Heterogeneous Institutional Investors and Earnings Smoothing

Abstract

This paper examines the relationship between institutional ownership and earnings smoothing by taking into account the heterogeneity of institutional investors. The paper finds that ownership by transient institutional investors, who have short investment horizons and trade actively, is negatively related to the incidence of earnings smoothing when pre-managed earnings are above earnings trend. In contrast, ownership by dedicated institutional investors, who have longer horizon and concentrated holdings, is positively related to the incidence of earnings smoothing when pre-managed earnings are below earnings trend. The findings suggest that institutional investors affect earnings smoothing through their preference for certain pattern of earnings, instead of through their monitoring activities. The results are robust after potential endogeneity is controlled for.