A recent innovation in stock repurchase execution, the accelerated share repurchase or ASR has gained in popularity in recent years. For example, ASRs as a percentage of aggregate repurchases increased from approximately 0.5 percent in 2002 to approximately 14 percent in 2007. This is an important phenomenon given that aggregate repurchases for S&P corporations (which include the bulk of our sample) almost tripled during this same period.
The popularity of ASRs may be explained in part by current accounting for these transactions, which results in a more immediate (relative to other stock repurchase methods) boost to reported EPS, due to the reduction in shares outstanding. Some have suggested that the current accounting treatment does not result in financial statements that accurately reflect the assets, obligations, and income effects arising from execution of the ASR. Because of their growing popularity and their potential misrepresentation in financial statements, the market’s interpretation of these transactions is of interest.
Rather than purchasing shares on the open market, in an ASR, companies purchase shares from an investment bank. The investment bank borrows these shares from investors (shorts the shares) and requires the company to enter into a forward sale contract to protect the investment bank’s short position. At a later date, the investment bank purchases the shares on the open market. If share prices increase, the company will owe the investment bank money as a result of the forward contract (or it will be owed money if stock prices fall). The company settles the forward contract with the investment bank with either cash or shares.
As is discussed more fully below, the ASR structure is attractive because it generally permits more immediate EPS accretion than a traditional repurchase. However, while the ASR is outstanding the company is exposed to changes in the value of its shares which create a future obligation (benefit) if share prices increase (decrease). Under current GAAP the forward contract is considered an equity instrument. As a consequence, the changes in the value of the forward sale agreement, while the contract is outstanding, remain off balance sheet. That is, the balance sheet does not reflect the potential ASR asset or liability prior to settlement. In addition to balance sheet misrepresentation, earnings of an ASR company may be misrepresented, because unrealized gains and losses on the ASR prior to settlement are not recorded. Indeed, the gains and losses at settlement of the forward sale agreement are recorded as adjustments to equity and thus bypass income completely.
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The Accounting and Market Consequences of Accelerated Share Repurchases
