Individual Large Shareholders, Earnings Management, and Capital‐Market Consequences

Abstract

Using a large hand‐collected sample of all blockholders (ownership ≥ 5%) of S&P 1500 firms for the years 2002–2009, we first document significant individual blockholder effects on earnings management (accrual‐based earnings management, real earnings management, and restatements). This association is driven primarily by these large shareholders influencing rather than selecting firms’ financial reporting practices. Second, the market's reaction to earnings announcements suggests that investors recognize the heterogeneity in blockholders’ influence on earnings management. The results highlight the highly individualized effects of blockholders and a mechanism through which shareholders impact reported earnings.

Blockholder Exit Threats and Financial Reporting Quality

“…They conclude that blockholders have an influence on earnings quality, rather than blockholders selecting firms based on earning quality. Our paper differs from Dou et al (2016) in the following respects. First, Dou et al (2016) assume each blockholder affects financial reporting independently.…”

“…Our paper differs from Dou et al (2016) in the following respects. First, Dou et al (2016) assume each blockholder affects financial reporting independently. Thus, their study cannot speak to the strategic interaction among blockholders, which is the primary focus of our paper.…”

“…Firms' FRQ has been linked to important outcomes such as firms' investment efficiency (Biddle and Hilary 2006) and cost of capital (Lambert et al 2007), both of which have a direct impact on firm value. A recent study by Dou et al (2016) finds significant individual blockholder fixed effects on earnings quality. They conclude that blockholders have an influence on earnings quality, rather than blockholders selecting firms based on earning quality.…”

“… Dou et al () find individual blockholder fixed effects on earnings quality without considering the strategic interaction among blockholders. The results in Tables and suggest that the strategic interaction (i.e., competition) in the context of exit theory has important implications for financial reporting.…”

Institutional Ownership, Blockholder Ownership, and the Board’s Tenure to Disclosure of Corporate Governance

“…Edmans (2014) states that blockholders have a crucial role in governance, because the size of their shares in the company gives impetus to bear the costs incurred for monitoring activities. Same is the case with Dou et al (2016) which says when shareholders do not have a majority interest, it will be less economical for individual shareholders to incur significant monitoring costs, because the benefits they will receive tend to be small. For this reason, blockholders can help improve reporting quality and transparency.…”