Earnings Dilution and the Explanatory Power of Earnings for Returns

45 Pages Posted: 22 Oct 1999

See all articles by Mark R. Huson

Mark R. Huson

University of Alberta - Department of Finance and Statistical Analysis

Thomas W. Scott

Independent

Heather A. Wier

University of Alberta - Department of Accounting, Operations & Information Systems

Multiple version iconThere are 3 versions of this paper

Date Written: April 24, 2001

Abstract

Executive stock options and convertible securities can increase the number of common shares outstanding while adding less than the market value of the newly issued securities to a firm's assets. We model the effect of expected dilution on the earnings/return relation. Expected dilution effectively reduces the permanence of an earnings innovation. Empirical evidence supports the hypothesis that dilutive securities attenuate the relation between earnings and returns. Estimated earnings response coefficients (ERCs) are significantly lower when there are shares reserved for conversion. The effect is more pronounced for firms that have experienced price increases or positive earnings news, as these increase the expected dilutive effect of conversions.

Keywords: Stock Options, Dilution, Earnings, Stock Returns

JEL Classification: G12, G14, M41

Suggested Citation

Huson, Mark R. and Scott, Thomas W. and Wier, Heather A., Earnings Dilution and the Explanatory Power of Earnings for Returns (April 24, 2001). Available at SSRN: https://ssrn.com/abstract=180768 or http://dx.doi.org/10.2139/ssrn.180768

Mark R. Huson (Contact Author)

University of Alberta - Department of Finance and Statistical Analysis ( email )

4-20C Business
University of Alberta
Edmonton, Alberta T6G 2R6
Canada
780-492-2803 (Phone)
780-492-3325 (Fax)

Thomas W. Scott

Independent

No Address Available

Heather A. Wier

University of Alberta - Department of Accounting, Operations & Information Systems ( email )

Edmonton, Alberta T6G 2R6
Canada
780-492-3053 (Phone)
780-420-3325 (Fax)

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