Stock Repurchases as the Earnings Management: An Unintended Consequence of the 2003 Dividend Tax Cut
I examine the impact of the 2003 dividend tax cut (Jobs and Growth Tax Relief Reconciliation Act, JGTRRA) on firms using stock repurchases for earnings per share (EPS) manipulation. Prior to 2003, dividends were taxed at the individual’s income tax rate, which usually was ranged from 28 percent to 50 percent, compared to 20 percent tax rate on capital gains. In May 2003, with the passage of the JGTRRA, the dividend tax was cut significantly to 15 percent for the majority of individual income tax brackets, which is equal to the tax rate of capital gain. Consistent with Blouin et al. (2011), using a sample of U.S. public companies both before and after the 2003 JGTRRA passage, I find that there are more firms using dividends and fewer firms using stock repurchases in the one-year period immediately after the passage of the JGTRRA than in the one-year period before the passage of the JGTRRA. Building on this finding, I examine whether firms using stock repurchases in the period after the 2003 JGTRRA passage are more likely to do so for earnings manipulation purposes than in the period before the JGTRRA passage. I find that using stock repurchases to meet-or-beat analyst forecasts is a strong motivation to conduct stock repurchases; it increases the likelihood of conducting stock repurchases in the post JGTRRA period by 30 points, which offsets the JGTRRA’s impact on stock repurchase activities. In addition, firms using stock repurchases in the post JGTRRA passage period have higher abnormal accruals, suggesting that they use stock repurchases in addition to accrual-based earnings management. I also find similar results to Hribar et al. (2006) that the market discounts the EPS surprise if firms use stock repurchases to meet-or-beat analyst forecast; moreover, 2003 JGTRRA does not weaken or enhance this market reaction.^
Gao, Xiang, "Stock Repurchases as the Earnings Management: An Unintended Consequence of the 2003 Dividend Tax Cut" (2018). ETD Collection for University of Texas, El Paso. AAI10930296.