Conflict or alignment? The role of return-oriented foreign shareholders and domestic relational shareholders in mitigating earnings management

This study investigates the effects of foreign return-oriented shareholders and domestic relational shareholders of Japanese companies on the earnings management behavior of their invested firms when stock option pay is adopted. We theorize that foreign shareholders seek short-term returns and do no...

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Bibliographic Details
Main Authors: YOSHIKAWA, Toru, REQUEJO, Ignacio P., COLPAN, Asli, UCHIDA, Daisuke
Format: text
Language:English
Published: Institutional Knowledge at Singapore Management University 2023
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Online Access:https://ink.library.smu.edu.sg/lkcsb_research/6905
https://ink.library.smu.edu.sg/context/lkcsb_research/article/7904/viewcontent/14761270211069609_av.pdf
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Institution: Singapore Management University
Language: English
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Summary:This study investigates the effects of foreign return-oriented shareholders and domestic relational shareholders of Japanese companies on the earnings management behavior of their invested firms when stock option pay is adopted. We theorize that foreign shareholders seek short-term returns and do not engage in close monitoring due to an information disadvantage while domestic shareholders prevent managerial behavior that distorts information disclosure. Our findings show that managers of firms that use stock option pay engage in earnings management to increase their private financial benefits and meet capital markets’ expectations, which allows them to enhance their own reputation. However, this managerial behavior is contingent on the firm’s ownership structure. Our results show that while foreign shareholders enhance the positive impact of stock options on earning management, domestic shareholders and affiliated directors mitigate this positive effect. Our empirical analyses support the argument that ownership heterogeneity is a key determinant of managerial propensity to engage in earnings management when Japanese firms adopt stock option pay.