Ownership Structure and Characteristics of Earnings
This study investigates the relationship between ownership structure and various earnings characteristics assumed to be associated with the quality of reported earnings. I provide evidence that the absolute value of discretionary accruals, the standard deviation of residuals from the Dechow-Dichev model, and earnings smoothing ratio are increasing in managerial ownership and the persistence of Return-on-Assets is decreasing in managerial ownership. On the other hand, the opposite associations are observed for institutional ownership except for earnings smoothing ratio. These associations persist after controlling for other factors expected to affect the relationship such as firm size, book-to-market, risk, leverage, sales growth, and regulatory environment. These findings suggest that the presumable incentive alignment effect that prompts firms to provide stock ownership to a larger set of executives come at a cost to investors, namely that of diminishing reliability of reported earnings. Additional tests show that the proprietary costs of disclosure may, in part, lead managers to internalize the costs by reducing the quality of disclosure as their ownership grows in size. These findings shed new light on conflicting results documented in prior literature by the role of the proprietary costs of disclosure play in reporting earnings.
University of Illinois - Urbana-Champaign
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University of Illinois at Urbana-Champaign