Analysts or Vultures: Do Transient Investors Target Firms with Lower Financial Reporting Quality?

Abstract

This study examines the portrayal of transient investors as short-termists who exploit poorly monitored firms against the competing portrayal of transient investors as informed investors. More specifically, the study examines 1) whether transient institutional investors directly target firms which exercise greater accounting discretion and 2) whether the superior abnormal returns earned by transient investors are more prevalent in firms with greater accounting discretion. The tests are performed using a linear regression model on a panel dataset. Three proxies, adapted from prior literature, are used to measure accounting discretion, abnormal accruals, earnings smoothing, and the incidence of small positive earnings surprises. Results are inconsistent with the short-termist portrayal of transient investors. Transient investors are not found to invest more heavily in firms with greater accounting discretion. Furthermore, the positive abnormal returns earned by transient investors are not more prevalent in firms with greater accounting discretion. By providing results that contradict the portrayal of transient investors as short-termists who exploit poorly monitored firms, the current study makes an important contribution to the debate regarding the effects of a short-term institutional investor base on firm value.