The Pricing of Mismeasured EPS

This study examines whether and under what conditions common stock prices reflect the accounting mismeasurement of diluted EPS related to convertible instruments. As the costs and benefits of information processing related to the accounting mismeasurement are high, it is unclear under what conditions stock prices reflect the accounting mismeasurement. On average results are consistent with stock prices reflecting dilution based on an economic prediction of future conversion. When the net benefits of information processing are high, I find an association between accounting mismeasurement and prices ninety days after year-end consistent with investors incurring the costs necessary to impound the mismeasurement into prices when accounting information is available. In contrast, I find positive market-adjusted returns around settlement for firms with low net benefits consistent with investors adjusting prices when the costs of information processing are lower. Overall, results suggest that information processing acts as a constraint on investors' unwinding accounting mismeasurement