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Why do managers avoid EPS dilution? Evidence from debt–equity choice

Review of accounting studies, 2014-06, Vol.19 (2), p.877-912 [Peer Reviewed Journal]

Springer Science+Business Media New York 2013 ;Springer Science+Business Media New York 2014 ;ISSN: 1380-6653 ;EISSN: 1573-7136 ;DOI: 10.1007/s11142-013-9266-3

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  • Title:
    Why do managers avoid EPS dilution? Evidence from debt–equity choice
  • Author: Huang, Rong ; Marquardt, Carol A. ; Zhang, Bo
  • Subjects: Accounting ; Accounting/Auditing ; Business and Management ; Contracts ; Corporate Finance ; Dilution ; Earnings per share ; Equity ; Executive compensation ; Managers ; Mortgage companies ; Proxy statements ; Public Finance ; Stockholders ; Studies
  • Is Part Of: Review of accounting studies, 2014-06, Vol.19 (2), p.877-912
  • Description: Survey evidence reveals that managers prefer to avoid dilution of earnings per share (EPS), though financial theory suggests it is irrelevant in firm valuation. We explore contracting and behavioral explanations for this apparent paradox using a large sample of debt–equity issuers. We first provide evidence that firms with greater agency conflicts between managers and shareholders are more likely to use EPS as a performance measure in bonus contracts. After controlling for possible endogeneity related to compensation contract design, we find that managers are more likely to avoid earnings dilution when their bonus compensation explicitly depends upon EPS performance. This effect is increasing in the magnitude of bonus compensation for this subset of firms; we document no such associations for the firms that do not use EPS in setting bonus pay. Additional tests of firms’ speed of adjustment to target leverage ratios and firms’ debt conservatism levels indicate that explicitly rewarding executives on EPS performance helps to resolve underleveraging problems. We also find that clientele effects are associated with managers’ aversion to earnings dilution. Our findings provide a deeper understanding of the factors that underlie the use of accounting performance in compensation contracts and new evidence on the implications of the contracting role of accounting in firm decision-making.
  • Publisher: Boston: Springer US
  • Language: English
  • Identifier: ISSN: 1380-6653
    EISSN: 1573-7136
    DOI: 10.1007/s11142-013-9266-3
  • Source: Alma/SFX Local Collection
    ProQuest Central
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