Earnings Management Through Transaction Structuring: Contingent Convertible Debt and Diluted Earnings Per Share

39 Pages Posted: 8 May 2006

See all articles by Christine I. Wiedman

Christine I. Wiedman

University of Waterloo

Carol A. Marquardt

City University of New York (CUNY) – Baruch College

Date Written: 2004-12-06

Abstract

In this article we examine whether firms structure their convertible bond transactions to manage diluted earnings per share (EPS). We find that the likelihood of firms issuing contingent convertible bonds (COCOs), which are often excluded from diluted EPS calculations under Statement of Financial Accounting Standard (SFAS) 128, is significantly associated with the reduction that would occur in diluted EPS if the bonds were traditionally structured. We also document that firms` use of EPS-based compensation contracts significantly affects the likelihood of COCO issuance and find weak evidence that reputation costs, measured using earnings restatement data, play a role in the structuring decision. These results are robust to controlling for alternative motivations for issuing COCOs, including tax and dilution arguments. In addition, an examination of announcement returns reveals that investors view the net benefits and costs of COCOs as offsetting one another. Our results contribute to the literature on earnings management, diluted EPS, financial reporting costs, and financial innovation.

Suggested Citation

Wiedman, Christine I. and Marquardt, Carol, Earnings Management Through Transaction Structuring: Contingent Convertible Debt and Diluted Earnings Per Share (2004-12-06). Journal of Accounting Research, Vol. 43, pp. 205-243, May 2005. Available at SSRN: https://ssrn.com/abstract=876669 or http://dx.doi.org/10.1111/j.1475-679x.2005.00168.x

Carol Marquardt (Contact Author)

City University of New York (CUNY) – Baruch College ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States
646-312-3241 (Phone)

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