• Institutional Ownership, Income Smoothing and the Value-relevance of Accounting Numbers

Abstract

The active monitoring hypothesis provides evidence that firms with higher institutional ownership are less likely to manage earnings, which in turn, enhances the value-relevance of accounting numbers. Yet, recent studies also highlight the importance of explicitly considering the short-term oriented investing behavior of institutional investors (the myopia hypothesis) when investigating the association between institutional ownership and managerial earnings reporting. Thus, the role of institutional investors in managerial earnings reporting remains an open question. Based on the informative association between income smoothing and the value-relevance of financial reporting, this study uses the unbalanced-panel data regressions to examine the monitoring or myopia role of institutional investors on the association between income smoothing and the value-relevance of accounting numbers. The empirical results to some extent support the monitoring hypothesis that the higher institutional ownership is, income smoothing generates more value-relevance of both earnings and equity book value. Moreover, in the income smoothing with higher institutional ownership/lower ownership volatility case, it reveals that the increasing value-relevance of earnings is enhanced. However, in the income smoothing with lower institutional ownership/higher ownership volatility case, it is found that the increasing value-relevance of earnings is mitigated. This study also documents that the role of institutional ownership on the association between income smoothing and the value-relevance of equity book value is unobvious in the analysis, both in the high and low ownership volatility cases. We demonstrate some diagnostic checks and evidence the results are robust to the various specifications.

Keywords: Institutional Ownership, Income Smoothing, Value-Relevance, Monitoring Hypothesis, Myopia Hypothesis