Do Passive Investors Demand High Earnings Quality? Evidence from Natural Experiment

ETF and corporate reporting

“…Specifically, while our findings are closely related to Francis et al. (2020) who document the effect of passive ownership on reporting practices, our study significantly differs from them in the following ways. First, while Francis et al.…”

“…We add to the above strand of literature, showing that ETFs deter managerial incentives for opportunistic financial reporting. Specifically, while our findings are closely related to Francis et al (2020) who document the effect of passive ownership on reporting practices, our study significantly differs from them in the following ways. First, while Francis et al (2020) define passive ownership from the quasi-indexer of Bushee (1998) which is estimated using institution-level 13F data, our ETF ownership is constructed from fund-level data, providing a cleaner measure of owners' investment style.…”

“…Specifically, while our findings are closely related to Francis et al (2020) who document the effect of passive ownership on reporting practices, our study significantly differs from them in the following ways. First, while Francis et al (2020) define passive ownership from the quasi-indexer of Bushee (1998) which is estimated using institution-level 13F data, our ETF ownership is constructed from fund-level data, providing a cleaner measure of owners' investment style. Because a large institution typically offers both active and passive funds, it is necessary to use fund-level data to identify passive ownership.…”

“…Several recent studies show that, despite their investing strategy, passive owners take an active stance on improving corporate governance (Appel et al, 2016(Appel et al, , 2019Crane et al, 2016;Fisch et al, 2019;Kahan & Rock, 2020). Relatedly, passive ownership is negatively associated with earnings manipulation score (Baig et al, 2023), and improves earnings quality (Francis et al, 2020). However, DeLisle et al (2017 show that passive ownership worsens price informativeness.…”

“…Second, our focus is ETF while Francis et al (2020) anism through which the long investment horizon channel transmits to managerial behavior. We show that the capital market consequence to missing short-term earnings is lower for firms with high ETF ownership, thus managers of such firms are disincentivized for earnings and expectation managements.…”