The Pricing of Mismeasured EPS
53 Pages Posted: 23 Aug 2019 Last revised: 15 Jun 2022
Date Written: June 15, 2022
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: Suggested Citation