JIAR and AOS conference Effect of institutional investor participation on price lead earnings and earnings quality: international evidence Edmilson P. Sousa, PhD at USP, Associate Prof. at UNEB Gerlando Lima, PhD at USP, Associate Professor at USP Marcia de Luca, PhD at USP, Associate Professor at UFC Augsburg, July, 2016

The views expressed in our research are our own and do not represent the views of our universities.

Motivation We evaluated the effects of institutional investor participation on two aspects of capital market efficiency: price lead earnings and earnings quality. Why these points? Understand institutional investors participation in Brazil compared with other countries. They are important players in the stock market, because of the amount of money they spend. Making a within-country study instead of a between-countries, but comparing them.

What did we do? In this study, we used the methodology of Jiambalvo et al. (2002) to evaluate the relation between institutional investor participation and price lead earnings in different countries. Our analysis of the relation between institutional investor participation and earnings quality was based on the theoretical framework developed by Dechow and Dichev (2002) and modified by Jones et al. (2008).

About the hypotheses (H1) Since the mix of information reflected in the price is richer than the mix of information incorporated into the accounting earnings of the same period (Beaver et al., 1980), a greater participation of sophisticated investors would be expected to cause present prices to reflect a greater amount of information which will only be recognized in earnings realized in the future (Jiambalvo et al., 2002). Hypothesis 1: The amount of information on future performance anticipated by the present price is positively correlated with the percentage of institutional investor participation.

About the hypotheses (H2) Dechow and Dichev (2002) define accrual quality as the extent to which working capital accruals map into operating cash flow realizations. Hence, accrual quality decreases in inverse proportion to the underlying estimation error. The monitoring pressure from institutional investors (Chu & Zhang, 2011) is expected to influence managers to make more careful estimates of earnings recognized as actual accruals. Hypothesis 2: The greater the percentage of institutional investor participation, the higher the earnings quality.

Research Design Data: Capital IQ. Countries: Brazil, France, Germany, Italy, the Netherlands, Spain, Switzerland, the UK, and the USA. Time: Between 2004 and 2013. Companies Non-financial firms traded on stock markets. 4,076 companies and 20,174 observations in total.

Research Design Hypothesis 1: The amount of information on future performance anticipated by the present price is positively correlated with the percentage of institutional investor participation. SUR approach.

Research Design  

Results For the first hypothesis: The data suggest that institutional investors in Italy and USA are sophisticated investors, with a competitive advantage over other types of investors. In Italy, the long-term was significant, but not the short term period. The lack of statistical significance of E x INST in Brazil, France, Germany, the Netherlands, Spain, Switzerland and the UK suggests institutional investors do not have an information advantage over individual investors.

Results For the second hypothesis: Graphical analisys and means Divided by 10 portfolios: France, Germany, the UK and the USA Divided by 5 portfolios: Divided by 3 portfolios:

Results For the second hypothesis: Hypothesis tests - robustness test Extreme Values and significant for: France, Germany, Spain, the USA, and the UK.

Results For the second hypothesis: Correlation between INST and RESID – negative and significant: France, Germany, Italy, Spain, the USA, and the UK.

Conclusions Overall, the results of the empirical tests confirmed that institutional investors in Italy and the USA are sophisticated investors with a competitive advantage over individual investors, but the same could not be confirmed for institutional investors in Brazil, Germany, the Netherlands, Spain, Switzerland and the UK. The tests also revealed evidence of a positive relation between institutional investor participation and earnings quality in France, Germany, the UK and the USA, suggesting that institutional investors in these countries generally have a monitoring effect on company managers, encouraging them to estimate values recognized in the financial results with greater accuracy.

Next steps We did a Mishkin Test to see the presence of prices’ anomaly with institutional investors and it was negative for the 9 countries. We are running more regressions in the hypothesis 2 with cultural, law and enforcements characteristics to understand the difference between countries and not see just the within countries models.

Dank! Contacts: Edmilson Sousa- epsousa@uneb.br Gerlando Lima – gerlando@usp.br Marcia de Luca – marciammdeluca@gmail.com