same factors that motivate
compensation policies also affect repurchase structure. One such variable is suggested by
the ‗informativeness principle,‘ which states that when a performance measure reflects
the influence of factors other than the executive‘s actions, i.e., the performance measure
is ‗noisy,‘ firms will reduce the weight placed on that measure in CEO compensation
packages (see Holmstrom, 1979; Milgrom and Roberts, 1992). Yermack (1995) and
Bryan, et al., (2000) find support for this idea in that they find that firms with noisy
accounting earnings relative to stock returns tend to rely more on stock option awards for
compensation purposes. We thus expect that firms that rely on EPS-based compensation
contracts will have earnings realizations that are less noisy relative to stock returns. We
control for this effect by including in our model the variable NOISE, which is defined as
the ratio of the standard deviation in return on assets to the standard deviation of stock
returns, measured over the five-year period preceding the repurchase. We expect NOISE
to be negatively associated with the likelihood of an ASR.
We also include the firm‘s marginal tax rate (MTR) as a control. Section 162(m)
of the Internal Revenue Code eliminates the tax deductibility of non-performance based
executive compensation over $1 million, and Balsam and Ryan (1996) show that
compliance with 162(m) is positively associated with firms‘ marginal tax rates.13
To
ensure that our BONUS variable, which would qualify as performance-based
compensation measure under the Code, is not confounded with a tax effect, we include
13
On a related note, Perry and Zenner (2001) document increased pay-for-performance sensitivity for the
firms affected by 162(m). More recently, Carter et al. (2008) find increased reliance on earnings
information in bonus contracts in the post-SOX era.
17
MTR in our model. We use simulated marginal tax rates as calculated by Graham and
Mills (2008) using financial statement data, which are highly correlated with marginal
rates based on actual tax returns.14
We expect MTR to be positively associated with the
likelihood of an ASR.
We also control for alternative financial reporting objectives associated with stock
repurchases. Barth, et al. (1999) and Myers, et al. (2007) find that the market rewards
patterns of increasing earnings, and Bens, et al. (2003) find that firms increase the level
of their firms‘ stock repurchases when earnings are below the level required to achieve
the desired rate of EPS growth. We therefore control for firms‘ incentives to use
repurchases to maintain strings of consecutive earnings increases by including in our
model the variable STRING, which equals the number of consecutive quarters prior to the
announcement date of the repurchase that the firm has met or exceeded the benchmark of
the prior year‘s EPS for the same fiscal quarter, up to a maximum of 20 quarters.
Because OMRs are arguably better suited to managing EPS over a period of several
quarters – managers can easily vary the timing and number of shares repurchased with an
OMR plan – we expect that STRING will be negatively (positively) associated with the
likelihood of an ASR (OMR).
In addition, because Skinner and Sloan (2002) find that market penalties for
negative earnings surprises are stronger for high growth than for low growth firms,
incentives to maintain earnings strings should be stronger for high growth firms. We
therefore also include SALESGROWTH, defined as annual sales growth over the fiscal
14
We thank John Graham for providing data on marginal tax rates. When these data are not available, we
use Graham and Mill‘s (2008) ―PseudoStatutory‖ variable, which they show is a second-best alternative to
their simulated rates.
18
year prior to the repurchase announcement, as an additional control variable.15
As with
the STRING variable, we expect a negative association between SALESGROWTH and the
likelihood of an ASR.
Our second-stage model is as follows:
Pr(ASRi) = αt + β1ACCRETIVEi + β2BONUSi + β3TURNOVERi + β4COBi
+ β5NOISEi + β6MTRi + β7STRINGi+β8SALESGROWTHi + β9IMRi + εi (2)
where i denotes firm i. In summary, we predict positive estimated coefficients on
ACCRETIVE, BONUS, TURNOVER, COB, and MTR, and negative estimated coefficients
on NOISE, STRING, and SALESGROWTH. A significant estimated coefficient on IMR
would indicate the existence of endogeneity in the repurchase decisions.16
5. Sample selection
We identify our sample of ASR firms by conducting key word searches on
Factiva and the SEC‘s EDGAR database for the terms ―accelerated‖ and ―repurchase‖
and ―stock or share.‖ The following is an example of a typical announcement of an ASR:
‗Laboratory Corp. of America Holdings (NYSE: LH) has entered into an
accelerated share repurchase agreement with an affiliate of Lehman
Brothers Inc. (NYSE: LEH) to repurchase around $250 million of
LabCorp stock. Under the agreement, LabCorp purchased around 3.4
million shares for subsequent delivery for a prepayment of $250 million.
The purchase price for these shares is subject to an adjustment based on
the volume weighted average price of LabCorp's stock during a period
15
We also use market-to-book as an alternative measure to proxy for growth and our results are
qualitatively similar. 16
It could be argued that a number of the variables in equation 1 might also affect the decision to
undertake an ASR versus an OMR. For example, Chemmanur, et al. (2008) hypothesize that differences in
firm size, cash levels, payout ratios, leverage, takeover measures, and valuation ratios could play a role in
choosing between an ASR and an OMR. We effectively include these variables as controls by including
the IMR from the first stage analysis in the second stage probit model. However, in sensitivity tests, we
examine the robustness of our main analysis to inclusion of these variables as individual regressors in the
second-stage model.
19
following execution of the agreement. The purchase price adjustment
should be settled in the first quarter of 2007.‘
When a company‘s announcement of share repurchase type was unclear, the company
was excluded from the sample. For example, we exclude Seagate Technology who made
the following announcement on August 6, 2008:
‗Stock repurchases under this program may be made through a variety of
methods, which may include open market purchases, privately negotiated
transactions, block trades, accelerated share repurchase transactions or
otherwise, or by any combination of such methods.‘
Our initial search yielded 109 firms that had engaged in one or more ASR during
2001-2006.17
Consistent with reports in the financial press stating that the prevalence of
ASRs has recently increased dramatically, we note that we could identify only six ASRs
prior to 2004; we therefore limit our focus to the 2004-2006 period.
For the first stage tobit analysis, the sample consists of all firms listed on
Compustat and CRSP over 2003-2006 that have all the data necessary to estimate
equation (1).18
This selection criterion results in 21,499 firm-years, of which 3,531 are
identified as repurchasers and 17,968 as non-repurchasers. The proportion of
repurchasers (16.4%) is comparable to Dittmar (2000), where repurchases occur in 16.7%
of sample firm-years.
For the second stage analysis, our probit model requires a sample of firms that
executed OMRs over 2004-2006. Because ASR transactions are typically announced
publicly through a press release at the time that they are executed, we limit our sample of
17
There were 18 firms that engaged in an ASR as well as an OMR during the 2004-2006 period. We
included these firms in our final sample. We also re-ran the tests excluding these firms and the results are
qualitatively the same. 18
Estimation of equation (1) requires one year of lagged data; hence we require data from 2003 to examine
repurchase activity over 2004-2006.
20
OMRs to those where firms announce the initiation of an OMR program and
subsequently follow through with an actual repurchase of shares during the same fiscal
quarter as the OMR program announcement. We believe these selection criteria best
enhance the comparability of the firms undertaking ASRs versus OMRs. Following Lie
(2005), we use the SDC Platinum database to identify OMR program announcements and
identify actual repurchases as occurring when quarterly Compustat data item #93
(Purchases of Common and Preferred Stock) exceeds 1% of the firm‘s market value.
After eliminating observations with missing data, our final sample consists of 70 ASR
firm-years and 201 OMR firm-years.
6. Results
6.1 First stage analysis: Tobit model of repurchases
Table 1, Panel A provides univariate comparisons of the independent variables
used to estimate equation (1). We compare both means and median across repurchasing
and non-repurchasing firm-years. Consistent with Dittmar (2000), repurchasing firms
generally have higher cash flows (CFO) and cash levels (CASH), have lower market-to-
book ratios (MKBK), are larger in firm SIZE, have lower stock RETURNS, and higher
dividend PAYOUT, are less levered (LEV), and have a greater proportion of potentially
dilutive securities (DILUTION) than non-repurchasing firms.
Table 1, Panel B provides the results of the first-stage tobit regression. The
estimated coefficients on CFO, CASH, SIZE, and DILUTION are significantly positive,
consistent with our expectations. The estimated coefficients on MKBK, PAYOUT and
RETURN are significantly negative (p = 0.0275, 0.0012, and 0.0001, respectively). The
21
pseudo-R2 is 9.1%. Overall, our results from the first-stage regression suggest that the
firm characteristics of repurchasers and non-repurchasers are significantly different in the
predicted fashion over our sample period. We use the results from this analysis to
calculate the inverse mills ratio (IMR), which we require as a control in our second-stage
model.
6.2 Second stage analysis: ASRs versus OMRs
In Table 2, we present univariate results for our second-stage variables. As
expected, the accretive effects to EPS are significantly greater for ASR firms, with the
repurchase increasing reported EPS by one cent or more for 44.3% of the ASR firms
versus 13.9% of the OMR firms (p=0.0001). In addition, a significantly higher
proportion of ASR firms explicitly reward their executives on EPS performance than do
OMR firms (57.5% vs. 30.0%, p=0.0001). We also document striking differences in
CEO turnover. For the ASR group, 23.8% of CEOs voluntarily leave the firm in the year
following the repurchase versus 7.6% of the CEOs in the OMR group (p = 0.0022). The
CEOs of the ASR firms also yield significantly more power, as measured by the
frequency with which they hold dual CEO and COB positions: 81% versus 51% for OMR
firms (p=0.0001). The univariate results are thus consistent with H1 – H4.
The control variables are also generally consistent with our expectations. ASR
firms have significantly lower median levels of relative noise in earnings (NOISE) than
OMR firms (0.033 versus 0.052, p=0.0019), consistent with the informativeness
principle. ASR firms also have significantly higher marginal tax rates (MTR), shorter
strings of consecutive earnings increases (STRING), and lower sales growth
22
(SALESGROWTH) than OMR firms. The inverse mills ratio (IMR) from the first-stage
regression is significant, highlighting the importance of controlling for the repurchase
decision.
We present Pearson and Spearman correlation coefficients in Table 3. The
strongest pair-wise correlation is between STRING and SALESGROWTH (Spearman ρ =
0.228), which are both proxies for financial reporting incentives related to benchmark
beating, followed by the correlation between ACCRETIVE and COB (ρ = 0.188), which
suggests that entrenched managers may be more likely to undertake repurchases in order
to secure financial reporting benefits. In general, however, the low correlation levels
suggest that multicollinearity is not likely to be a major concern.
Table 4 provides the second-stage probit regression of the ASR versus OMR
repurchase decision on our variables of interest. For completeness, we report results with
and without controlling for selection bias (IMR); as a sensitivity test, we also include
specifications with SIZE and RETURNS as additional regressors. Consistent with our
expectations, ACCRETIVE is significantly positively associated with the likelihood of
undertaking an ASR versus an OMR across all five specifications, as is BONUS and
COB, while TURNOVER is at least marginally significantly positive in Models 1 through
4. The estimated coefficients for the control variables NOISE, MTR, and STRING are
generally not significantly different from zero, but the estimated coefficient on
SALESGROWTH is at least marginally significantly negative across all five models. The
significance of the IMR variable, which proxies for self-selection bias, is sensitive to
model specification -- it is not significantly different from zero in Models 2 and 4, but if
RETURNS is added to the analysis, as in Model 5, it becomes significantly negative.
23
Lastly, if we include firm SIZE as an additional regressor, as in Models 3 and 4, the
significance levels of the other variables increase slight, but the basic tenor of the results
does not change.19,20
Overall, our findings are consistent with H1 – H4 and do not appear
to be driven by self-selection bias: short-term financial reporting incentives related to
executive compensation contracts and employment horizons are significant determinants
of the ASR versus OMR choice.
6.3 Additional analysis: Effect on executive cash compensation
In our main tests, we implicitly assume that compensation committees do not
adjust reported EPS for the effects of the ASR when setting executive pay. In this section,
we directly examine the validity of this assumption. We estimate a cross-sectional model
in which CEO cash compensation for the fiscal year of the repurchase is regressed on the
change in reported EPS and the market value of equity. Following Healy et al. (1987), we
transform both cash compensation and firm size by taking natural logs of both variables
so that their distributions more closely approach linearity. Our models are as follows:
log(Cash Compensationt) = β1+β2 ∆EPSt + β3 LogSIZEt + ε (3)
log(Cash Compensationt) = β1+β2 ∆EPSASRt + β3 LogSIZEt + ε (4)
Cash compensation is defined as the sum of annual salary and bonus; ΔEPS is
defined as the difference between current and prior year diluted EPS, divided by the
absolute value of prior year diluted EPS; ΔEPSASR is defined as the difference between
19
As a sensitivity test, we include the remaining independent variables from equation (1) as additional
regressors in equation (2). Only SIZE and RETURNS are significant determinants of the ASR versus OMR
choice after controlling for selection bias, and inclusion of the other variables from equation (1) does not
qualitatively change the results in Table 4. 20
In untabulated analyses, we also include CEO age as an additional regressor, as Desai, Hogan, and
Wilkins (2006) find that CEO age is a significant determinant of executive turnover. CEO age is not a
significant determinant of repurchase structure, and our inferences drawn from Table 4 remain unchanged.
24
diluted EPS for the current fiscal year, with the numerator adjusted for after-tax interest
charges related to the repurchase and the denominator adjusted for the time-weighted
number of shares repurchased, and prior year diluted EPS, divided by prior year diluted
EPS; and Size is the (logged) market value of equity as of the fiscal year-end. We
compare adjusted R2‘s across the two specifications using a Vuong Z-test. If
compensation committees adjust reported EPS for the effects of the ASR, we should
observe a higher adjusted R2 in the second model (equation 4). We obtain cash
compensation data from Execucomp when available; otherwise, we hand-collect the
information from firms‘ proxy statements filed with the SEC. We examine both the
CEO‘s cash compensation, as well as the sum of cash compensation for the top five
executives of the firm.
Results are presented in Table 5. In Panel A, we present descriptive statistics on
cash compensation and EPS. Mean (median) CEO cash compensation in the fiscal year of
the ASR is $1.886.0 ($1.261.3) million, which is slightly higher than the mean (median)
CEO cash compensation of $1.707 ($1.120) million for all Execucomp firms during our
sample period. The average CEO bonus comprises almost one-third of total cash
compensation, which is comparable to the average for Execucomp firms. Average cash
compensation for the top five executives is slightly higher than the Execucomp average
of $4.823 million. The average bonus for the top five executives in ASR firms comprises
31 percent of total cash compensation compared to 36 percent for all Execucomp firms.
The average cash compensation of the mean (median) diluted EPS is $2.646 ($2.380),
which indicates that ASR firms are fairly profitable. When diluted EPS is adjusted for the
effects of the ASR, the mean (median) figure is $2.589 ($2.372). The mean (median)
25
percentage effect of the ASR on diluted EPS is 2.2% (1.1%), which is relatively large. In
addition, mean (median) annual growth in diluted EPS is 20.1 percent (10.4 percent), but
would be 16.4 percent (8.5 percent) if the ASR had not taken place.
Panel B presents the results from the OLS regressions. The adjusted R2‘s are
similar across models and Vuong Z-tests comparing adjusted R2‘s from Models 1 and 2
and from Models 3 and 4 are not significant at conventional levels. Based on these
findings, it does not appear that compensation committees adjust reported EPS for the
effects of ASRs, consistent with the managerial entrenchment exhibited by firms that
undertake these transactions. We caution, however, that our lack of results could also be
due to low statistical power.
6.4 Additional analysis: Post-repurchase operating performance
To assess whether there are negative long-run consequences associated with
ASRs, we compare the post-repurchase operating performance of ASRs versus OMRs.
We eliminate firms that are missing necessary accounting data on quarterly Compustat to
compute performance-adjusted ROA. Similar to Lie (2005), we develop matched samples
based on: 1) announcement year and quarter, 2-digit SIC code, and firm size as measured
by total assets; and 2) announcement year and quarter, 2-digit SIC code, and performance
as measured by return on assets (ROA) and market to book ratio (M/B) in the
announcement quarter. We define performance as operating income scaled by cash-
deflated assets at the beginning and end of the quarter.
We present results for the firms matched on industry and size in Table 6
(untabulated results for firms matched on performance measures are qualitatively
similar). The sample size is limited due to both to the availability of an appropriate
26
matching control firm and by the recency of our sample firms. In particular, firms that
completed ASRs in 2006 would have little data available on quarterly Compustat with
which to carry out the analysis.
As shown in Panel A, mean and median unadjusted ROA are significantly smaller
for ASR firms in quarters -1 through +2. However, when operating performance is
adjusted for industry and size, we no longer observe any significant differences between
ASRs and OMRs. Similarly, in Panel B, where changes in operating performance are
presented, no significant differences between the two groups are apparent. These findings
suggest that either the choice between an ASR and OMR has no significant effects on
future performance or, alternatively, that our small sample size does not allow us to
detect underlying performance differences. Hence, we do not find conclusive evidence
that the use of ASRs damages the firm in the long run. This finding is consistent with
those of Bowen, et al. (2008), who link managerial opportunism to poor corporate
governance, but are also unable to document a deterioration in future firm performance.21
6.5 Additional analysis: Executive pensions
Finally, we examine whether certain types of pension plans may also increase the
likelihood of choosing an ASR. According to recent articles in the business press (see e.g.
21
We also examined final settlement costs for 45 ASR firms in our sample that disclosed this information.
Eight of these firms chose to settle the forward contract using shares, and 37 chose to settle in cash. Of the
cash settlement firms, 33 had an increase in share price over the contract period and therefore had a further
obligation to the investment bank, while none of the stock settlement firms had an increase and therefore
were not required to issue additional stock to the investment bank. A chi-squared test reveals that this
difference in settlement patterns is highly significant (χ2 = 26.76, p <= 0.0001) and is consistent with
companies choosing to settle in cash to avoid issuing additional shares that further dilute EPS. This pattern
of settlement strongly suggests that ASR firms are concerned with the financial reporting effects of the
forward contract.
27
Schultz and McGinty, 2009), another area of executive compensation that has been
overlooked as a means of excessive pay is supplemental executive retirement plans
(SERPs). These plans, which are non-qualified and non-contributory, are designed for
key employees and provide benefits above and beyond those covered in qualified
retirement plans. Sometimes termed ‗camouflage‘ or ‗stealth‘ compensation, they are a
potential area where compensation can be hidden from investors and analysts (Bebchuk
and Fried, 2004). In a period where many employers have frozen pension plans for
regular employees, the Wall Street Journal found that pensions for top executives rose
almost twenty percent in 2008. The value of these contracts can be difficult to determine
from information in corporate footnotes yet can result in tens of millions of dollars in
post-retirement pay (Bebchuk and Fried, 2004).
Kalyta (2009) suggests that these supplementary retirement plans present an
excellent opportunity to examine managers‘ discretionary accounting choices. He finds
that managers make income increasing discretionary accounting choices in the years prior
to retirement when CEO pension is based on firm performance. Kalyta and Magnan
(2008) provide evidence that the vague disclosure of these SERPs also prevents effective
monitoring of this compensation mechanism. They find that proxies for CEO power are
significantly related to the occurrence and size of CEO SERP benefits.
To examine this relationship, we create an indicator variable which equals one if
the firm has a performance-contingent SERP in the year of the repurchase and zero
otherwise. We collect this information from the pension and deferred compensation
benefits section of firm proxy statements. Our results provide some evidence that the
existence of a SERP is related to the probability of choosing an ASR over an OMR.
28
Results show this pension variable is significant in the multivariate analysis at the p<.05
level (untabulated) when size is not included in the regression. However, when size is
added to the full model, the results are not significant at traditional levels.
We also examine the interaction of SERP with BONUS and include this in the
probit regression. If the firm has a performance-contingent supplemental executive
retirement plan and EPS is used as a performance benchmark, then we would expect
these firms to more likely choose an ASR over an OMR. We correct for the interaction
effect in the probit regression using the approach of Ai and Norton (2003) and Norton,
Wang and Ai (2004). While the multivariate results are not significant, we do find in
untabulated results, that approximately 19% of OMR firms have SERPs and one-third of
these firms have SERPs that are linked to EPS as a performance indicator (Pearson Χ2 =
0.217). More than half of the ASR firms have SERPs (53%) and nearly two-thirds of
these firms have SERPs linked to EPS (Pearson Χ2 = 1.984). Overall, our results provide
only limited evidence that firms with performance-contingent SERPs are more likely to
choose an ASR over an OMR.
7. Conclusions
In this paper, we examine whether short-term financial reporting incentives
related to executives‘ compensation contracts and employment horizons affect firms‘
decisions to undertake ASRs versus OMRs. We find that firms are more likely to choose
ASRs over OMRs when the repurchase is accretive to EPS, when annual bonus
compensation is explicitly tied to EPS performance, when CEO horizons are short, and
when CEOs are more entrenched. Importantly, our findings are robust to controlling for
endogeneity in the decision to repurchase shares. Overall, these results suggest that
29
short-term financial reporting benefits are a significant determinant of decisions to
undertake ASRs, consistent with assertions in the financial press. These findings have
particular relevance in light of the recent intensified focus on executive compensation and
managerial myopia in the investment and regulatory communities.
In additional analyses, we examine whether compensation committees adjust for
the reporting effects of the ASR when setting CEO pay; we find no evidence of
adjustment, consistent with the managerial entrenchment exhibited by these firms. We
also examine whether ASRs impair the long-run performance of firms; our findings are
inconclusive, consistent with Bowen et al. (2006), who similarly document a link
between managerial opportunism and poor governance yet are unable to document
deleterious subsequent firm performance. Finally, we do not find evidence that firms
with performance-contingent supplemental executive retirement plans and that treat EPS
as a performance benchmark are more likely to choose and ASR over an OMR. However,
we caution that the lack of results in our additional analyses may be due to low statistical
power stemming from small sample size.
30
Appendix
The following is an example of the accounting treatment for an ASR. Suppose Company
X wants to buy back 1 million shares of stock. Currently, the company has 10 million
shares outstanding and the stock price is $10 per share. After the decision, the company
has net earnings of $2 million for the quarter ended March 31.
Scenario 1: The stock price stays the same over the quarter.
Company X enters into an ASR agreement on January 1 and agrees to repurchase
1 million shares of stock. The ASR has an end contract date of March 31. The
current stock price is $10 per share.
Jan. 1: Treasury Stock $10,000,000
Cash or Liability $10,000,000
Forward agreement: no entry made as the forward contract has no significant
value at the contract‘s initiation date. However, any fees charged by the
investment bank would be recorded as an expense.
March 31: No entries required
Effect on EPS at 3/31:
With ASR: Without ASR:
$2,000,000/9,000,000 = $.22 $2,000,000/10,000,000 = $.20
Scenario 2: The stock price increases to $15/share on January 31 and remains there for
the rest of the quarter.
Jan. 1: Treasury Stock $10,000,000
Cash or Liability $10,000,000
March 31: The VWAP over the three months is $13.33 per share.
If settled in cash:
Treasury Stock $3,333,333
Cash or Liability $3,333,333
EPS on 3/31 is same as above.
If settled in stock:
An adjustment would be made to the shares outstanding. The company would
now show that approximately 888,888 shares have been repurchased, versus
1,000,000. However, as EPS is calculated on a weighted-average basis, there is no
change in reported EPS for the first quarter. There is no impact on the balance
sheet.
31
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36
FIGURE 1
Overview of ASR transaction*
Pays cash and enters
E into forward contract Loan shares to bank
Borrows shares and enters
into forward contract
Purchases shares
and returns to investors
*See McConnell et al. (2006).
Investment
Bank
Open
Market
Investors
ASR
Firm
37
TABLE 1 First stage tobit regression of stock repurchase model Panel A: Univariate comparisons of first stage independent variables
Non-repurchasers Repurchasers p-value
CFO
Mean
Median
0.0221
0.0625
0.1155
0.1145
0.0001
0.0001
CASH
Mean
Median
0.1955
0.1258
0.2216
0.1368
0.0001
0.7859
MKBK
Mean
Median
2.2313
1.5779
2.1708
1.7862
0.1331
0.0001
SIZE
Mean
Median
5.7731
5.6417
7.3521
7.3700
0.0001
0.0001
RETURNS
Mean
Median
0.1866
0.1352
0.1361
0.1290
0.0001
0.0001
PAYOUT
Mean
Median
0.1653
0.0000
0.1765
0.0361
0.2576
0.0001
LEV
Mean
Median
0.0343
-0.0037
0.0237
-0.0178
0.0388
0.0872
DILUTION
Mean
Median
0.0261
0.0059
0.0349
0.0209
0.0001
0.0001
Panel B: Tobit estimation results
REPt = αt +β1CFOt-1+β2 CASHt-1+β3MKBKt-1+β4PAYOUTt-1+β5SIZEt-1
+β6RETURNSt-1+β7LEVt-1+β8DILUTIONt-1+εt
Estimated coefficient p-value
Intercept -0.158 0.0001
CFO 0.248 0.0001
CASH 0.056 0.0001
MKBK -0.003 0.0275
PAYOUT -0.017 0.0012
SIZE 0.018 0.0001
RETURNS -0.620 0.0001
LEV -0.015 0.1687
DILUTION 0.139 0.0001
Log likelihood -760.22
Pseudo R2 0.091
N=21,499. Number of non-repurchasers = 17,968; number of repurchasers = 3,531. CFO equals operating cash flows,
divided by assets, at t-1; CASH equals cash and cash equivalents, divided by assets, at t-1; MKBK equals the ratio of the
market value of equity plus debt to the book value of assets at t-1; PAYOUT equals cash dividends divided by net
income before extraordinary items at t-1; SIZE equals the log of total assets at t-1; RETURN equals the one-year stock
return from year-end t-2 to year-end t-1; LEVER equals the difference between a firm‘s net debt-to-asset ratio (where
net debt equals debt minus cash) and the median net debt-to-asset ratio of all firms with the same two-digit SIC code at
t-1; DILUTION equals the difference between the shares outstanding used to calculate diluted earnings per share and
basic earnings per share, divided by the latter at t-1. All variables are winsorized at 1% and 99%. P-values in Panel A
are based on two-sided t-tests for means and Wilcoxon tests for medians. REP is the dollar volume of repurchases
divided by the prior year-end market value of equity, truncated at 1%.
38
TABLE 2
Univariate comparisons of second stage variables
Variable
ASRs
(n=70)
OMRs
(n=201)
p-value
ACCRETIVE
Proportion
BONUS
Proportion
0.443
0.575
0.139
0.300
0.0001
0.0001
TURNOVER
Proportion
0.238
0.076
0.0022
COB
Proportion
0.810
0.510
0.0001
NOISE
Mean
Median
0.084
0.033
0.108
0.052
0.3901
0.0019
MTR
Mean
Median
0.258
0.350
0.191
0.350
0.0020
0.0032
STRING
Mean
Median
3.038
2
4.857
3
0.0013
0.0057
SALESGROWTH
Mean
Median
0.097
0.069
0.169
0.123
0.0031
0.0015
IMR
Mean
Median
1.386
1.373
1.550
1.563
0.0001
0.0001 ACCRETIVE equals 1 if the repurchase is accretive to diluted EPS by one cent or more for the fiscal quarter
of the repurchase and 0 otherwise. BONUS equals 1 if EPS if explicitly mentioned in the firm‘s proxy
statement as one of the determinants of annual cash bonuses and 0 otherwise. TURNOVER equals 1 if the
CEO voluntarily leaves the firm in the year following the repurchase and 0 otherwise. COB equals 1 if the
CEO is also Chairman of the Board and 0 otherwise. NOISE is the ratio of the standard deviation in return
on assets to the standard deviation of stock returns, measured over the five-year period preceding the
repurchase. MTR is the firm‘s marginal tax rate. STRING is the number of consecutive quarters prior to the
announcement date of the share repurchase that the firm has met or exceeded the benchmark of the prior
year‘s EPS for the same fiscal quarter, up to a maximum of 20 quarters. SALESGROWTH is measured
annually. All variables are measured in the fiscal year prior to the repurchase announcement, except where
indicated, and are winsorized at 1% and 99%. P-values for BONUS, TURNOVER, and COB are based on
two-tailed test of differences in population proportions; p-values for differences in means are based on two-
tailed t-tests; p-values for differences in medians are based on two-tailed Wilcoxon tests.
39
TABLE 3
Pearson/Spearman correlation coefficients
Variable
ACCRETIVE
BONUS
TURNOVER
COB
NOISE
MTR
STRING
SALES
GROWTH
IMR
ACCRETIVE
1.000
-
0.007
(0.916)
0.094
(0.137)
0.188
(0.003)
-0.087
(0.167)
0.091
(0.149)
0.046
(0.462)
-0.125
(0.048)
-0.159
(0.011)
BONUS 0.007
(0.916)
1.000
-
0.040
(0.494)
0.104
(0.082)
-0.117
(0.045)
0.140
(0.017)
-0.140
(0.017)
-0.071
(0.227)
-0.151
(0.012)
TURNOVER 0.094
(0.137)
0.040
(0.494)
1.000
-
0.092
(0.125)
-0.190
(0.001)
0.129
(0.001)
-0.002
(0.971)
-0.037
(0.523)
-0.123
(0.041)
COB 0.188
(0.003)
0.104
(0.082)
0.092
(0.125)
1.000
-
-0.188
(0.002)
0.179
(0.002)
-0.080
(0.181)
-0.037
(0.537)
-0.147
(0.017)
NOISE -0.074
(0.242)
-0.123
(0.036)
-0.093
(0.112)
-0.013
(0.826)
1.000
-
-0.194
(0.001)
-0.090
(0.124)
-0.019
(0.742)
0.178
(0.003)
MTR 0.091
(0.149)
0.139
(0.017)
0.129
(0.027)
0.180
(0.003)
-0.197
(0.001)
1.000
-
-0.104
(0.075)
0.092
(0.115)
-0.012
(0.837)
STRING 0.063
(0.316)
-0.115
(0.051)
-0.003
(0.958)
-0.098
(0.103)
-0.003
(0.957)
-0.096
(0.103)
1.000
-
0.228
(0.001)
0.062
(0.302)
SALESGROWTH -0.015
(0.813)
-0.008
(0.892)
0.010
(0.871)
-0.018
(0.759)
-0.015
(0.806)
0.112
(0.058)
0.223
(0.001)
1.000
-
0.054
(0.367)
IMR -0.182
(0.004)
-0.147
(0.014)
-0.120
(0.045)
-0.141
(0.023)
0.082
(0.175)
-0.022
(0.722)
0.056
(0.353)
0.052
(0.389)
1.000
- N=271. Pearson (Spearman) correlation coefficients are presented below (above) the diagonal. Variable definitions are provided in Table 2. P-values (in
parentheses) are based on two-tailed significance levels.
40
TABLE 4
Probit regressions of repurchase type on firm characteristics
iiiiiii
iiii
RETURNSSIZEIMRHSALESGROWTSTRINGMTR
NOISECOBTURNOVERBONUSACCRETIVEASR
)(
)Pr(
11109876
543210
Variable Predicted
Sign
Model 1
Model 2
Model 3
Model 4
Model 5
Intercept ? -1.4087
(0.0001)
0.3507
(0.6375)
-3.4488
(0.0001)
-4.8360
(0.0008)
1.1784
(0.1627)
ACCRETIVE + 0.8682
(0.0001)
0.8191
(0.0004)
0.8219
(0.0004)
0.8558
(0.0003)
0.8163
(0.0006)
BONUS + 0.4860
(0.0208)
0.4720
(0.0258)
0.3902
(0.0378)
0.3971
(0.0386)
0.3837
(0.0313)
TURNOVER + 0.5670
(0.0530)
0.4991
(0.0478)
0.5297
(0.0815)
0.5478
(0.0732)
0.3248
(0.1525)
COB + 0.7013
(0.0023)
0.6819
(0.0035)
0.6681
(0.0113)
0.6016
(0.0124)
0.6035
(0.0123)
NOISE - 0.2131
(0.6262)
0.2948
(0.4998)
0.5397
(0.2341)
0.5397
(0.2375)
0.4303
(0.3670)
MTR + 0.1784
(0.7747)
0.1765
(0.7792)
0.1373
(0.8343)
0.2258
(0.7341)
0.0158
(0.9810)
STRING - -0.0401
(0.0919)
-0.0387
(0.1047)
-0.0334
(0.1768)
-0.0330
(0.1849)
-0.0349
(0.1637)
SALES GROWTH - -1.2119
(0.0517)
-1.2223
(0.0588)
-1.1031
(0.0958)
-1.1031
(0.0911)
-1.4899
(0.0217)
IMR ?
-0.7040
(0.1308)
0.6323
(0.2800) -2.3087
(0.0003)
SIZE +
0.2644
(0.0002)
0.3217
(0.0003)
RETURNS ?
8.6336
(0.0001)
Log likelihood -101.02 -99.34 -93.47 -92.89 -111.45 N=271. The dependent variable, ASR, is an indicator variable that equals 1 if the stock repurchase is
accelerated and 0 if open market. All other variables are defined in Table 2. P-values are presented in
parentheses and are based on two-tailed significance levels.
41
TABLE 5
Regression of logged executive cash compensation on EPS and size
Panel A: Descriptive Statistics
Variable
Mean
Median
Std. Dev.
Total CEO Cash Compensation ($ 000‘s) $1,886.0 $1,261.3 2,115.7
CEO Bonus / Total CEO Cash Compensation 0.314 0.409 0.309
Total Top5 Cash Compensation ($ 000‘s) $5,409.3 $4,005.5 3,718.4
Top5 Bonus / Total Top5 Cash Compensation 0.310 0.367 0.264
EPS (as reported) $2.646 $2.380 1.694
EPSASR (as if ASR had not occurred) $2.587 $2.372 1.667
% Difference (EPS-EPSASR)/EPS 0.022 0.011 0.061
∆EPS 0.201 0.104 0.741
∆EPSASR
0.164 0.085 0.723
Panel B: OLS Regressions of Cash Compensation on EPS
Model 1: log(CEO Cash Compensationt) = β1+β2 ∆EPS + β3 SIZE + ε
Model 2: log(CEO Cash Compensationt) = β1+β2 ∆EPSASR + β3 SIZE + ε
Model 3: log(Top5 Cash Compensationt) = β1+β2 ∆EPS + β3 SIZE + ε
Model 4: log(Top5 Cash Compensationt) = β1+β2 ∆EPSASR + β3 SIZE + ε
Model
β1
β2
β3
Adj. R2
1 4.692
(0.0001)
0.128
(0.0112)
0.287
(0.0001)
25.89%
2 4.673
(0.0001)
0.128
(0.0124)
0.288
(0.0001)
25.71%
3 6.311
(0.0001)
0.098
(0.0141)
0.237
(0.0001)
26.87%
4 6.299
(0.0001)
0.100
(0.0138)
0.238
(0.0001)
26.65%
N=70. Cash compensation figures for the CEO and Top 5 executives are obtained from Execucomp where
possible or hand-collected from proxy statements filed with the SEC otherwise. All variables are measured
as of the end of the fiscal year of the repurchase. EPS is diluted EPS (Compustat data item #57). EPSASR
is diluted EPS with the numerator adjusted for the time-weighted interest earned on the cash used in the
repurchase and the denominator adjusted by the time-weighted number of shares repurchased. ΔEPS is
current year‘s diluted EPS minus lagged diluted EPS, divided by lagged diluted EPS. ΔEPSASR is
EPSASR minus lagged diluted EPS, divided by lagged diluted EPS. SIZE is the log of the market value of
equity. P-values are presented in parentheses.
42
TABLE 6
Quarterly operating performance for firms with share repurchases during the announcement quarter
Unadjusted Industry and Size Adjusted
ASRs OMRs ASRs OMRs ASRs OMRs ASRs OMRs
Quarter n n Mean Median Mean Median n n Mean Median Mean Median
Panel A: Levels of operating performance
-1 54 174 .0353 a**
.0289 a***
.0504 a .0462
a 46 156 .0078 -.0006 -.0024 .0101
0 54 175 .0359 a**
.0290 a**
.0489 a .0410
a 48 161 .0071 .0016 -.0090 .0082
1 45 161 .0343 a*
.0307 a***
.0493 a .0426
a 37 142 .0054 .0008 -.0031 .0085
2 38 117 .0339 a**
.0294 a***
.0554 a .0458
a 31 97 .0079 .0038 .0071 .0111
3 34 73 .0336 a .0294
a .0489
a .0357
a 30 52 .0078 .0001 .0001 .0064
4 24 36 .0372 a .0291
a .0412
a .0388
a 22 27 .0121 .0033 .0054 .0078
Panel B: Changes in operating performance
0 to +1 45 159 -.0005 -.0004 .0015 .0005 36 136 .0035 .0004 -.0068 -.0021
0 to +2 38 117 -.0008 -.0017 -.0049 b .0002 31 95 -.0010 -.0004 -.0109
b -.0005
0 to +3 34 73 .0011 -.0007 .0035 .0023 30 51 -.0011 -.0008 -.0154 b .0028
0 to +4 24 35 .0037 .0014 .0067 b .0013 21 26 .0004 .0018 .0020 .0008
Operating performance is measured as operating income scaled by cash-adjusted assets at the beginning and end of the fiscal quarter. Quarter 0 is the
announcement quarter. Industry adjusted performance is the difference between the operating performance of the sample firms and the operating performance of
their respective date, industry and asset matched firm. OMRs used in this analysis are those that repurchase shares totaling at least one percent of total assets in
the same quarter as the repurchase announcement. a and
b denote that the mean or median is different than zero at the .01 and .10 level, respectively.
***, **, * indicates that ASRs are significantly different from OMRs at the .01, .05 and .10 level, respectively.