Gaming the Float: How Managers Respond to EPS-based Incentives

Table 1 presents the summary statistics of the sample. The key dependent variable used in this study is
shares outstanding (median = 23.55 million, mean = 83.85 million). EPS has a median of $0.19 and mean
of $0.20. This translates to a median and mean earnings target size of ±2.6% and ±2.5% of expected net
income.
3.2 Results
We begin by examining if data are consistent with the view that managers recognize the effects of rounding
and the earnings target size, and in particular the lower bound of earnings required to meet forecasts.
Evidence in prior literature is consistent with this.
For example, Das and Zhang (2003) document an
abnormally large number of net income realizations that round upwards when translating net income to
EPS. Given this evidence, we expect that an abnormal number of net income realizations will be just above
the minimum that will round to the EPS forecast.
We present a figure that is similar in spirit to analyses presented in Burgstahler and Dichev (1997)
and Degeorge et al. (1999), who find an abnormal number of EPS outcomes that are just enough to clear
certain thresholds. Instead of examining EPS outcomes, we plot net income realizations around the threshold
E[EP S] ∗ s −
s
200
, which is the minimum net income required to meet the median analyst EPS forecast.
We scale each firm’s realized net income by E[EP S] ∗ s − s
200
and plot frequencies in Figure 2. Any value
< 1 means the firm missed the EPS forecast, and a value of 1 indicates that the firm reported just enough
net income such that it rounds to the EPS forecast.
[Insert Figure 2 Here]
The red line (left line) in the figure indicates the minimum net income that meets forecasts - the lower
bound of the target size. The green line (right line) indicates, for the average firm, the net income implied by
analysts’ forecasts (E[EP S] ∗ s). The figure shows a disproportionate occurrence of net income realizations
that are just enough to meet the minimum net income required to satisfy the EPS forecast.
In what follows, we examine if managers recognize that the location of this threshold is a choice variable
and choose the number of shares accordingly.
Our main hypothesis is that managers of firms with
unpredictable net income will choose high levels of shares outstanding so that a wide range of net income
realizations will meet forecasts. We also expect that managers with high incentive compensation will choose
more shares outstanding for similar reasons. We briefly examine these relationships using multivariate sorts.
Figure 3 presents the average median shares outstanding across deciles of net income volatility in Panel
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