Why do stock repurchases change over time?

Author:Chia‐Wei Huang, Yuan‐Teng Hsu
Publication Date:01 Sep 2020
Eur Financ Manag. 2020;26:938957.wileyonlinelibrary.com/journal/eufm938
© 2019 John Wiley & Sons Ltd.
DOI: 10.1111/eufm.12251
Why do stock repurchases change over time?
YuanTeng Hsu
ChiaWei Huang
Research Center of Finance, Shanghai
Business School, Shanghai, China
Graduate Institute of Management,
College of Management, National Taiwan
Normal University, Taipei, Taiwan
YuanTeng Hsu, Research Center of
Finance, Shanghai Business School, 2271
West Zhong Shan Rd., Shanghai 200235,
Email: yuanteng.hsu@gmail.com
Funding information
Ministry of Science and Technology in
Recent studies have shown the time trends of firm stock
repurchase behavior. We examine these time changes
for stock repurchase through the lens of real activities
earnings management. Managers appear more likely to
manipulate earnings through stock repurchases since
the passage of the SarbanesOxley Act (SOX) in 2002.
Furthermore, suspect firms that just missed analyst
earnings per share forecasts have higher incentives to
manipulate earnings through stock repurchases. The
results are not driven by changes in corporate govern-
ance associated with the passage of SOX. Overall, our
results suggest earnings management can be a signifi-
cant determinant of the dynamics of stock repurchases.
earnings management, SarbanesOxley Act, stock repurchase
G18; G31; G35; G38
Payout policy is at the core of most questions in corporate finance (FarreMensa, Michaely, &
Schmalz, 2014). It is important because of the amount of money involved and the repeated
We thank John Doukas (the editor) and an anonymous referee for very helpful comments and suggestions that greatly
improved the paper. We also thank Konan Chan, ChingHung Chang, Yuanchen Chang, HongYi Chen, ShengSyan
Chen, YanShing Chen, Yehning Chen, YennRu Chen, K. Victor Chow, PoHsin Ho, ChihYen Lin, YangPin Shen,
ChengYi Shiu, and Yanzhi Wang for helpful comments and suggestions. Seminar participants at National Taiwan
University, National Chengchi University, National Chiao Tung University, and Yuan Ze University provided many
valuable comments. ChiaWei Huang gratefully acknowledges financial support from Ministry of Science and
Technology in Taiwan. Part of this research was done while ChiaWei Huang was the Associate Professor of Finance at
Yuan Ze University.
nature of the decision, as well as its close relation to most of the financial and investment
decisions firms make (Allen & Michaely, 2003). Theories of optimal cash holdings, financing,
capital structure decisions, mergers and acquisitions, and employee compensation all have
conceptual and mechanical links to payout levels. Understanding the patterns and
determinants of payout policy could also help us to better understand the other pieces in this
puzzle. The time trend of dividend payouts has attracted significant research attention,
including authors such as Baker and Wurgler (2004a, 2004b), Bradford, Chen, and Zhu (2017),
DeAngelo and DeAngelo (2007), DeAngelo, DeAngelo, and Skinner (2004), DeAngelo,
DeAngelo, and Stulz (2006), Fama and French (2001), FarreMensa et al. (2014), and Hoberg
and Prabhala (2009). There have been fewer studies on stock repurchase time trends, however.
Compared with dividends, stock repurchases have become the most popular form of corporate
payout since 1997, and FarreMensa et al. (2014) and Floyd, Li, and Skinner (2015) have shown
them becoming more volatile over time. The aggregate dollar amount of repurchases increased
dramatically after 2002, peaking in 2007 and then sharply declining during the 20082009
financial crisis. These timevariant characteristics of repurchases motivate us to explore the
reasons for stock repurchase changes over time.
We examine the time trends in stock repurchases through the lens of earnings management.
Stock repurchases can be a device of real activities earnings management (Almeida, Fos, &
Kronlund, 2016; Bens, Nagar, Skinner, & Wong, 2003; Brav, Graham, Harvey, & Michaely,
2005; Farrell, Unlu, & Yu, 2014; Hribar, Jenkins, & Johnson, 2006; Myers, Myers, & Skinner,
Firmsstock repurchases can improve their earnings per share (EPS) by reducing the
amount of shares outstanding, that is, lowering the denominator of the relation.
We take advantage of the macroeconomic event of the passage of the SarbanesOxley Act
(SOX) to test our conjecture. Did it affect stock repurchases? Passed by US Congress in July
2002, SOX aimed to improve the quality of financial reporting and enhance investor confidence
by curbing earnings management and accounting fraud. Cohen, Dey, and Lys (2008) and Cohen
and Zarowin (2010) show that accrualbased earnings management has declined significantly
since the passage of SOX, and they also note that this decline was concurrent with increases in
real activities earnings management.
The reason for this is the heightened costs of using
accrualbased earnings management, given the additional scrutiny of auditors and regulators
and potential litigation penalties after the legislation's passage (Graham, Harvey, & Rajgopal,
2005; Zang, 2012). Managerschoices of particular earnings management methods depend on
the tradeoff between the benefits and costs. We therefore expect firms to be more likely to
engage in stock repurchases to boost their EPS postSOX.
We start by examining the impact of SOX on stock repurchases. We split the sample period
into two segments: the period from 1987 through 2001 (the preSOX period) and the period
from 2002 through 2017 (the postSOX period). Consistent with our hypothesis, following the
passage of SOX, stock repurchases increased significantly. At the same time, the decline in
accrualbased earnings management caused firms to repurchase more shares. This finding
suggests that firms switched to managing earnings using stock repurchases, a manipulation of
Other uses include signaling undervaluation (Bessler, Drobetz, Seim, & Zimmermann, 2016; Chan, Ikenberry, & Lee, 2004; Ikenberry, Lakonishok, & Vermaelen, 1995;
Ikenberry, Lakonishok, & Vermaelen, 2000; Lie, 2005), the distribution of excess cash (Brennan & Thakor, 1990; Denis & Denis, 1993; Grullon & Michaely, 2004), shifting
toward optimal financial leverage (Dittmar, 2000), the expropriation of creditors (Maxwell & Stephens, 2003), the funding of employee stock option plans (Kahle, 2002),
takeover defense (Billett & Xue, 2007), and the enhancement of investormanagement agreements (Huang & Thakor, 2013).
Real activities earnings management is defined as actions that deviate from normal business practices, such as the acceleration of the timing of sales through
increased price discounts or more lenient credit terms, the reporting of lower costs of goods sold through increased production, and reductions in discretionary
expenses (e.g., Cohen et al., 2008; Cohen & Zarowin, 2010; Roychowdhury, 2006).

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