Abstract

This study examines how financial analysts incorporate dilution effects and tests the dilution effects by analyzing financial analysts' forecast errors. If dilutive securities contain an information that future earnings per share is to be reduced, dilution effects will increase financial analysts' forecast errors. Since diluted EPS reported on the income statements may not capture the full effects of dilutive securities, this study uses two measures of dilution effects. One is share based and the other is diluted EPS based. To test the effects of dilutive securities on the financial analysts' forecast errors, this study uses all companies having analysts' forecasts during 1999－2007. The results are as follows：The share based measure is positively related to financial analysts' forecasts errors, but the one based on diluted EPS is not. These results indicate that the diluted EPS reported on the income statements does not fully convey the dilution information anticipated by analysts for their earnings forecasts. These are several contributions for accounting research and practitioners. First, the results of this study indicate that diluted EPS does not fully communicate the dilution information of dilutive securities. These results may be helpful for accounting regulators to set and revise accounting standards in the future. Second, this study suggests that share based dilution measure is more effective than diluted EPS based one. The results of this study may be useful for financial analysts to forecast or perform valuations.

Keywords

• Dilutive Securities
• Dilution Effect
• Financial Analysts' Forecast Errors

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