"Modeling Managers As EPS Maximizers"

Abstract: Textbook corporate-finance models assume managers maximize the NPV (net present value) of expected future equity payouts. But, in practice, the people running large public companies often seem more concerned with increasing EPS (earnings per share). Perhaps this is a mistake. Or maybe EPS growth is a good second-best proxy for value creation. Whatever the reason, we show that the simplest possible EPS-maximizing model can explain a number of important corporate policies such as firm leverage, share repurchases, cash accumulation, and M&A payment method. There are two different routes to maximizing EPS, depending on whether a firm’s earnings yield is above or below the riskfree rate.We document strong empirical support for our model’s predictions.

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