Uma Velury

The role of institutional ownership in the market for auditing services: an empirical investigation

Abstract In this paper, we report the results of an investigation of the relation between auditor firm size and the level of institutional ownership. In this paper, we argue that institutional owners demand high audit quality. As a result, they prefer audits conducted by large audit firms because they perceive that these firms, on average, provide relatively higher audit quality. Because institutional owners have large holdings, they have more influence over management. Therefore, the greater the level of institutional ownership, the more likely that a firm will provide audits conducted by a large audit firm. Our findings support this assertion-institutional ownership is positively associated with the audit firm size, even after controlling for other variables that could account for such an association, including client firm size, debt, growth and business complexity.

Institutional Ownership and the Selection of Industry Specialist Auditors

This study provides evidence linking corporate governance mechanisms to the choice of auditor, namely industry specialists. Given that institutional investors are likely to prefer higher quality financial reports to lower quality reports, we theorize that institutional investors will influence managers of companies in which they invest to improve reporting quality by using higher quality, industry specialist auditors. Our findings indicate that firms having relatively greater levels of institutional ownership tend to employ industry specialist audit firms. The results of this study contribute to an understanding of an important facet of corporate governance, the selection of a high quality audit firm.

Earnings Conservatism and Value Relevance Across the Business Cycle

Prior research has demonstrated higher value relevance of current earnings during economic expansions relative to contractions. We largely attribute such a result to expected growth prospects being captured in the current earnings coefficient when a direct proxy for expected future earnings is omitted from the returns-earnings model. We demonstrate that the conservatism and value relevance of current earnings is actually higher during economic contractions when including a proxy for future earnings expectations. We further demonstrate that the value-relevance of expected future earnings is higher during expansions, when the association between historical accounting information and future growth opportunities likely weakens. Copyright (c) 2009 The Authors Journal compilation (c) 2009 Blackwell Publishing Ltd.

THE ASSOCIATION BETWEEN AUDITOR INDUSTRY SPECIALIZATION AND EARNINGS MANAGEMENT

Abstract The purpose of this paper is to investigate if clients of industry-specialist auditors are less likely to manage earnings relative to clients of non-specialist auditors. This paper focuses on two specific contexts: (1) when firms are highly leveraged; and (2) when the accrual generating ability of the firm is substantial. Using discretionary accruals as a proxy for earnings management, this study found that there is less earnings management for specialist clients, consistent with industry-specialists constraining earnings management when the accrual generating ability of the firm is substantial. Such an association was not apparent for highly leveraged firms, however. Prior research indicates that the quality of an audit is a function of the size of the auditor. The results of this paper indicate that quality of the audit is partly a function of auditor industry expertise as well. Such an association is, however, context-specific.

The Impact of Arbitrage Costs on Intertemporal Changes in the Earnings Response Coefficient

In this paper, we present a market-based explanation to the documented decline in the value relevance of earnings. Specifically, we argue that an increase in arbitrage costs in the markets has arguably caused an increased departure of stock price from fundamental value and in turn a decline in the returns-earnings relation over time. We first test and document that the presence of arbitrage costs indeed dampens the returns-earnings relation. Next, we find that, consistent with prior research, there has been a decline in the Earnings Response Coefficient (ERC) over time, however, the decline is insignificant after controlling for arbitrage costs.

THE EFFECT OF INSTITUTIONAL OWNERSHIP ON THE INFORMATIVENESS OF DISCRETIONARY ACCRUALS

We examine whether the pricing of discretionary accruals is associated with the level of institutional ownership. We posit that if institutional investors monitor their investment actively, then managers would be discouraged from using the discretion in U.S. GAAP to manage earnings and would be encouraged to convey private information which would translate into greater information content. As a sensitivity test, we also examine the relation between discretionary earnings and future earnings. We find that this association is positively related to the level of institutional ownership. Our results collectively support the notion that institutional investors actively monitor their investments and encourage managers to report informative accruals. Keyword: Institutional ownership, discretionary accruals, earnings management * University of Delaware, Department of Accounting and Management Information Systems, Newark, Delaware 19716 (302) 831-6823, e-mail: jenkinsd@lerner.udel.edu ** Corresponding Author: University of Delaware, Department of Accounting and Management Information Systems, Newark, Delaware 19716, (302) 831-1764, e-mail: veluryu@lerner.udel.edu

THE EFFECT OF INSTITUTIONAL OWNERSHIP ON THE REPORTING OF CONSERVATIVE EARNINGS

Given the spate of financial reporting scandals and enactment of the Sarbanes-Oxley Act of 2002 following the stock market crash of 1999, we examine the role of institutional monitoring as it pertains to reporting conservatism. Using the Basu (1997) asymmetric timeliness models, we examine the relation between institutional ownership and the conservatism of reported earnings, as defined by the asymmetric timeliness measures. Our results indicate that larger institutional holdings are associated with a decrease in earnings conservatism. We attribute these findings in part to the incentives of large institutional investors to capitalize on private information obtained through their role as corporate monitors. As such, it may be unlikely that large investors would not encourage the timely reporting of bad news.