Do appearances matter? The impact of EPS accretion and dilution on stock prices

There is a widespread concern among practitioners and corporate managers that transactions which result in changes in future earnings-per-share (“EPS”) have real effects on stock prices, irrespective of whether these changes reflect differences in future cash flows. As a result, investment decisions are often conditioned on their being accretive to EPS. This paper addresses this notion by testing whether there is any relation between EPS accretion and both announcement and long-term abnormal returns for acquiring firms in mergers and acquisitions. Using a sample of 224 transactions completed between 1975 and 1994, and a measure of EPS accretion designed to exclude the real effects of any potential synergies from the acquisition, I find that EPS accretion has a positive and statistically significant effect on acquirer abnormal performance, both at announcement and for the period up to 18 months following completion of the deal. This effect is robust across different measures of abnormal performance, and after controlling for other factors known to affect the long-term performance of acquiring firms. Also, the magnitude of the effect is higher for firms with a larger percentage of unsophisticated investors. On the other hand, the estimated effect, although reliably positive, is one order of magnitude smaller than implied by practitioners' views, suggesting that the concerns expressed by managers are largely exaggerated.