Corporate governance mechanisms and accretive share buyback to meet or beat earnings per share forecast

(ProQuest: . denotes formulae omitted.)1. INTRODUCTIONEarnings are important information in the financial report for analyst, investors, senior executives and board of directors (Degeorge, Patel & Zeckhauser, 1999). Among the various earnings metrics to measure firm performance, earnings per share (EPS) are well-known and essential tool to measure firm performance (Graham, Harvey & Rajgopal, 2005; Seetharaman & Raj, 2011). Investors need a threshold or benchmark to measure the earnings performance as to evaluate firm's financial success and also to compensate the managers. Degeorge et al. (1999) developed three thresholds as follows: (1) to report quarterly profits, (2) to achieve quarterly earnings increases as previous year quarterly period, and (3) to achieve quarterly earnings surprises (whether or not actual EPS meets or beats earnings forecast predicted by analysts). According to Brown and Caylor (2005) after mid-1990s, among the three thresholds, achieving earnings surprises (meet or beat EPS forecast - MBEF) is the most salient thresholds due to investors realization on the importance of achieving earnings forecast (positive earnings surprises- MBEF) as it put forward media attention and precision in analyst forecasting. Obviously, meeting or beating earnings forecast (MBEF) is an anchor of today's corporate culture, of being able to boost share prices, maximizing management's credibility and avoiding litigation cost that could trigger from negative earnings surprises (Bartov, Givoly & Hayn, 2002). In general, firms achieve earnings threshold either through business success with good financial performance or through earnings management. It is manifested that, due to business pressure, managers practice earnings management to meet or beat EPS forecast (MBEF). Firms commonly involve in accruals manipulation (indirect impact to cash flows) and real activities manipulation (transactions that gives direct impact to cash flows) as an earnings management proxies to adjust the financial reports. Among the two proxies, real activities manipulation is difficult to detect as it proceeds like an ordinary business transactions in general. Hribar, Jenkins and Johnson (2006) reported that firms used accretive share buyback (real activity manipulation) as the earnings management device to meet or beat EPS forecast. Accretive share buyback is an earnings management tool that can increase post-buyback EPS by a minimum of one cent. Earnings management is a short-term focused that do not contribute to firm value (Roychowdhury, 2006). Further, existence of earnings management activities indicates a flaw in corporate governance practices in the firm (Graham et al., 2005). Because corporate governance is a symbol of good principles and best practices of a firm to protect the shareholders rights and not to mislead shareholders through earnings management practices. Further, an ineffective board monitoring mechanism is detrimental to a firm (Rahman & Ali, 2006). Therefore, strong corporate governance is a remedy to decrease earnings management activities in firms. This study investigates the nature of relationship between the corporate governance mechanisms and accretive share buyback to MBEF. The accretive share buyback to MBEF refers to the usage of accretive share buyback to meet or beat the EPS forecast. Malaysian earnings management studies commonly use accruals manipulation as the earnings management proxy to investigate the relationship between earnings management and corporate governance mechanisms. Therefore, this is a good platform to study on corporate governance mechanisms and the accretive share buyback as the earnings management proxy. This study contributes to the body of knowledge on role of corporate governance mechanisms and accretive share buyback the earnings management device to MBEF.2. THEORETICAL ASSUMPTIONS OF PRIOR RESEARCHIn Malaysia share buyback is a corporate payout policy where listed firms are allowed to buy back their firm shares under the open market buyback program. …