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
Date Written: December 24, 2021
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: Suggested Citation