The Unintended Effect of FAS 123R on Firms’ Stock Repurchase Activity
44 Pages Posted: 21 Oct 2014
Date Written: October 15, 2014
We investigate whether or not Financial Accounting Standards (FAS) 123R, which requires recognizing stock-based compensation at fair value, affects stock repurchase activity. Prior research has shown that the dilution effect of dividends on earnings per share (EPS) decreases the value of stock options. Therefore, firms tend to use stock repurchases rather than dividends to return cash to shareholders, which is known as the dividend substitution effect. Also, prior research shows that stock repurchases are used to manage earnings per share. FAS 123R negatively impacts EPS and return on assets as firms record stock-based compensation at fair value. Therefore, we hypothesize and find that FAS 123R is associated with increases in stock repurchases overall and that this effect is greater with increased levels of management stock options. Our study fills a gap in research on the potential effect that FAS 123R might have on how firms decide to return cash to shareholders. Furthermore, we provide evidence on unintended economic consequences of the change in accounting for stock-based compensation.
Keywords: FAS 123R, Stock Repurchases, Stock Options
JEL Classification: M41
Suggested Citation: Suggested Citation