The Relationship between Institutional Ownership and Earnings Management in UK’s firms.

Abstract

This research studies the effect of Institutional ownership on Earnings Management. Shipper (1989) defines Earnings Management as “purposeful intervention in the external financial reporting process with the intent of obtaining one private gain”. Moreover, institutional ownership has been identified as the factor that significantly links to the efficient monitoring of managerial decisions, most importantly, the discretionary role of managers in reporting earnings. It is identified that managers are involved in the manipulation and misrepresentation of data related to finance and other aspects of business, but little information is provided about the influence of ownership structure on earnings management. As part of quantitative methodology, data related to ownership structure and earnings management were collected from the UK firms from 2005 to 2018. The results of the study identified that institutional ownership has a negligible effect on earnings management in UK firms. A strong correlation was observed between independent board members and earnings quality. The Independent board of directors maintains corporate governance, transparency, and authenticity of financial data. Hence, restricting the managers from utilizing their discretionary powers to indicate earnings. The firms with institutional investors increase the level of monitoring that decreases the aggressive and risky earnings management activities in the firms. The managers of the firms can report high-level profits by identifying enhancing accruals. Also, they can report decreased profits by utilizing income reducing accruals. However, institutional ownership decreases these efforts of managers concerning earnings management. An increased level of the institutional power hold by independent board members and shareholders increase the quality of reporting earnings as the management is obliged to follow corporate governance rules and restricted to implement strategies to report incorrect financial position. Ultimately, the trust and sustainability level increases that positively affect the performance of the firms. Nevertheless, at the same time, the percentage increase in independent board members in the organizational ownership structure may lead to various managerial issues, including directors' autonomy in the board that affects the decision-making efficiencies.