Hometown Advantage: The Effects of Monitoring Institution Location on Financial Reporting Discretion

51 Pages Posted: 11 Apr 2010 Last revised: 1 Feb 2011

See all articles by Benjamin C. Ayers

Benjamin C. Ayers

University of Georgia

Santhosh Ramalingegowda

University of Georgia - Terry College of Business

P. Eric Yeung

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: January 31, 2011

Abstract

We examine the impact of institutional ownership on financial reporting discretion, focusing on whether the impact varies with institutions’ cost of acquiring monitoring information. We posit that geographic distance between the firm and a monitoring institutional investor impacts the institution’s cost of acquiring monitoring information and predict that corporate managers are less likely to use financial reporting discretion in the presence of local monitoring institutions (our proxy for monitors with low information costs) than distant monitoring institutions. We base our expectation on prior research that suggests that information asymmetry between the firm and stakeholders is a necessary condition for managers to engage in opportunistic reporting discretion and prior findings that institutional investors located in proximity to the firm are more informed than other institutional investors located far away. We find a negative association between the magnitude of abnormal accruals and local monitoring institutional ownership and that this association is more negative than the association between abnormal accruals and distant monitoring institutional ownership. We also find that the impact of monitoring institutions on financial reporting discretion varies with the costs and benefits of financial reporting discretion. Specifically, when the costs of opportunistic financial reporting discretion are particularly high for outside shareholders monitoring the firm (e.g., high growth firms, firms engaging in takeovers, financial statement frauds), corporate managers are less likely to use financial reporting discretion in the presence of local monitoring institutions than distant monitoring institutions. In contrast, we find that the presence of local monitoring institutions does not deter financial reporting discretion when such discretion has clear benefits to shareholders (e.g., signaling private information around stock splits).

Keywords: Reporting discretion, Institutional investors, Geographic location, Corporate governance, Earnings management

JEL Classification: M41, G2, G34

Suggested Citation

Ayers, Benjamin C. and Ramalingegowda, Santhosh and Yeung, P. Eric, Hometown Advantage: The Effects of Monitoring Institution Location on Financial Reporting Discretion (January 31, 2011). Journal of Accounting & Economics (JAE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=1586859

Benjamin C. Ayers

University of Georgia ( email )

Athens, GA 30602
United States
706-542-3772 (Phone)
706-542-3630 (Fax)

Santhosh Ramalingegowda

University of Georgia - Terry College of Business ( email )

Brooks Hall
Athens, GA 30602-6254
United States
706-542-3612 (Phone)

P. Eric Yeung (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

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