Financial Reporting Consequences of Sovereign Wealth Fund Investment*

Abstract

Sovereign wealth funds (SWFs) are government‐owned institutional investors pursuing political and financial investment objectives. With $8 trillion in assets, SWFs are geopolitical powerbrokers actively participating in global capital markets, yet we know little about the financial reporting consequences of SWF investment. I document evidence supporting the hypothesis that the simultaneous pursuit of political and financial investment objectives renders SWFs weak monitors. Using a staggered difference‐in‐differences research design, I document economically significant increases in discretionary accruals for SWF target firms after SWF investment, relative to an entropy‐balanced control group of non‐SWF target firms. Corroborating tests document that the effect of SWF investment on discretionary accruals strengthens with SWFs' equity stake and SWF target firms' earnings management incentives and weakens when regulators curb SWFs' pursuit of political objectives. I highlight SWFs' distinct monitoring effect by replicating my analyses after replacing SWF investment with conventional institutional investment, and document that conventional institutional investment instead reduces discretionary accruals. I further corroborate SWFs' distinct monitoring role among conventional institutional investors using a wide variety of robustness tests employing alternate specifications, samples, and financial reporting proxies. Overall, this study introduces an economically important and fundamentally distinct but little‐studied institutional investor to the accounting literature.

Investor relations and investment efficiency

“…These results are consistent with our hypothesis that investment efficiency is increasing with IROs' market intelligence collection 17 Recent literature has extensively employed entropy balancing to address selection bias and covariate balance concerns. See, for example, Godsell (2022), Boland and Godsell (2020) T A B L E 5 IRO time across capital market participants.…”

Sovereign wealth funds in the post-pandemic era

“…There is a literature documenting that institutional, non-state investors are associated with lower earnings management and healthier financial reporting (Beuselinck, Blanco, & Garcı ´a Lara, 2017;Fang, Maffett, & Zhang, 2015), while transient institutional investment is associated with higher earnings management (Bushee, 1998). Godsell (2022) contributes to the literature on the monitoring capabilities of SWFs by studying the financial reporting consequences from SWF investment for target firms. The author uses the change in discretionary accruals to proxy for earnings management.…”

Sovereign wealth fund investments and financial performance of target firms: The disciplinary role of debt in political agenda theory

“…Prior studies on SWF investments and financing decisions can be categorized into two streams. Scholars in the first stream have investigated the impact of SWFs on the cost of corporate borrowings [ [6] , [7] , [8] , [9] , [10] , [11] ], equity pricing, firm ESG reputation risk, return-to-risk performance, national culture, and firm value [ 1 , 2 , 6 , 7 , 11 , 12 ]. Godsell [ 11 ] submits that financial reporting quality becomes weak after SWF investments.…”

“…Scholars in the first stream have investigated the impact of SWFs on the cost of corporate borrowings [ [6] , [7] , [8] , [9] , [10] , [11] ], equity pricing, firm ESG reputation risk, return-to-risk performance, national culture, and firm value [ 1 , 2 , 6 , 7 , 11 , 12 ]. Godsell [ 11 ] submits that financial reporting quality becomes weak after SWF investments. Also, a target firm faces an increasing reputation risk following SWF investment [ 1 ].…”

“…However, more answers are yet to be provided on whether sovereign wealth funds are associated with capital structure. Prior studies have majorly established that SWFs matter for the cost of capital [ [9] , [10] , [11] ], suggesting that SWFs could impact access to finance and may distort the financing structure of firms.…”