The Pricing of Mismeasured EPS

53 Pages Posted: 23 Aug 2019 Last revised: 15 Jun 2022

Date Written: June 15, 2022

Abstract

This study examines whether and under what conditions common stock prices reflect the accounting mismeasurement of diluted earnings per share (EPS) in determining dilution related to convertible instruments. The mismeasurement relates to the way GAAP procedures determine whether a convertible instrument is expected to convert. On average, I find that accounting mismeasurement of diluted EPS is associated with equity prices, suggesting that investors assess the effects of dilution based on an economic prediction of future conversion. However, this relationship varies with the net benefits of information processing. I find an association between accounting mismeasurement and prices when the net benefits are high but not when net benefits are low. Positive market-adjusted returns around the time the convertible instruments settle corroborate this inference for firms with low net benefits. Overall, results suggest that information processing to unwind accounting mismeasurement is not always cost-beneficial to investors.

Keywords: diluted EPS, convertible debt, convertible preferred stock, information costs, if-converted method, dilution

JEL Classification: G10, G14, M41

Suggested Citation

Partridge, Clay, The Pricing of Mismeasured EPS (June 15, 2022). Available at SSRN: https://ssrn.com/abstract=3439091 or http://dx.doi.org/10.2139/ssrn.3439091

Clay Partridge (Contact Author)

The Ohio State University ( email )

2100 Neil Avenue
Columbus, OH 43210
United States

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