The purpose of this paper is to examine the effect of shareholder rights on the quality of reported earnings using a proxy for strength of shareholder rights. In the analysis, the influence of institutional investors on shareholder rights is incorporated and their joint impact on earnings quality is studied.
Alternative regression models with the level of discretionary accrual (DA) as the dependent variables are estimated. To measure DA, a model developed by DeChow et al. is used. Higher levels of DA imply lower quality of earnings. The independent variables of interest are shareholder rights (measured by a modified Gomper's index) and institutional ownership (measured in three different ways discussed in the paper). A number of control variables, which prior research indicates, that can influence earnings quality is also included.
It is found that stronger shareholder rights are associated with higher earnings quality. However, when firms' stocks are held predominantly by institutions with short investment horizons (transient institutions), the role of shareholder rights in constraining aggressive and opportunistic management of earnings is significantly diminished or rendered essentially ineffective.
This research adds to the understanding of how levels of institutional ownership moderate the association between shareholder rights and earnings quality.
