Common Institutional Ownership and Earnings Management

Posted: 17 Aug 2020 Last revised: 15 Mar 2021

See all articles by Santhosh Ramalingegowda

Santhosh Ramalingegowda

University of Georgia - Terry College of Business

Steven Utke

University of Connecticut - Department of Accounting

Yong Yu

University of Texas at Austin

Date Written: June 12, 2020

Abstract

This study examines the relation between earnings management and block ownership of same‐industry peer firms by a common set of institutional investors (common institutional ownership). This relation is important given the tremendous growth of common institutional ownership and the significant influence of blockholders on financial reporting. We hypothesize that common institutional ownership mitigates earnings management by enhancing institutions’ monitoring efficiency and by encouraging institutions to internalize the negative externality of a firm's earnings management on peer firms' investments. Consistent with our hypothesis, we find that higher common institutional ownership is related to less earnings management. Analyses of a quasi‐natural experiment based on financial institution mergers show that this negative relation is unlikely to be driven by the endogeneity of common institutional ownership. Cross‐sectional tests provide evidence that the negative relation is stronger among firms for which common institutional ownership is likely to generate a greater reduction in institutions' information acquisition and processing costs, and among firms whose severe financial misstatements are more likely to distort co‐owned peer firms' investments, supporting both mechanisms underlying our hypothesis. Our findings inform the ongoing debate on the costs and benefits of common institutional ownership by highlighting an important benefit: the enhanced monitoring of financial reporting.

Keywords: institutional investors, common ownership, earnings management, monitoring, externality, blockholdings

Suggested Citation

Ramalingegowda, Santhosh and Utke, Steven and Yu, Yong, Common Institutional Ownership and Earnings Management (June 12, 2020). Contemporary Accounting Research, Vol. 38, No. 1, Spring 2021, Available at SSRN: https://ssrn.com/abstract=3652349

Santhosh Ramalingegowda

University of Georgia - Terry College of Business ( email )

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

Steven Utke

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States

Yong Yu (Contact Author)

University of Texas at Austin ( email )

1 University Station B6400
Austin, TX 78712
United States
(512)471-6714 (Phone)
(512)471-3904 (Fax)

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