Institutional Stock Ownership, Accrual Management, and Information Environment

Abstract

This study examines the empirical relationship between institutional percentage shareholding and accounting discretion exercised by firms to manage accruals over a period of time. It also evaluates the effects of firm size and information environment on such relationship. By employing a firm-specific abnormal accrual estimation design to measure accounting flexibility/discretion used to adjust abnormal accruals in financial reporting, the study documents that institutional stock ownership is inversely related to such accounting discretion exercised to manage abnormal current accruals. This inverse relationship is, however, found to be dependent on firm size and richness of information environment. Specifically, the inverse relationship strongly holds for smaller firms that are deemed to have an impoverished information environment compared with larger firms having information-rich environment. Furthermore, by using a two-stage least-squares approach, the study addresses the endogeneity-driven ambiguity which is inherent in the simple identification of a negative relation between institutional stock ownership and accrual management. The analysis demonstrates that the overall negative relationship is partly attributed to institutional shareholder monitoring that constrains management's ability to opportunistically manage abnormal accruals. The evidence is consistent with the view that active monitoring of institutional shareholders mitigates opportunistic reporting behavior of corporate managers and improves the quality of governance in the financial reporting process.

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