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among firms that manage earnings to meet/beat their earnings benchmarks. The author
indicates that transient institution-associated managerial myopia may not be as prevalent as
suggested by other research. Therefore, it is fair to conclude that the monitoring or
opportunistic role of institutional investors to some extent depends on their investing
horizons and/or trading strategy.
Together with a firm’s income smoothing behavior and the role of QFIIs on earnings
reporting, it is expected that high QFIIs’ ownership with short-term oriented trading strategy
weaken the earnings informativeness of income smoothing. Alternatively, the opportunistic
role is mitigated for QFIIs with a long-term oriented investing strategy. Thus, by
incorporating QFIIs’ ownership and their trading strategies into an empirical model, this
study can provide evidence to understand the role of QFIIs in the informative earnings
component of managerial income smoothing decision.
2.3 Hypotheses
Theoretical analysis (e.g., Shleifer and Vishny, 1986; Kahn and Winton, 1998)
highlights the choice institutional investors face between exerting monitoring effort for
shared gain versus simply trading for private gain. Institutional investors have incentives to
monitor managerial financial reporting. When the magnitude of institutional ownership is
sufficiently high, such monitoring arguably discourages managers from providing intended
deceptive accounting information. Prior studies provide confirmatory evidence to support
that institutional investors are playing an active role in monitoring and disciplining
managerial discretion, as well as improving information efficiency in the capital market
(Bushee, 1998; Koh, 2003; Velury and Jenkins, 2006; Hadani, Goranova, and Khan, 2011).
Yet, some institutional investors might focus on information gathering and trading, choosing
not to expend effort on influencing management (Parrino, Sias, and Starks, 2003). This
hypothesis argues that institutional investors are more likely to enjoy certain benefits such as
access to private information, which can be exploited for trading purposes (Velury and
Jenkins, 2006; Bhojraj and Sengupta, 2003). Thus, the relation between institutional
ownership and the informative component of income smoothing would depend on the
monitoring or trading role of institutional investors.
1
1 Within a cost-benefit framework, Chen, Harford, and Li (2007) documented that only independent institutions
with long-term investments will specialize in monitoring, yet, the trading institutions will not monitor.