42 Pages Posted: 6 Jan 2014 Last revised: 13 Jul 2016
Date Written: July 12, 2016
Recent theoretical and empirical studies suggest that blockholders (shareholders with ownership ≥ 5%) exert governance through the threat of exit. Blockholders have strong incentives to gather private information and sell their shares when managers are perceived to underperform. To prevent blockholders from selling their shares and the firm from suffering a stock price decline, managers align their actions with the interests of shareholders. As a result of the greater manager-shareholder alignment, managers’ actions are more likely to be in shareholders’ best interest, and consequently there is less need for managers to manipulate earnings. Consistent with these predictions from economic theory, we find evidence that as exit threat increases, firms have higher financial reporting quality. Theory also predicts that the impact of blockholders’ exit threat on financial reporting quality should increase as the manager’s wealth is tied more closely to the stock price, and this is what we find. Our study contributes to the research on the impact of shareholders on financial reporting quality and to an emerging literature on the impact of blockholders in financial markets. Blockholders play an important role in managers’ reporting outcomes through their actions as informed investors.
Keywords: Blockholders, exit theory, financial reporting quality, liquidity, wealth-performance sensitivity
JEL Classification: G1, G2, G20, G30, G31, G32, M41, M10, N20
Suggested Citation: Suggested Citation
Dou, Yiwei and Hope, Ole-Kristian and Thomas, Wayne B. and Zou, Youli, Blockholder Exit Threats and Financial Reporting Quality (July 12, 2016). Rotman School of Management Working Paper No. 2374770. Available at SSRN: https://ssrn.com/abstract=2374770 or http://dx.doi.org/10.2139/ssrn.2374770
By Alex Edmans