The purpose of this paper is to examine whether firms engage in earnings decreasing management before share repurchases to mislead investors or to smooth earnings and improve earnings informativeness.
The authors examine discretionary accruals and cash flows around open-market share repurchases. The primary discretionary accruals measure is industry- and performance-adjusted discretionary current accruals estimated from cash-flow data.
Results show that, firms experience temporary increases in operating cash flows and use negative discretionary accruals to smooth earnings before share repurchases. Firms with the highest pre-repurchase cash flows use the lowest pre-repurchase discretionary accruals. Moreover, pre-repurchase discretionary accruals reflect expectations about future operating cash flows. Firms with the strongest deterioration in operating cash flows after repurchases use the lowest pre-repurchase discretionary accruals. These findings suggest that repurchasing firms use earnings management to increase smoothness and predictability of reported earnings rather than to mislead investors.
This paper provides an alternative explanation to the finding of negative discretionary accruals before share repurchases. It adds to the literature on repurchases and earnings smoothing by showing that firms use earnings management around share repurchases to smooth earnings.
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