THE ASSOCIATION BETWEEN STOCK RETURNS AND ALTERNATIVE EARNINGS PER SHARE NUMBERS

SCOTT I JERRIS, Purdue University

Abstract

Since 1969, generally accepted accounting principles have required firms with complex capital structures to disclose both primary and fully diluted earnings per share numbers. Primary earnings per share is computed under the assumption that common stock equivalents are converted into common shares at the beginning of the fiscal year while fully diluted earnings per share is computed under the assumption that all potentially dilutive securities are converted into common at the beginning of the fiscal year. However, neither of these two earnings measures take into account the probability of conversion of potentially dilutive securities into common stock. This thesis is to generate alternative earnings per share numbers which specifically incorporate conversion probabilities of convertible debentures. The option pricing model is used to generate these conversion probabilities. In addition, raw earnings per share, a number not specifically reported on the financial statements but easily calculated, is also analyzed. Correlation and regression analyses are used to test the strength of the association between abnormal security returns and unexpected earnings for the required and for the alternative earnings per share numbers. Results show that the association is stronger both for the new probabilistic measures and the raw earnings measure than for the two currently required earnings per share numbers.

Degree

Ph.D.

Subject Area

Accounting

COinS