On Constructing an EPS Measure: An Assessment of the Properties of Dilution

This paper evaluates the information content of the treasury stock method for computing diluted earnings per share (EPS). We demonstrate that the treasury stock method decreases the annual association between earnings changes and stock returns and explain why this is the case. Further, we show that...

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Bibliographic Details
Published in:Contemporary accounting research 2000-07, Vol.17 (2), p.303-326
Main Authors: SCOTT, THOMAS W., WIER, HEATHER A.
Format: Article
Language:English
Subjects:
Accounting
Basic earnings per share
Diluted earnings per share
Dilution
Earnings
Earnings dilution
Earnings per share
Forecasts
Market prices
Measurement
Rates of return
Regression analysis
Samples
Statistics
Stock prices
Stock returns
Studies
Time series
Treasuries
Treasury
Treasury stock
Treasury stock method
Warrants
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Summary:This paper evaluates the information content of the treasury stock method for computing diluted earnings per share (EPS). We demonstrate that the treasury stock method decreases the annual association between earnings changes and stock returns and explain why this is the case. Further, we show that the treasury stock method leads to a dilutive adjustment that biases the random walk model of annual earnings in a predictable direction. Finally, we demonstrate that using the treasury stock method appears to confuse both analysts and investors: analysts' forecast errors increase with the size of the dilutive adjustment, and the association between unexpected earnings and stock returns at the earnings announcement date weakens as the dilutive adjustment increases.
ISSN:0823-9150
1911-3846
DOI:10.1506/1C8G-XVCN-9QQM-0GEP