Institutional monitoring and opportunistic earnings management

Abstract

Investment institutions with substantial shareholdings in a firm have the resources and incentives to monitor and influence management decisions. Whether the institutions actually monitor and exert pressure on managers is an empirical question. Previous studies have reported mixed results on this question. We examine whether large institutional shareholdings in a firm deter earnings management by its managers when those executives otherwise have incentives to increase or decrease reported profits. Using discretionary accounting accruals as the measure of earnings management, we find that the presence of large institutional shareholdings inhibit managers from increasing or decreasing reported profits towards the managers' desired level or range of profits. The evidence is consistent with institutional investors monitoring and constraining the self-serving behavior of corporate managers.