Can Institutional Investors Restrain Earnings Management Activities in Weak Investor Protection Countries? The Role of Foreign and Domestic Institutional Investors

Abstract

I investigate the role that foreign institutional investors play in restraining earnings management activities of firms under varying investor protection environments. I find that corporate earnings management is less prevalent when independent foreign institutional investors are among shareholders, especially for firms where monitoring is potentially more valuable: in weak investor protection countries and when growth opportunities and capital expenditures are greater. These effects are robust to a plausibly quasi-exogenous shock to foreign institutional investors’ shareholdings, unobserved firm heterogeneity, and alternative earning management measures. Following such investments, foreign director presence on the firms’ board of directors and audit committees increase.