Earnings Dilution and the Explanatory Power of Earnings for Returns

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 effectiv...

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Bibliographic Details
Published in:The Accounting review 2001-10, Vol.76 (4), p.589-612
Main Authors: Huson, Mark R., Scott, Thomas W., Wier, Heather A.
Format: Article
Language:English
Subjects:
Accounting
Assets
Dilution
Dilutive securities
Earnings
Earnings per share
Investors
Market value
Modeling
Options on stocks
Proxy reporting
Proxy statements
Rates of return
Securities issues
Shareholders
Shares outstanding
Stock options
Stock returns
Stock shares
Studies
Treasury stock
Value
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Summary: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.
ISSN:0001-4826
1558-7967
DOI:10.2308/accr.2001.76.4.589