The relationship between earnings per share rounding and institutional investors - Evidence from North America

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School of Business | Master's thesis
Degree programme
56 + 6
Opportunistic earnings management increases information asymmetry between managers and owners and decreases earnings quality. Corporate governance mechanisms are frequently mentioned as tools to constrain managerial discretion. The role of institutional investors in particular has been under scrutiny due to their increasing equity stake in North America, and the ambiguous research results on their sophistication as monitors. This study examines the role of institutional investors in preventing earnings management, hypothesizing that a higher institutional ownership percentage decreases the likelihood of earnings management. Deviating from the norm in earnings management literature, earnings per share rounding stemming from capital market incentives is measured through unusual patterns in the distribution of reported earnings. The first post-decimal digit zero in the earnings per share number is used as a proxy for earnings management. For this purpose, a conditional logistic regression model with several explanatory variables was run on a North American sample collected from Compustat and Thomson Reuters from the period 1995-2008. Institutional holdings are measured quarterly to account for the difference in institutional ownership percentages in the four quarters. The results show that there is a negative relationship between institutional investor ownership and earnings management. Institutional investors only decrease the likelihood of earnings management when their ownership percentage is comparably higher in the third and fourth quarters. No statistically significant results were found for the lower institutional ownership percentages in quarters one and two. To summarize, evidence is found that the ownership stake must reach a certain level to enable or engage institutional investors to fulfil their monitoring role efficiently.
Thesis advisor
Jarva, Henry
earnings management, EPS-rounding, ownership structure, institutional investor sophistication
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