Stable shareholdings, the decision horizon problem, and patterns of earnings management
AbstractPrevious studies argue that stable shareholdings with long-term horizon create incentives for managers to pursue long-term stable earnings and restrict them from conducting myopic behavior. Due to their asymmetric payoff function, stable shareholders are not expected to respond favorably to temporarily inflated earnings that cause higher volatility of earnings. To test the implications of this argument, we focus on cross-shareholdings and stable shareholdings by financial institutions as stable shareholdings in Japan and investigate the effect of these ownership structures on two earnings management patterns: earnings smoothing and big bath. Consistent with our hypothesis, we find that under the stable ownership structure, stable shareholders encourage managers to perform earnings smoothing, which decreases earnings volatility, and discourage them from engaging in big bath, which increases earnings volatility. Further, additional analysis reveals that stable shareholdings reduce incentives for managers to reduce discretionary expenditure for short-term earnings benchmarks; this implies that stable shareholdings can reduce the possibility of the myopic problem. Our results suggest that stable shareholders pressurize managers to create stable earnings strings through earnings management and prevent them from pursuing short-term earnings goals.
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Bibliographic InfoPaper provided by Research Institute for Economics & Business Administration, Kobe University in its series Discussion Paper Series with number DP2011-18.
Length: 55 pages
Date of creation: Mar 2011
Date of revision: May 2012
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Stable shareholdings; Earnings smoothing; Big bath; Horizon problem; Myopic problem;
Find related papers by JEL classification:
- M41 - Business Administration and Business Economics; Marketing; Accounting - - Accounting - - - Accounting
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-09 (All new papers)
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- Yusuke Takasu & Makoto Nakano, 2012. "What Do Smoothed Earnings Tell Us about the Future?," The Japanese Accounting Review, Research Institute for Economics & Business Administration, Kobe University, vol. 2, pages 1-32, December.
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