Which Types of Institutional Investors Constrain Abnormal Accruals?

Abstract Manuscript Type Empirical Research Question/Issue This study analyses which type of institutional investors constrains accruals management using a sample of UK listed firms in the period of 1997–2010. Research Findings/Results Empirical results show that block‐holding levels, investment strategies, and investment durations influence institutional investors' role in constraining accruals management of the investee firms. Institutional investors with 10–20 percent ownership, adopting an active investment strategy, and having moderate investment duration significantly decrease the probability of income‐inflating abnormal accruals but increase the probability of income‐deflating abnormal accruals. In addition, these three aspects have a significant joint impact on accruals management. Even after considering the interaction among the three aspects of institutional investors, 10–20 percent block‐holding and moderate investment duration remain as significant driving forces on the constraint of accruals management by institutional investors. Further tests are conducted for sub‐sample periods of 2001–2005 and 2007–2009. Institutional investors with an active investment strategy and moderate investment duration are better motivated to constrain accruals management of UK firms during 2001–2005 when there were vigorous regulatory changes in corporate governance. Institutional investors with a passive investment strategy and short investment duration encouraged accruals management during the recent financial crisis (2007–2009). Theoretic/Academic Implications The findings of the paper provide some much needed clarity to the mixed evidence in the extant literature on the role of institutional investors in constraining accruals management. Block‐shareholding level, investment strategies, and the actual investment duration are valid dimensions to reflect their heterogeneous incentives in monitoring managerial discretions in accruals management. Institutional investors are a complex group of diverse types of financial institutions and would be more appropriately analyzed with multiple dimensions in future research on their monitoring of managerial discretion. Practitioner/Policy Implications This study underpins the concern of UK policymakers over the short‐term investment orientation of institutional investment by showing that institutional investors with less than one year investment duration significantly encourage accruals manipulations. Policymakers may pay attention to the three aspects, as identified in the present paper, of institutional investors in terms of enhancing shareholder engagement with their investee firms.