Index Mutual Fund Ownership and Financial Reporting Quality

Abstract

We examine the relation between index mutual fund ownership and financial reporting quality measured by the propensity for fraudulent statements (Beneish’s (1999) M-Score) and accounting aggressiveness (discretionary accruals). We find that index mutual fund ownership is negatively related to both measures of financial reporting quality, suggesting that index mutual funds provide a monitoring role with respect to financial reporting quality. These relations are muted when firms employ one of the four largest auditing firms. The evidence is consistent with the notion that resource-constrained index mutual funds, however, relinquish their monitoring role to Big 4 auditing firms. The monitoring efforts by index mutual funds have an economic impact additional to that performed by active mutual funds. Our results are robust to controlling for a spurious relation between index mutual fund ownership and financial reporting quality.

Keywords: index mutual fund ownership, corporate governance, fraud, financial reporting, financial reporting aggressiveness, discretionary accruals