Monitoring by Institutional Investors: Evidence from Ownership Changes and Trading Behavior Around Restatements

Abstract

We examine institutional ownership and financial reporting practices. We find that institutions sell a significantly large fraction of their holdings in the quarter of a restatement announcement, however, not in the days prior to or on the announcement day. Further, we find that the likelihood and magnitude of misstatement are positively related to the amount of institutional ownership, though negatively related to the size of the largest institutional holding. These results suggest that the presence of institutional investors create incentives to manage earnings and does not provide monitoring sufficient to predict or prevent restatements, though a significant blockholder may monitor the firm sufficiently to prevent misstatement. Nevertheless, there is evidence that firms that institutions buy on the announcement day subsequently outperform those that are sold suggesting that institutions may be familiar enough with firms to better evaluate the significance of a restatement announcement.

Keywords: Large Shareholder monitoring, accounting restatements