JOURNAL OF INTERNATIONAL ACCOUNTING RESEARCH American Accounting Association

Vol. 17, No. 1 DOI: 10.2308/jiar-51988

Spring 2018
pp. 103–119

Effect of Institutional Investor Participation on Price Lead

Earnings and Earnings Quality: International Evidence
Gerlando Augusto Sampaio Franco de Lima
University of Illinois at Urbana–Champaign

Alan Diógenes Góis

University of São Paulo

Márcia Martins Mendes De Luca

Federal University of Ceará

Edmilson Patrocı́nio de Sousa

State University of Bahia
ABSTRACT: In this study we evaluated the effects of institutional investor participation on two aspects of capital
market efficiency, namely price lead earnings and earnings quality, measured according to the theoretical framework
proposed by Jiambalvo, Rajgopal, and Venkatachalam (2002) and Dechow and Dichev (2002) and modified by
Jones, Krishnan, and Melendrez (2008). The sample consists of nonfinancial organizations listed on stock markets in
France, Germany, Italy, The Netherlands, Spain, Switzerland, the U.K., and the U.S. between 2004 and 2013. The
results indicate that the effect of institutional investor participation on price lead earnings and earnings quality is
market specific. In civil law and low anti-director rights index countries, institutional investors have an information
advantage over individual investors, and institutional investor participation is associated with higher earnings quality.
Keywords: market efficiency; institutional investors; price lead earnings; earnings quality.

I. INTRODUCTION

I
n this study we evaluated the effects of institutional investor participation on two aspects of capital market efficiency,
namely price lead earnings and earnings quality, measured according to the theoretical framework proposed by Jiambalvo,
Rajgopal, and Venkatachalam (2002) and Dechow and Dichev (2002) and modified by Jones, Krishnan, and Melendrez
(2008). Our sample consisted of accounting data from nonfinancial organizations traded on stock markets in France, Germany,
Italy, The Netherlands, Spain, Switzerland, the U.K., and the U.S. between 2004 and 2013.
Although institutional investors are important players on the capital market in view of the volume of assets they mobilize,
there is no consensus in the literature on whether they act primarily as monitoring agents, encouraging the adoption of best
practices of corporate governance (Chung and Zhang 2011), with the expectation of returns in the long run (Callen and Fang
2013), or as traders, with near-exclusive focus on short-term returns (Bushee 2001).
Bushee (1998, 2001) groups institutional investors into dedicated, quasi-indexing, and transient institutions. Dedicated
investors are characterized by a preference for large investments, portfolios with low turnover, a tendency for long-term
relationships with investees, and greater interest in detailed company information. Quasi-indexing investors have highly
diversified portfolios but low turnover rates. Finally, transient institutions are characterized by short investment horizons,
diversified portfolios with high turnover, and little interest in detailed company information.

We thank Ervin L. Black (editor), Wolfgang Schultz (associate editor), and the reviewers for their valuable notes. In addition, we thank Agnes Chen,
Giorgio Gotti, and all the others who attended the 2016 JIAR Symposium in Augsburg, Germany.
Editor’s note: Accepted by Wolfgang Schultze, under the Senior Editorship of Ervin L. Black.
Submitted: November 2015
Accepted: January 2018
Published Online: January 2018
103
104 Lima, Góis, De Luca, and Sousa

On the other hand, Shleifer and Vishny (1997) believe institutional investors have incentives to acquire value-relevant
information and monitor management because their investments are large enough to allow them to profit from this type of
competitive advantage. According to this perspective, institutional investors are well informed and their presence is positively
associated with the timeliness of stock price adjustment in response to the disclosure of information on company performance
(Bartov, Radhakrishnan, and Krinsky 2000; Jiambalvo et al. 2002).
Determining whether institutional investors in different countries are generally well informed and play a monitoring role or
are primarily focused on short-term profits helps contextualize the effects of investor preferences in terms of market efficiency
and the effects of investors’ responses to incentives from the environment in which they operate.
In markets in which institutional investors are better informed than individual investors, investment size is expected to be
positively associated with the extent to which current prices reflect information on future earnings—a phenomenon referred to
as price lead earnings (Jiambalvo et al. 2002)—and on the quality of reported earnings (Callen and Fang 2013).
In this study, we used the methodology of Jiambalvo et al. (2002) to evaluate the relation between institutional investor
participation and price lead earnings in different countries. Our analysis of the relation between institutional investor participation and
earnings quality is based on the theoretical framework developed by Dechow and Dichev (2002) and modified by Jones et al. (2008).
Our study contributes to the literature in two ways. First, we provide evidence that the information advantage of
institutional investors is more prominent in common law and high anti-director rights index countries with strong national
governance. Second, our findings show that institutional investor participation is positively associated with earnings quality,
suggesting that in these capital markets’ institutional investors play a role in monitoring management, encouraging the
reporting of earnings of superior quality.
Following the present introduction, we explain the theoretical framework underpinning the investigation, followed by
descriptions of the study hypotheses and the study design, including the sampling procedures adopted. Finally, we present our
empirical findings and conclusions.

II. THEORETICAL FRAMEWORK

Effect of Institutional Investor Participation on Price Lead Earnings

According to Hand (1990), investors may be sophisticated in the sense that they have a superior ability to acquire and use
value-relevant public information, incorporating it into their investment decisions. In contrast, unsophisticated investors do not
collect detailed information on target firms or use such information in their decision making.
Well-informed (sophisticated) investors are important for the market because they encourage timely adjustment of stock
prices to levels compatible with available company information. This helps less-sophisticated investors revise their expectations
of future performance (Grossman 1976).
Sophistication is costly. According to Lev (1989), richer investors have access to information that smaller investors cannot
afford. The former includes institutional investors in possession of the resources and incentives necessary to acquire, process,
and incorporate value-relevant public information into the decision-making process (Bartov et al. 2000).
In Bushee (1998), institutional investors are defined as entities that invest on behalf of third parties (e.g., pension funds,
insurance companies, investment banks, investment funds, and clubs). The large stock portfolios they operate provide them
with the resources and incentives required to become sophisticated investors.
The sophistication of institutional investors was evidenced by Bartov et al. (2000), who found institutional investor
participation to be negatively correlated with post-announcement abnormal returns.
In an efficient market, stock prices are driven by expectations of present and future company performance (Kothari 2001).
Such expectations are frequently revised in light of new information (Kothari and Sloan 1992). Information not yet contained in
earnings is used by the market to revise stock prices. Therefore, the mix of information reflected in the price is richer than the
mix of information incorporated into the accounting earnings of the same period (Beaver, Lambert, and Morse 1980). This
phenomenon is known as price lead earnings.
The attribution of sophistication to the category of institutional investors is supported by Jiambalvo et al. (2002)—
according to whom institutional investors possess a superior ability to use current information to forecast earnings—and by the
positive association between price lead earnings and institutional investor participation observed for the North American capital
market. However, the findings of Jiambalvo et al. (2002) call for an inquiry into whether the observed positive association is a
global phenomenon or is restricted to specific markets.

Effects of Institutional Investor Participation on Earnings Quality

According to Dechow, Kothari, and Watts (1998), earnings play a central role in accounting, as they are widely used in the
stock and performance evaluations required for management and loan/funding contracts. Some attribute the importance of

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Effect of Institutional Investor Participation on Price Lead Earnings and Earnings Quality: International Evidence 105

earnings to the fact that they reflect cash flow predictions and are more closely correlated with company value than current cash
flow, since the recognition of earnings on the accrual basis promotes the incorporation of information on predicted cash flows
(Dechow 1994; Dechow et al. 1998; Penman and Sougiannis 1998).
The adoption of accrual-based accounting increases the information quality of earnings (Dechow 1994), but since accruals
require estimates of future cash flows, the benefit of using accruals may be offset by estimation error (Dechow and Dichev
2002). All accruals must be reverted a posteriori once the represented cash flow is realized. The difference between the initial
accrual value and the cash flow into which it is converted represents accrual components unrelated to cash flow and reveals the
magnitude of the estimation error.
Estimation error reduces the ability of accruals to anticipate information on future cash flows, while accrual reversions
reduce accrual and earnings persistence (Allen, Larson, and Sloan 2013). Persistence is often used as a proxy for accrual and
earnings quality since it is positively correlated with superior earnings quality (Dechow, Ge, and Schrand 2010). Thus, the
greater the estimation error, the lower the accrual and earnings quality (Dechow and Dichev 2002).
Based on the assumption that company accruals unrelated to cash flow are a consequence of estimation errors, Dechow and
Dichev (2002) proposed to express earnings quality as the standard deviation of the residue in the following equation:
DWCit ¼ a þ b1 CFit1 þ b2 CFit þ b3 CFitþ1 þ eit ð1Þ
where DWCit is variation in company i’s working capital in the period t; CFit1 is company i’s operational cash flow in the
period t1; CFit is company i’s operational cash flow in the period t; CFitþ1 is company i’s operational cash flow in the period
tþ1; and eit is company i’s error term or residue in the period t, representing accruals unrelated to operational cash flow.
The empirical tests of Dechow and Dichev (2002) have shown that the greater the standard deviation of the residues in
Equation (1), the smaller the accrual and earnings persistence.
Accrual and earnings quality may be expected to be directly related to the efforts of company managers to produce the best
possible estimates for values recognized in the earnings. According to Callen and Fang (2013), there is evidence that
institutional investors have a monitoring effect on managers, encouraging them to focus on long-term value generation and
adopt best practices of corporate governance. In fact, Chung and Zhang (2011) found evidence of a positive correlation
between institutional investor participation and quality of corporate governance structure.
The monitoring effect of institutional investors is important because it discourages managers from indulging in earnings
management (Koh 2003) and serves as a catalyst for improved earnings quality (Velury and Jenkins 2006). However, it
remains to be seen whether institutional investors play a monitoring role in all markets or whether the phenomenon is local. The
present investigation is an attempt to answer this question.

III. DEVELOPMENT OF HYPOTHESES

Accrual-based accounting restricts recognition of earnings to specific information about transactions and economic events
that have already caused an impact on corporate assets. In other words, conservative accounting rules prevent information on
future transactions and economic events from being recognized in advance as earnings. Nevertheless, this same information is
used by the market to revise stock prices, generating the phenomenon of price lead earnings (Kothari and Sloan 1992).
Since the mix of information reflected in the price is richer than the mix of information incorporated into the accounting
earnings of the same period (Beaver et al. 1980), a greater participation of sophisticated investors would be expected to cause
present prices to reflect a greater amount of information that will only be recognized in earnings realized in the future
(Jiambalvo et al. 2002). Thus, in countries where the class of institutional investors may be used as a proxy for that of
sophisticated investors, a positive correlation between institutional investor participation and price lead earnings may be
expected. In other words, in countries with strong governance, common law, and high levels of investor protection, a
considerable amount of information on future performance may be anticipated by the present price due to greater market
effectiveness, allowing institutional investors to act more efficiently and become more sophisticated (La Porta, Lopez-de-
Silanes, Shleifer, and Vishny 2000). Based on these assumptions, the following hypothesis is formulated:
H1: The amount of information on future performance anticipated by the present price is positively correlated with the
percentage of institutional investor participation.
According to Bushee (1997), institutional investors control large enough resources to hold significant stock over extended
periods. The combination of large investments and stability makes it possible for institutional investors to monitor the behavior
of corporate managers, discouraging them from managing earnings (Chung and Zhang 2011).
Dechow and Dichev (2002) define accrual quality as the extent to which working capital accruals map into operating cash
flow realizations. Hence, accrual quality decreases in inverse proportion to the underlying estimation error. The monitoring
pressure from institutional investors (Chung and Zhang 2011) is expected to influence managers to make more careful estimates

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106 Lima, Góis, De Luca, and Sousa

of earnings recognized as actual accruals. Likewise, earnings quality may be expected to be higher in countries with strong
governance, common law, and high levels of investor protection, where the presence of institutional investors favors adherence
to corporate governance practices, thereby minimizing opportunistic behaviors (Aggarwal, Erel, Ferreira, and Matos 2011).
Based on these assumptions, the following hypothesis was formulated:
H2: The greater the percentage of institutional investor participation, the higher the earnings quality.

IV. STUDY DESIGN

Sampling
The study data were retrieved from the S&P Capital IQ database and include stock prices, percentage of institutional
investor holdings, percentage of insider holdings, analyst following, and data from financial reports of firms traded on stock
markets in France, Germany, Italy, The Netherlands, Spain, Switzerland, the U.K., and the U.S. between 2004 and 2013. As the
U.S. has not adopted IFRS, this country is analyzed separately.

Relation between Institutional Investor Participation and Price Lead Earnings

The empirical study of the relation between institutional investor participation and price lead earnings is performed with
the methodology of Jiambalvo et al. (2002), derived from an approach developed by Kothari and Sloan (1992). Thus, Equation
(2) is estimated as follows:
Rits;t ¼ x0 þ x1ðsÞ Eit þ x2ðsÞ Eit 3 INSTits þ eits ð2Þ
where Rits,t is returns on stock held for one year (s ¼ 1) or two years (s ¼ 2); E is the annual income of company i in the period
t; and INSTits is the percentage of institutional investor participation in company i at the beginning of the period ts.
Equation (2) is estimated using the SUR (seemingly unrelated regression) approach. By comparing x2(s¼2) and x2(s¼1), we
examined the influence of institutional investor participation on the amount of information on future earnings reflected in
current stock prices. If, in fact, companies with greater institutional investor participation incorporate more information on
future earnings, then x2(s¼2) . x2(s¼1).
Since sophisticated investors tend to use available information earlier, part of the information on earnings in the period t
(which would be used in the returns of the period ts to s ¼1) is already incorporated in the returns of the period s ¼ 2, as
illustrated in Figure 1. Thus, it may be expected that, as s increases, more information about period t is incorporated into the
returns of the period ts.
The period covered by our data (2004–2013) includes the years 2008 and 2009, when the sampled financial markets were
heavily impacted by a global crisis. Thus, to control for the effects of the crisis, a dummy variable was inserted into regression
Equation (2), estimating Equation (3):
Rits;t ¼ x0 þ x1ðsÞ Eit þ x2ðsÞ Eit 3 INSTits þ x3ðsÞ CRISIS þ eits ð3Þ
where CRISIS is a dummy variable with the value 1 for the years 2008 and 2009, and 0 for all other years, while the other
variables remain unchanged.
As shown by Jiambalvo et al. (2002), several factors are known to interfere in the relation between earnings and returns.
Thus, in addition to institutional investor participation, the empirical test of H1 includes the estimation of a regression equation
for each country in our sample (Equation (4)):
Rits;t ¼ x0 þ x1ðsÞ Eit þ x2ðsÞ Eit 3 INSTits þ x3ðsÞ Eit 3 CRISISt þ x4ðsÞ Eit 3 MGRits þ x5ðsÞ Eit 3 ANALYSits
þ x6ðsÞ Eit 3 MBits þ x7ðsÞ Eit 3 LEVits þ x8ðsÞ Eit 3 EVARi þ x9ðsÞ Eit1 þ x10ðsÞ Eit 3 SIZEits þ eits ð4Þ
where MGRits is the percentage of insider investor participation in company i in the period ts; ANALYSits is the number of
analysts following company i in the period ts; MBits is the market-to-book rate (a proxy for growth opportunity) of company
i in the period ts; LEVits is the rate of debts in relation to the total assets (leverage) of company i in the period ts; EVARi is
the standard deviation of the earnings of company i; Eit1 is the earnings of company i in the period t1; and SIZEits is the
natural logarithm of the market value of the equity of company i in the period ts. The other variables remain unchanged.
It should be noted that the interactive variables were constructed by dummies that represent 1 if the variable of interest has
a value above the median, and 0 otherwise: for example, when the interactive variable Eit 3 INSTits, has a value of 1, it
represents companies with net income and institutional investors above the median, and 0 otherwise. The variables INSTits,
CRISISt, MGRits, ANALYSits, MBits, LEVits, EVARits, and SIZEits were inserted in the model with no interaction term.

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Effect of Institutional Investor Participation on Price Lead Earnings and Earnings Quality: International Evidence 107

FIGURE 1
Timeline Underlying the Design of the Test of H1

Based on Jiambalvo et al. (2002).

Rt,ts ¼ returns on stock held between ts and t (s ¼ 1, 2);
Et ¼ earnings in the period ending in t;
x1(s¼1) ¼ proportion of information on earnings in the period t (Et) incorporated into stock prices between t1 and t;
x1(s¼2) ¼ proportion of information on earnings in the period t (Et) incorporated into stock prices between t2 and t;
x1ðs¼2Þ
x1ðs¼1Þ ¼ proportion of information on earnings in the period t (Et) incorporated into the returns of (t2, t) in relation to the returns of (t1, t); and
INSTts ¼ institutional investor participation at the beginning of the period ts.

Relation between Institutional Investor Participation and Earnings Quality

To test H2, we use the model developed by Dechow and Dichev (2002), who proposed an empirical measure of short-term
accrual quality and operational earnings based on the standard deviation of the residuals of the regression of the change in
working capital in relation to operational cash flow in the periods t1, t, and tþ1. Jones et al. (2008) observed that the relation
between short-term accruals and operational cash flows is affected by the growth of the company (reflected in increased
revenues) and gross investments in fixed assets, and thus proposed a modification of the model by adding variables:
DWCit ¼ a þ b1 CFit1 þ b2 CFit þ b3 CFitþ1 þ DSALESit þ PPEit þ eit ð5Þ
where DWCit is the variation in the working capital of company i in the period t; CFit1 is the operational cash flow of company
i in the period t1; CFit is the operational cash flow of company i in the period t; CFitþ1 is the operational cash flow of company
i in the period tþ1; DSALESit is the variation in operational revenues of company i in the period t; PPEit is the balance of
tangible assets of company i at the end of the period t; and eit is the error term or residue of company i in the period t,
representing accrual components unrelated to operational cash flow.
For each company in the sample, the greater the standard deviation of e, the lower the quality of the accruals and earnings.
After estimating Equation (5) and determining the value of the error term by way of observation, we calculated the
standard deviation by company, creating the variable EQ:
EQ ¼ Standard DeviationðeÞ ð6Þ
Subsequently, we divided each subsample into ten portfolios according to the INST percentile. In each subsample,
Portfolio 1 contains the companies with the lowest INST and Portfolio 10 those companies with the highest INST. In cases
where institutional investors have a monitoring effect on management, companies with larger INST are known to display higher
earnings quality, reflected in a smaller EQ. Thus, if H2 is true, a decrease in average EQ values from Portfolio 1 to 10 may be
expected. Equation (7) is used to test H2:
EQit ¼ b0 þ b1 INSTit þ b2 ANALYSit þ b3 MBit þ b4 LEVit þ b5 SIZEit þ b6 CRISIS þ eit ð7Þ
where EQit is the absolute value of earnings quality (Dechow and Dichev [2002] modified by Jones et al. [2008]) of company i
in the period t; INSTit is the percentage of institutional investor participation at the beginning of the return period of company i
in the period t; ANALYSit is the number of analysts following company i in the period t; MBit is the market-to-book rate (a
proxy for growth opportunity) of company i in the period t; LEVit is the rate of debts in relation to the total assets (leverage) of
company i in the period t; SIZEit is the natural logarithm of the market value of the equity of company i in the period t; and
CRISIS is a dummy variable with the value 1 for the years 2008 and 2009, and 0 for all other years.

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108 Lima, Góis, De Luca, and Sousa

Due to the difficulty of measuring earnings quality with noisy metrics, we develop a test of robustness based on the Jones
(1991) model, modified by Dechow, Sloan, and Sweeney (1995), and estimate the following equation:
 
ACCTit 1 DSALESit DRECit PPEit
¼ b1 þ b2  þ b3 þ eit ð8Þ
TAit1 TAit1 TAit1 TAit1 TAit1
where ACCTit is total accruals of company i in the period t; TAit1 is total assets at the beginning of the period; DSALESit is the
variation in revenues of company i in the period t; DRECit is the variation in receivables of company i in the period t; and PPEit
is property, plant, and equipment of company i in the period t.
If the residue of Equation (8) represents the amount of discretionary accruals, and greater discretionary accruals reflect
lower earnings quality, then the relation between institutional investor participation and earnings quality may be tested by
regressing the residues of the regression against the percentage of institutional investor participation.
To evaluate the robustness of our analysis, H1 and H2 are tested with regard to national governance, the legal system, and
the anti-director rights index (La Porta, Lopez-de-Silanes, Shleifer, and Vishny 1998). Thus, five models are created: (1) a
general model, (2) a model considering only firms in common law countries, (3) a model considering only firms in civil law
countries, (4) a model considering only firms in high anti-director rights index countries, and (5) a model considering only
firms in low anti-director rights index countries. Following the example of La Porta et al. (1998), we used median country
values to distinguish between high and low anti-director rights index (ARI) countries (low:  3; high: . 3).

V. RESULTS

Relation between Institutional Investor Participation and Price Lead Earnings

In this study we use the model developed by Jiambalvo et al. (2002) to analyze the influence of institutional investor
participation on the information content of stock prices. We evaluate whether the superior ability of institutional investors to
use information in their transactions on the capital market is a universal phenomenon or market specific. The purpose of the
study is to determine whether institutional investors are generally well informed in different countries and, if so, whether this
represents a competitive advantage over individual investors.
In countries where institutional investors are better informed than individual investors, a positive and significant correlation
between the percentage of institutional investor participation and return on stocks may be expected (Jiambalvo et al. 2002),
since a greater ability to acquire and use value-relevant information would give institutional investors an advantage in the
estimation of future earnings and make it possible to revise expectations sooner and with greater accuracy than would be
possible for less-informed individual investors.
The sample of the current study consists of nonfinancial firms traded on stock markets in eight countries in the period
2004–2013 (Table 1). Excluded from the analysis are observations with incomplete information on stock prices, institutional
investor participation, insider investor participation, analyst following, and total assets. Return outliers are also excluded. Thus,
the final sample includes 3,985 firms based on 19,969 observations (Table 1).
As shown in Table 1, the U.S. accounts for the largest number of observations (10,497 observations representing 2,034
firms), while The Netherlands accounts for the smallest number (323 observations representing 63 firms).
Once the return outliers are excluded, operational earnings are divided by the total assets of the previous period, and the top
and bottom 1 percent are winsorized. Table 2 presents the descriptive statistics of the sample.
Institutional investor participation (INST) is smallest in Italy (12 percent) and greatest in the U.K. (59 percent) and the U.S.
(57 percent) (Table 2). Country means were compared pairwise with a nontabulated t-test. No statistically significant difference
was found between the mean values of the U.K. and the U.S.
With regard to institutional investor participation, the U.K. and the U.S. displayed the smallest data dispersion, while The
Netherlands presented the smallest variation coefficient (55.56 percent), not tabulated. The latter indicates that institutional
investment was less volatile in the Dutch capital market than in the other countries in our sample. The U.S. and the U.K. ranked
third and fourth, respectively.
The high percentage of institutional investor participation and small variation coefficient of the U.K. and the U.S. highlight
the relevance of these players and provide an opportunity to examine the relation between institutional investment and other
aspects of the capital market.
The distribution of institutional investment in the U.S. (histogram inclined to the left, with a negative asymmetry of 0.10)
was different from that of all other countries in the sample (histogram inclined to the right, positive asymmetry), indicating that
institutional investors in the U.S. prefer large investments, whereas institutional investors in other countries predominantly
invest smaller amounts. These differences show that institutional investors play a special role on the North American market,
the effects of which it would be interesting to investigate.

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TABLE 1
Size of the Sample Used in the Empirical Testing of H1
Number of Firms Number of Observations
Country Initial Final Initial Final
France 700 296 7,000 1,275
Germany 754 287 7,540 1,220
Italy 231 149 2,310 681
The Netherlands 84 63 840 323
Spain 140 80 1,400 382
Switzerland 159 138 1,590 694
U.K. 1,328 938 13,280 4,897
U.S. 8,210 2,034 82,100 10,497
Total 11,606 3,985 116,060 19,969

Our analysis of mean insider participation (MGR) shows Germany (24 percent) at the top of the list. None of the sampled
countries displayed an MGR value below 10 percent. This is not a negligible level of participation, indicating the need for
controlling for this variable when evaluating the relation between institutional investor participation and returns.
When comparing company size in terms of market value of equity (SIZE), The Netherlands presented the highest mean value
(USD 8,942 million). Although the largest company belonged to the North American market (USD 511,887 million), the U.S.
also presented the greatest positive asymmetry, followed by the U.K. In other words, in the U.S. and the U.K., the distribution of
SIZE revealed a greater concentration of small values, potentially compromising the information environment of these markets.
The country with the greatest average analyst following was the U.S. (2.94), followed by the U.K. (1.64). This finding
suggests that the U.S., and the U.K. have capital markets with rich information environments.
Table 3 shows the Pearson correlation coefficients between institutional investor participation (INST) and the remaining
study variables.
In all the sampled countries, INST was positively and significantly correlated with SIZE and ANALYS (Table 3), indicating
an overall preference among institutional investors for larger and greater availability of information.
On the other hand, INST was negatively and significantly correlated with MGR (Table 3). The sign and strength of the
correlation reveal a tendency among institutional investors to invest less in firms with high levels of insider participation.
Finally, a significant and positive correlation was found between INST and Rt1,t (Table 3), suggesting that institutional
investors are better informed than individual investors, matching the findings of Nofsinger and Sias (1999).
Also, Table 3 reveals a positive and significant correlation between Rt1,t and ANALYS, suggesting that the greater
availability of information is correlated to a better-informed investor.
To determine whether the presence of institutional investors is a driving force of price lead earnings, we estimate Equations
(2), (3), and (4). We expect E, E 3 INST, E 3 MGR, E 3 ANALYS, E 3 MB, Eit1, and E 3 SIZE to be positive, and E 3 LEV
and E 3 EVAR to be negative. The variable E 3 CRISIS is considered indeterminate.
The results of the estimation of Equation (2) (not adjusted for the financial crisis) and Equation (3) (adjusted for the
financial crisis) were not tabulated since the two equations were used to estimate Equation (4) (Table 4).
Results of Equations (2) and (3) (not tabulated) show that the earnings coefficient is significant and positive for s ¼ 1 and s
¼ 2, considering all the countries in the sample, except for the U.S. However, the coefficients for s ¼ 1 and s ¼ 2 were
statistically different whether the CRISIS dummy was used (Wald ¼ 5.86) or not (Wald ¼ 5.68), indicating that an increase
from one to two years in the time of return changed the amount of information on future earnings incorporated into the stock
price. When we consider only the U.S., the earnings coefficient is nonsignificant for s ¼ 1 and is significant and positive for s ¼
2, either in the presence or not of the CRISIS variable, in which the Wald test indicates that an increase from one to two years in
the time of return changed the amount of information on future earnings incorporated into the stock price.
When only common law countries (the U.K.) or high anti-director rights index countries (Spain and the U.K.) are
considered, the earnings coefficient is significant and positive for s ¼ 1 and s ¼ 2, so there isn’t an increase from one to two
years in the time of return changed the amount of information on future earnings incorporated into the stock price. Moreover,
the result is not affected by the inclusion of the variable CRISIS.

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TABLE 2
Descriptive Statistics of the Study Variables According to Country
(1) (2) (3) (4) (5) (6) (7) (8)
INST
Mean 0.2 0.17 0.12 0.36 0.21 0.26 0.59 0.57
SD 0.16 0.17 0.12 0.2 0.16 0.2 0.42 0.37
Median 0.16 0.13 0.09 0.36 0.18 0.23 0.61 0.63
Asymmetry 1.06 3.17 1.8 0.38 0.68 2.87 21.19 0.1
MGR
Mean 0.19 0.24 0.16 0.1 0.1 0.2 0.15 0.12
SD 0.24 0.24 0.26 0.17 0.17 0.25 0.19 0.16
Median 0.06 0.17 0.03 0.01 0.03 0.1 0.07 0.05
Asymmetry 1.21 1.72 2.27 2.26 2.49 2.37 2.13 1.92
SIZE
Mean 5.584 1.769 2.692 8.942 6.732 7.432 3.188 5.078
SD 16.101 9.761 9.506 29.364 17.867 27.582 14.787 22.649
Median 407 96.67 258 789 866 546 116 423
Asymmetry 5.68 8.14 6.48 6.02 4.63 5.68 8.35 11.38
MB
Mean 2.72 1.46 1.37 1.89 1.95 2.78 3.19 2.89
SD 37.22 15.62 2.04 2.54 2.81 4.72 44.16 30.71
Median 1.34 1.38 0.98 1.63 1.28 1.87 1.56 1.76
Asymmetry 35.5 31.18 5.57 8.14 1.12 12.58 39.77 8.21
ANALYS
Mean 0.64 0.46 0.03 1.12 1.08 0.75 1.64 2.94
SD 1.35 1.16 0.08 1.75 1.93 1.49 3 4.16
Median 0 0 0 0 0 0 0 1
Asymmetry 3.07 3.9 2.53 1.97 2.6 3.41 2.78 1.82
E
Mean 0.05 0.02 0.03 0.06 0.04 0.06 0 0.16
SD 0.09 0.18 0.08 0.13 0.08 0.12 0.25 1.15
Median 0.06 0.04 0.03 0.07 0.03 0.07 0.05 0.05
Asymmetry 1.79 2.81 0.19 1.57 0.12 1.54 3.48 8.63
Rit1,t
Mean 0.03 0.01 0.11 0.03 0.08 0.02 0.01 0.04
SD 0.38 0.44 0.36 0.39 0.37 0.43 0.48 0.44
Median 0.04 0.04 0.11 0 0.07 0.02 0.02 0.05
Asymmetry 0.32 0.42 0.28 0.16 0.14 0.24 0.39 0.36
(1) ¼ France, (2) ¼ Germany, (3) ¼ Italy, (4) ¼ The Netherlands, (5) ¼ Spain, (6) ¼ Switzerland, (7) ¼ the United Kingdom, and (8) ¼ the United States. SD
¼ standard deviation. The outliers of the variable Rit1,t are excluded. The top and bottom 1 percent of all variable are winsorized.

Variable Definitions:
INST ¼ percentage of institutional investor participation;
MGR ¼ percentage of insider participation;
SIZE ¼ market value of equity in millions USD;
MB ¼ market-to-book rate at the beginning of the return period;
ANALYS ¼ number of analysts following the company at the beginning of the return period;
E ¼ earnings prior to extraordinary items of period t divided by the total assets of period t1; and
Rit1,t ¼ return on stock held for one year.

In contrast, when only civil law countries (France, Germany, Italy, The Netherlands, Spain, and Switzerland) or low anti-
director rights index countries (France, Germany, Italy, The Netherlands, and Switzerland) are considered, the earnings
coefficient is significant and positive for s ¼ 1 and s ¼ 2, so that there is no increase from one to two years in the time of return
changed the amount of information on future earnings incorporated into the stock price. As before, the result is not affected by
the inclusion of the variable CRISIS.

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Effect of Institutional Investor Participation on Price Lead Earnings and Earnings Quality: International Evidence 111

TABLE 3
Pearson Correlation between Variables of H1
INST MGR SIZE LEV EVAR MB ANALYS E Rt1,t
INST 1
MGR 0.2384*** 1
SIZE 0.0506*** 0.1428*** 1
LEV 0.0105 0.0036 0.0023 1
EVAR 0.0124 0.0033 0.0032 0.9978*** 1
MB 0.0112 0.0089 0.0042 0.0011 0.0012 1
ANALYS 0.2695*** 0.1916*** 0.239*** 0.0048 0.0066 0.015 1
E 0.0111 0.0032 0.0031 0.9994*** 0.9981*** 0.0017 0.006 1
Rt1,t 0.0408*** 0.0111 0.002 0.0081 0.0064 0.0079 0.0216** 0.0079 1
**, *** Significant at 5 percent and 1 percent, respectively.
The Pearson correlations do not include the U.S. The top and bottom 1 percent of all variables were winsorized.

Variable Definitions:
INST ¼ percentage of institutional investor participation;
MGR ¼ percentage of insider participation;
SIZE ¼ market value of equity;
LEV ¼ debt divided by total assets of the preceding year;
EVAR ¼ standard deviation of earnings;
MB ¼ market-to-book rate at the beginning of the return period;
ANALYS ¼ number of analysts following the company at the beginning of the return period;
E ¼ earnings prior to extraordinary items; and
Rit1,t ¼ return on stock purchased and held for one year.

The results of Equations (2) and (3) also indicate that the interaction term E 3 INST (the primary variable of interest in this
study) increased significantly from 0.001 (0.01) to 0.26 (0.27), when the time of return was changed from one to two years.
Based on this, it may be inferred that, regardless of country, institutional investors are sophisticated investors with an edge over
other types of investors.
The same was observed for firms in countries with strong governance (common law and high anti-director rights index) as
well as in countries with weak governance (civil law and low anti-director rights Index). The only difference is that for the U.S.,
that the interaction term E 3 INST is negative and significant at s ¼ 1 and is positive and significant at s ¼ 2. This also
demonstrates that from period 1 to period 2, the amount of information incorporated in the price changed such that institutional
investors had a greater informational advantage than individual investors.
Interestingly, the results of Equations (2) and (3) stress the importance of including a dummy variable to control for the
effects of the financial crisis: the variable CRISIS was significant and negative for all models. In other words, the impact of the
2008 financial crisis on the capital markets of the sampled countries was not a negligible factor in the analysis.
The results of the estimation of the complete model are presented in Table 4. Note that the coefficients of the control
variables were left out, with the exception of E 3 CRISIS.
Considering the entire sample of countries excluding the U.S., the term E 3 INST is negative and significant at s ¼ 1 and
nonsignificant at s ¼ 2. Thus, it appears that institutional investors do not have an informational advantage over the individual
investor.
In countries with strong governance (common law, high anti-director rights index countries, and the U.S.), the result is the
same as for the general model, in which the term E 3 INST is negative and significant at s ¼ 1 and nonsignificant at s ¼ 2.
Again, the study shows that even countries with strong governance (common law, high anti-director rights index countries, and
the U.S.) do not in fact possess an information advantage.
In civil law and low anti-director rights index countries with weak governance, the term E 3 INST is nonsignificant at s ¼ 1
and positive and significant at s ¼ 2, having an increase between s ¼ 1 and s ¼ 2, indicating that in countries with weak
governance, institutional investors are more relevant, thus they would act as a reducer of informational asymmetry.
Overall, our empirical tests indicate that H1 was not rejected by countries with weak governance, suggesting institutional
investors are sophisticated investors since stock prices incorporate information earlier in firms with greater institutional
ownership participation.

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112 Lima, Góis, De Luca, and Sousa

TABLE 4
Analysis of the Relationship between Rit1,t and INST
Variable ALL COMMON CIVIL HIGH_ARI LOW_ARI USA
Rit1,t
Constant 0.026 0.062 0.008 0.067* 0.003 0.023
(1.01) (1.48) (0.24) (1.70) (0.10) (0.76)
E 0.281*** 0.099 0.815*** 0.107 0.802*** 0.01
(5.24) (1.44) (8.88) (1.58) (8.47) (1.08)
E 3 INST 0.053*** 0.067* 0.019 0.063* 0.015 0.123***
(2.62) (1.84) (0.70) (1.89) (0.55) (3.56)
E 3 CRISIS 0.060** 0.036 0.035 0.042 0.039 0.183***
(2.06) (0.78) (0.99) (0.97) (1.03) (5.43)
Rit2,t
Constant 0.112** 0.270*** 0.023 0.258*** 0.04 0.015
(2.27) (3.33) (0.40) (3.38) (0.66) (0.32)
E 0.610*** 0.561*** 0.547*** 0.564*** 0.529*** 0.068***
(5.91) (4.07) (3.32) (4.21) (3.10) (4.98)
E 3 INST 0.01 0.014 0.091* 0.011 0.103** 0.034
(0.26) (0.20) (1.88) (0.18) (2.02) (0.69)
E 3 CRISIS 0.140** 0.116 0.230*** 0.122 0.228*** 0.012
(2.43) (1.23) (3.51) (1.38) (3.28) 0.24
Adj. R2 (Rit1,t) 0.17 0.21 0.18 0.20 0.17 0.11
Adj. R2 (Rit2,t) 0.08 0.14 0.07 0.13 0.07 0.08
Wald Test 12.17*** 2.87* 14.03*** 14.62*** 2.75* 29.45***
*, **, *** Significant at 10 percent, 5 percent, and 1 percent, respectively.
The Wald test is used to compare the coefficients of the two periods of return. The standard error is given in parentheses. The top and bottom 1 percent of
all variables are winsorized.

Variable Definitions:
ALL ¼ all companies;
COMMON ¼ only firms in common law countries, according to La Porta et al. (1998);
CIVIL ¼ only firms in civil law countries, according to La Porta et al. (1998);
HIGH_ARI ¼ only firms in countries with a high anti-director rights index (. 3), based on La Porta et al. (1998);
LOW_ARI ¼ only firms in countries with a low anti-director rights index ( 3), based on La Porta et al. (1998);
USA ¼ only American firms;
Rits,t ¼ return on stock purchased and held for one year (s ¼ 1) or two years (s ¼ 2);
E ¼ annual earnings prior to extraordinary items at the end of the return period;
INST ¼ percentage of institutional investor participation at the beginning of the return period;
CRISIS ¼ a binary variable equal to 1 for the years 2008 and 2009, and equal to 0 for the remaining years;
ANALYS ¼ number of analysts following the company at the beginning of the return period;
MB ¼ market-to-book rate at the beginning of the return period;
LEV ¼ debt divided by total assets at the beginning of the return period;
EVAR ¼ standard deviation of earnings;
Eit1 ¼ earnings of the preceding year; and
SIZE ¼ natural logarithm of market value of equity at the beginning of the return period.

Empirical Testing of the Relation between Institutional Investor Participation and Earnings Quality
The empirical testing of H2 excludes observations with incomplete information on operational cash flow, operational
income, total assets, changes in receivables, and changes in stocks or institutional investor participation. We also exclude
observations containing extreme values for variations in working capital and operational cash flow. In addition, companies with
time series shorter than five years are excluded from the analysis. The final sample consists of 2,256 companies, based on
15,507 observations (Table 5).
The largest and smallest subsamples were those of the U.S. (9,540 observations, 1,384 companies) and The Netherlands
(231 observations, 34 companies), respectively (Table 5). The descriptive statistics are shown in Table 6.
As shown in Table 6, institutional investor participation (INST) was smallest in Italy (14 percent) and greatest in the U.K.
(69 percent) and the U.S. (70 percent). Differences between country means were verified pairwise with a nontabulated t-test.
The tests show that the U.K. and the U.S. were statistically similar with regard to INST.

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TABLE 5
Sample Size for the Empirical Testing of H2
Number of Companies Number of Observations
Country Initial Final Initial Final
France 700 165 7,000 1,130
Germany 754 152 7,540 1,041
Italy 231 79 2,310 538
The Netherlands 84 34 840 231
Spain 140 40 1,400 276
Switzerland 159 60 1,590 415
U.K. 1,328 342 13,280 2,336
U.S. 8,210 1,384 82,100 9,540
Total 11,606 2,256 116,060 15,507

All countries displayed a mean variation in working capital (DWCit), close to 0, but the dispersion in the dataset was large,
with coefficients varying by over 100 percent (Table 6). In almost all countries, the histogram was inclined to the right
(positive asymmetry), indicating a concentration of lower DWCit values. Spain was the only exception, displaying negative
asymmetry due to a concentration of higher DWCit values.
As expected from the sample used to test H1, the U.K. and the U.S. had the greatest mean INST values. Asymmetry was
negative for the U.S. and positive for all other countries.
Based on the framework proposed by Dechow and Dichev (2002) and modified by Jones et al. (2008), we calculate EQ
(the standard deviation of the residues) using the regression in Equation (5). A fixed-effects estimation provided the best fit for
the data of all subsamples.
We then divided each subsample into ten portfolios according to INST percentile (not tabulated). In each subsample,
Portfolio 1 contains the companies with the lowest INST and Portfolio 10 those with the highest INST.
Assuming that the presence of institutional investors has a monitoring effect on management, companies with greater
institutional investor participation should present earnings of higher quality, i.e., lower EQ values. Thus, mean EQ values are
expected to decrease from Portfolio 1 toward Portfolio 10. In addition, in view of the information advantage of institutional
investors in the U.S. and the U.K. (identified in the testing of H1), the relation between earnings quality and institutional
investor participation is expected to be particularly evident in these countries.
The values observed for the created portfolios were plotted into a dispersion diagram (Figure 2). The EQ of France, the
U.K., and the U.S. tend to decrease when going from lower to higher portfolio numbers (Figure 2), supporting H2. This implies
that institutional investors had a monitoring effect on managers in those countries, encouraging greater accuracy in the
estimation of values recognized in the financial results. However, this pattern was not observed for any other subsample.
The procedure was repeated for three and five portfolios using tertiles and quintiles, respectively (not tabulated). The
pattern remains unchanged, with the exception of the German subsample, which reveals a reduction in EQ when going from
lower to higher portfolio numbers.
The result of the portfolio composition based on tertiles and quintiles supports H2 with regard to Germany, in contrast with
the pattern observed when using deciles. As for the other countries, the pattern observed when using tertiles and quintiles is
similar to that observed when using deciles and to that of Figure 2.
Our data (Figure 2) show that institutional investors in France, the U.K., and the U.S. invest predominantly in companies
reporting earnings of superior quality.
The statistical significance of the difference between the first and last portfolios is evaluated with t-tests. The result is
significant for France, Germany, Spain, the U.K., and the U.S. (not tabulated), suggesting a relation between institutional
investor participation and earnings quality in these countries.
However, our findings provide no evidence that institutional investors have a monitoring effect on company managers in
The Netherlands, Italy, and Switzerland. Apparently, in these countries managers do not feel compelled by the presence of
institutional investors to improve the accuracy of their estimations, raising the earnings quality.
The relation between INST and EQ for the entire sample of countries is verified by calculating Pearson correlation
coefficients (Table 7). We used EQ according to both Dechow and Dichev (2002) (modified by Jones et al. [2008]) and Jones
(1991) (modified by Dechow et al. [1995]). In view of the above results, the coefficients are expected to be negative and
significant. Table 7 shows the corresponding Pearson correlation coefficients.

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TABLE 6
Descriptive Statistics of Variables According to Country
(1) (2) (3) (4) (5) (6) (7) (8)
DWCit
Mean 0.0 0.01 0 0.01 0.0 0.01 0.01 0.01
SD 0.02 0.04 0.03 0.02 0.02 0.03 0.03 0.03
Median 0.0 0.01 0.01 0.0 0.0 0.01 0.0 0.01
Asymmetry 0.25 0.05 0.14 0.23 0.06 0.04 0.1 0.07
CFit
Mean 0.08 0.08 0.06 0.09 0.08 0.1 0.09 0.1
SD 0.04 0.05 0.04 0.05 0.04 0.05 0.07 0.07
Median 0.08 0.08 0.06 0.09 0.08 0.1 0.08 0.1
Asymmetry 0.03 0.06 0.1 0.01 0.16 0.33 0.12 0.02
DSALESit
Mean 0.06 0.07 0.05 0.07 0.04 0.08 0.05 0.05
SD 0.15 0.27 0.15 0.26 0.1 0.21 0.27 0.39
Median 0.04 0.06 0.03 0.02 0.02 0.07 0.04 0.05
Asymmetry 0.6 7.54 0.47 0.08 0.88 0.97 5.19 8.47
PPEit1
Mean 0.47 0.39 0.54 0.49 0.72 0.73 0.5 0.58
SD 0.36 0.31 0.41 0.33 0.39 0.44 0.41 0.43
Median 0.37 0.33 0.46 0.53 0.79 0.62 0.42 0.49
Asymmetry 0.91 1.57 0.63 0.33 0.16 0.84 1.2 1.02
INSTit
Mean 0.2 0.23 0.14 0.38 0.23 0.25 0.69 0.7
SD 0.16 0.19 0.1 0.17 0.18 0.15 0.29 0.31
Median 0.16 0.18 0.13 0.4 0.19 0.23 0.75 0.77
Asymmetry 1.19 1.03 0.86 0.51 0.94 0.49 0.31 0.55
(1) ¼ France, (2) ¼ Germany, (3) ¼ Italy, (4) ¼ The Netherlands, (5) ¼ Spain, (6) ¼ Switzerland, (7) ¼ the United Kingdom, and (8) ¼ the United States. SD
¼ standard deviation. All variables are divided by mean total assets.

Variable Definitions:
DWCit ¼ variation in the working capital of company i in the period t;
CFit ¼ operational cash flow of company i in the period t;
DSALESit ¼ variation in the revenues of company i in the period t;
PPEit1 ¼ balance of fixed assets at the end of the period t1; and
INSTit ¼ percentage of institutional investor participation of company i in the period t.

The results (Table 7) met our expectations, once again confirming H2. In view of the fact that higher EQ values are
associated with lower discretionary accruals, our results reveal a positive relation between earnings quality and institutional
investor participation. Thus, it may be affirmed that institutional investors tend to invest in companies with superior earnings
quality and that managers are therefore encouraged to improve the accuracy of the estimations of values to be recognized as
earnings.
We also find that firms with a greater number of analysts, greater leverage, and greater size have higher earnings quality,
while for the firms with greater growth opportunities and periods of financial crisis have lower earnings quality. Regardless of
the EQ proxies used, Jonas et al. (2008) model or Dechow et al. (1995) model, in Table 6, the same results were found for the
variables under study, except for financial crisis.
Up to this point, based on bivariate analyses, H2 cannot be rejected. However, for greater robustness, we test H2 using a
fixed-effects regression (Table 8).
H2 was not rejected by the general model, as shown previously. Thus, since the presence of sophisticated investors favors
the adoption and monitoring of good practices of corporate governance, it follows that greater institutional investor
participation increases earnings quality.
However, when evaluating the influence of national governance according to legal system (common versus civil law) or
anti-director rights index (high versus low), we find greater institutional investor participation to be associated with higher
earnings quality in common law and high anti-director rights index countries, but for the U.S., this is not evident, very possibly

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Effect of Institutional Investor Participation on Price Lead Earnings and Earnings Quality: International Evidence 115

FIGURE 2
Mean Earnings Quality According to Portfolio and Country

EQ is earnings quality based on Dechow and Dichev (2002) modified by Jones et al. (2008). Portfolio is measured as the mean of the INST percentile.

due to their accounting standards. It may be inferred that national governance affects both capital market composition and
earnings quality because, due to the associated rights, it attracts institutional investors who in turn promote corporate
governance and, as a result, earnings quality. Moreover, national governance fosters corporate governance through the creation
of controls, laws, and regulations.
We also find the number of analysts (ANALYS), growth opportunity (MB), leverage (LEV), and financial crisis (CRISIS) to
be negatively associated with earnings quality in the general model, so there is a positive relationship between the variables and

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TABLE 7
Pearson Correlation Coefficients of the Variables Used to Test H2
EQ INST ANALYS MB LEV SIZE CRISIS
EQ 1 0.086*** 0.125*** 0.141*** 0.028*** 0.093*** 0.051***
INST 0.037*** 1 0.191*** 0.077*** 0.033*** 0.093*** 0.120***
ANALYS 0.109*** 0.215*** 1 0.088*** 0.076*** 0.318*** 0.176***
MB 0.110*** 0.140*** 0.154*** 1 0.057*** 0.062*** 0.149***
LEV 0.094*** 0.025** 0.120*** 0.030*** 1 0.074*** 0.085***
SIZE 0.133*** 0.056*** 0.344*** 0.090*** 0.089*** 1 0.022***
CRISIS 0.017* 0.002 0.083*** 0.130*** 0.017* 0.034*** 1
*, **, *** Significant at 10 percent, 5 percent, and 1 percent, respectively.
The area below the diagonal indicates earnings quality as measured by Dechow and Dichev (2002) and modified by Jones et al. (2008). The area above the
diagonal indicates earnings quality as measured by Jones (1991) and modified by Dechow et al. (1995). The Pearson correlations do not include the U.S.
The top and bottom 1 percent of all variables are winsorized.

Variable Definitions:
EQ ¼ absolute value of earnings quality based on Dechow and Dichev (2002) and modified by Jones et al. (2008), and also it is the absolute value of
earnings quality based on Jones (1991) modified by Dechow et al. (1995);
INST ¼ percentage of institutional investor participation at the beginning of the return period;
ANALYS ¼ number of analysts following the company at the beginning of the return period;
MB ¼ market-to-book rate at the beginning of the return period;
LEV ¼ debt divided by total assets at the beginning of the return period;
SIZE ¼ natural logarithm of market value of equity at the beginning of the return period; and
CRISIS ¼ a binary variable equal to 1 for the years 2008 and 2009, and equal to 0 for the remaining years.

EQ. Interestingly, during the financial crisis, discretionary accruals were higher, so the quality of accounting information is low,
due to market pressure.
To evaluate the robustness of our analysis, we repeat Equation (7) using the EQ derived from the Jones (1991) model,
modified by Dechow et al. (1995). Table 9 shows the result of the regression between earnings quality and institutional investor
participation.
Again, H2 cannot be rejected for the general model, and it remains constant in high national governance according to legal
system (common versus civil law) or anti-director rights index (high versus low). The results displayed in Table 9 are
compatible with the results shown in Table 8, with exceptions for several control variables: ANALYS has an inverted result, MB
has become nonsignificant, and SIZE has become significant. It should be emphasized that the financial crisis variable (CRISIS)
in the general model presents similar results in both tables. The fact that institutional investor participation is only a significant
factor in countries with strong governance (countries with common law and a high anti-director rights index) is consistent with
the claim by Aggarwal et al. (2011) that earnings quality is higher in countries with strong governance where opportunistic
behaviors are inhibited by the presence of institutional investors.
In other words, neither of the study’s hypotheses (H1 and H2) were rejected, indicating that the amount of information on
future performance anticipated by the present price is indeed positively correlated with the percentage of institutional investor
participation, and that the greater the percentage of institutional investor participation, the higher the earnings quality.

VI. CONCLUSION
The present study evaluates the effect of institutional investor participation on two aspects related to capital market
efficiency, namely price lead earnings and earnings quality, measured according to the theoretical framework developed by
Jiambalvo et al. (2002) and Dechow and Dichev (2002) and modified by Jones et al. (2008).
Overall, the results of the empirical tests confirm that institutional investors are sophisticated investors with a competitive
advantage over individual investors. According to La Porta et al. (1998), this is particularly true in common law countries (the
U.K.) and in high anti-director rights index countries (Spain and the U.K.), however, this study shows that in low anti-director
rights index countries (France, Germany, Italy, The Netherlands, and Switzerland) the current institutional investors decrease
the informational asymmetry, thus, they are more sophisticated than individual investors.
The tests also reveal evidence of a positive relation between institutional investor participation and earnings quality,
suggesting that institutional investors generally have a monitoring effect on company managers, encouraging them to estimate

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Effect of Institutional Investor Participation on Price Lead Earnings and Earnings Quality: International Evidence 117

TABLE 8
Analysis of the Relationship between INST and EQ
Based on Dechow and Dichev (2002) Modified by Jones et al. (2008)
Variable ALL COMMON CIVIL HIGH_ARI LOW_ARI USA
INST 0.008* 0.009* 0.003 0.009* 0.003 0.004
(1.94) (1.70) (0.56) (1.81) (0.42) (0.79)
ANALYS 0.000* 0.000 0.001*** 0.000 0.001*** 0.000***
(1.84) (1.51) (3.41) (0.07) (2.94) (2.96)
MB 0.001*** 0.001** 0.001 0.001*** 0.001 0.00
(3.14) (2.49) (1.53) (2.81) (1.30) (0.87)
LEV 0.008*** 0.008* 0.006 0.011** 0.003 0.024***
(2.61) (1.68) (1.44) (2.48) (0.78) (4.21)
SIZE 0.000 0.000 0.000* 0.000 0.000* 0.000**
(0.67) (0.36) (1.94) (0.39) (1.82) (2.36)
CRISIS 0.002*** 0.002 0.002** 0.002 0.002** 0.005***
(3.03) (1.51) (2.22) (1.59) (2.46) (4.96)
Constant 0.008* 0.009* 0.003 0.009* 0.003 0.004
(1.94) (1.70) (0.56) (1.81) (0.42) (0.79)
R2 0.007 0.008 0.009 0.009 0.007 0.016
F 5.92*** 3.88*** 5.00*** 4.36*** 3.80*** 9.02***
*, **, *** Significant at 10 percent, 5 percent, and 1 percent, respectively.
The standard error is given in parentheses. The top and bottom 1 percent of all variables are winsorized.

Variable Definitions:
ALL ¼ all companies;
COMMON ¼ only firms in common law countries, according to La Porta et al. (1998);
CIVIL ¼ only firms in civil law countries, according to La Porta et al. (1998);
HIGH_ARI ¼ only firms in countries with a high anti-director rights index (. 3), based on La Porta et al. (1998);
LOW_ARI ¼ only firms in countries with a low anti-director rights index ( 3), based on La Porta et al. (1998);
USA ¼ only American firms;
EQ ¼ absolute value of earnings quality based on Dechow and Dichev (2002) modified by Jones et al. (2008);
INST ¼ percentage of institutional investor participation at the beginning of the return period;
ANALYS ¼ number of analysts following the company at the beginning of the return period;
MB ¼ market-to-book rate at the beginning of the return period;
LEV ¼ debt divided by total assets at the beginning of the return period;
SIZE ¼ natural logarithm of market value of equity at the beginning of the return period; and
CRISIS ¼ a binary variable equal to 1 for the years 2008 and 2009, and equal to 0 for the remaining years.

values recognized in the financial results with greater accuracy, especially in common law and high anti-director rights index
countries.
The information advantage of institutional investors is found to be a market-specific phenomenon observed in civil law and
low anti-director rights index countries, but not in the other countries in our sample. The fact that institutional investor
participation is positively related to earnings quality, especially in civil law and low anti-director rights index countries,
suggests the phenomenon is not universal. Thus, it may be concluded that institutional investors play a monitoring role in some,
but not all, countries.
Our study has limitations. For example, we do not distinguish between different profiles of institutional investors (Bushee
1997), nor segregate investors according to type of institution (pension funds, insurance companies, investment banks, etc.),
although these distinctions are believed by some to impact the monitoring effect of institutional investor participation (Callen
and Fang 2013). Our study does not evaluate how the size of the investments made by specific institutional investors affects
their likelihood of becoming sophisticated investors and exerting a monitoring effect on managers. Consisting mainly of large
economies, most of which are civil law countries, our sample might have covered a wider spectrum if smaller countries with
strong governance (countries with common law and high anti-director rights index) had been included. It should also be kept in
mind that our study is based on the model of Jiambalvo et al. (2002), which does not control for other systematic differences in
institutional investor profiles. Finally, the period covered by our data is relatively short and is impacted by significant events,
such as the 2008 financial crisis and, in some countries, the conversion to international accounting standards.

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118 Lima, Góis, De Luca, and Sousa

TABLE 9
Analysis of the Relationship between INST and EQ
Based on Jones (1991) and Modified by Dechow et al. (1995)
Variable ALL COMMON CIVIL HIGH_ARI LOW_ARI USA
INST 0.322* 0.397* 0.032 0.394* 0.033 1.045
(1.65) (1.75) (0.10) (1.75) (0.09) (1.06)
ANALYS 0.000*** 0.001*** 0.000*** 0.001*** 0.000*** 0.002***
(6.40) (9.70) (6.64) (9.41) (6.22) (5.49)
MB 0.000 0.000 0.000 0.000 0.000 0.000
(0.57) (0.94) (1.11) (0.94) (1.09) (0.27)
LEV 0.002 0.004 0.006 0.004 0.007 0.01
(0.56) (0.81) (1.07) (0.81) (1.10) (0.60)
SIZE 0.000** 0.000*** 0.000 0.000** 0.000 0.000
(2.46) (3.00) (0.10) (2.40) (0.02) (1.34)
CRISIS 0.006*** 0.009*** 0.003*** 0.009*** 0.003*** 0.031***
(11.46) (10.90) (4.41) (10.89) (4.29) (8.10)
Constant 0.322* 0.397* 0.032 0.394* 0.033 1.045
(1.65) (1.75) (0.10) (1.75) (0.09) (1.06)
R2 0.006 0.009 0.014 0.008 0.015 0.006
F 33.94*** 27.24*** 13.76*** 27.16*** 12.78*** 14.95***
*, **, *** Significant at 10 percent, 5 percent, and 1 percent, respectively.
The standard error is given in parentheses. The top and bottom 1 percent of all variables are winsorized.

Variable Definitions:
ALL ¼ all companies;
COMMON ¼ only firms in common law countries, according to La Porta et al. (1998);
CIVIL ¼ only firms in civil law countries, according to La Porta et al. (1998);
HIGH_ARI ¼ only firms in countries with a high anti-director rights index (. 3), based on La Porta et al. (1998);
LOW_ARI ¼ only firms in countries with a low anti-director rights index ( 3), based on La Porta et al. (1998);
USA ¼ only American firms;
EQ ¼ absolute value of earnings quality based on Jones (1991) and modified by Dechow et al. (1995);
INST ¼ percentage of institutional investor participation at the beginning of the return period;
ANALYS ¼ number of analysts following the company at the beginning of the return period;
MB ¼ market-to-book rate at the beginning of the return period;
LEV ¼ debt divided by total assets at the beginning of the return period;
SIZE ¼ natural logarithm of market value of equity at the beginning of the return period; and
CRISIS ¼ a binary variable equal to 1 for the years 2008 and 2009, and equal to 0 for the remaining years.

Future studies might evaluate the effects of segregating institutional investors by profile, type of institution, and size of
investment, as well as the effects of IFRS adoption. It would likewise be interesting to investigate the relation between
differences in the ability of institutional investors in different countries to use information to their advantage and the quality and
accuracy of earnings forecasts and revisions by analysts.

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