Threat of Exit by Non-blockholders and Income Smoothing: Evidence from Foreign Institutional Investors in Japan

49 Pages Posted: 20 Dec 2021 Last revised: 6 Jan 2022

See all articles by Parthiban David

Parthiban David

American University - Kogod School of Business

Augustine Duru

American University - Kogod School of Business

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business

Johan Maharjan

Rensselaer Polytechnic Institute (RPI)

Yijiang Zhao

American University - Kogod School of Business

Date Written: December 24, 2021

Abstract

We examine how the threat of exit by non-blockholders (investors with ownership < 5%) relates to firms’ income smoothing. Unlike informed blockholders, non-blockholders lack private information and therefore rely more on reported accounting numbers to evaluate firm performance. To isolate the exit threat, we use the unique setting in Japan where strong firm-centric social norms and lack of insider access lead non-blockholding foreign institutions to influence management primarily through the threat of exit. We find that foreign non-blockholders’ exit threat is positively associated with the extent of income smoothing. This effect is more pronounced for firms less embedded in Japan’s stakeholder-based system, firms with greater stock liquidity, and firms with higher U.S. institutional ownership. In addition, smoothing associated with such an exit threat, on average, is informative. Our findings suggest that Japanese firms under non-blockholders’ exit threat increase income smoothing to reduce perceived uncertainty and that such smoothing generally meets non-blockholders’ information need.

Keywords: Non-blockholder exit threat, Foreign institutional investor, Income smoothing, Stock price informativeness, Stock market pressure, Stakeholder-based system

JEL Classification: G34, M41

Suggested Citation

David, Parthiban and Duru, Augustine and Lobo, Gerald J. and Maharjan, Johan and Zhao, Yijiang, Threat of Exit by Non-blockholders and Income Smoothing: Evidence from Foreign Institutional Investors in Japan (December 24, 2021). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3985740 or http://dx.doi.org/10.2139/ssrn.3985740

Parthiban David

American University - Kogod School of Business ( email )

4400 Massachusetts Avenue NW
Washington, DC 20816-8044
United States

Augustine Duru

American University - Kogod School of Business ( email )

4400 Massachusetts Avenue NW
Washington, DC 20816-8044
United States
202-885-1937 (Phone)
202-885-1992 (Fax)

Gerald J. Lobo (Contact Author)

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States
713-743-4838 (Phone)
713-743-4828 (Fax)

HOME PAGE: http://www.bauer.uh.edu/acct/acctprofile.asp?search=Gerald%20Lobo

Johan Maharjan

Rensselaer Polytechnic Institute (RPI) ( email )

Troy, NY 12180
United States

Yijiang Zhao

American University - Kogod School of Business ( email )

4400 Massachusetts Ave, NW
Washington, DC 20016
United States
202-885-1941 (Phone)

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