Institutional Ownership and the Extent to which Stock Prices Reflect Future Earnings*

Abstract

Articles in the financial press suggest that institutional investors are overly focused on current profitability, which suggests that as institutional ownership increases, stock prices reflect less current period information that is predictive of future period earnings. On the other hand, institutional investors are often characterized in academic research as sophisticated investors and sophisticated investors should be better able to use current-period information to predict future earnings compared with other owners. According to this characterization, as institutional ownership increases, stock prices should reflect more current-period information that is predictive of future period earnings. Consistent with this latter view, we find that the extent to which stock prices lead earnings is positively related to the percentage of institutional ownership. This result holds after controlling for various factors that affect the relation between price and earnings. It also holds when we control for endogenous portfolio choices of institutions (e.g., institutional investors may be attracted to firms in richer information environments where stock prices tend to lead earnings). Further, a regression of stock returns on order backlog, conditional on the percentage of institutional ownership, indicates that institutional owners place more weight on order backlog compared with other owners. This result is consistent with institutional owners using non-earnings information to predict future earnings. It also explains, in part, why prices lead earnings to a greater extent when there is a higher concentration of institutional owners.

Capitalization of R&D and the Informativeness of Stock Prices

“…7 Contemporaneous ERC is often estimated as the sum of the coefficients on current and lagged earnings, b 0 + b 1 . 8 Other recent papers using the informativeness measure are Durnev, Morck, Yeung, and Zarowin (2003), Ayres and Freeman (2001), Jiambalvo, Rajgopal, and Venkatachalam (2002), and Piotroski and Roulstone (2004). 9 There are a number of reasons why management may chose not to capitalize development expenditures which meet the five criteria outlined in SSAP #13.…”

Earnings management and internal mechanisms of corporate governance: Empirical evidence from Chilean firms

“…On the contrary, abnormal accruals should be affected by the ability and incentives of managers to manipulate earnings and are likely to depend on the efficiency of corporate governance mechanisms. Indeed, literature shows that earnings management can be reduced by outside directors (Peasnell et al, 2001), the auditing committee of the board of directors (Klein, 2002), institutional investors (Jiambalvo et al, 2002) or the active role of inside shareholders (Delgado, 2003). This is the approach of our paper since we try to analyze the relation between the discretionary behaviour of directors and two mechanisms of corporate governance such as capital and ownership structure.…”

Prices lead earnings no Brasil?

“…Moreover, the results also suggested that the stock prices of large firms anticipate information that affects the entire industry, so their returns can anticipate a portion of the small firms' returns. Jiambalvo, Rajgopal and Venkatachalam (2002) and Ayers and Freeman (2003) found a positive association between the institutional ownership percentage in firms' ownership structures and the prices lead earnings phenomenon. For Jiambalvo, Rajgopal and Venkatachalam (2002), this association occurs because institutional investors are more sophisticated and have advantages in acquiring and processing information that are only reflected in future earnings, which would impose lower informational synchronization as these investors' ownership increases.…”

“…Jiambalvo, Rajgopal and Venkatachalam (2002) and Ayers and Freeman (2003) found a positive association between the institutional ownership percentage in firms' ownership structures and the prices lead earnings phenomenon. For Jiambalvo, Rajgopal and Venkatachalam (2002), this association occurs because institutional investors are more sophisticated and have advantages in acquiring and processing information that are only reflected in future earnings, which would impose lower informational synchronization as these investors' ownership increases. Ayers and Freeman (2003) also evaluated the influence of analyst coverage on the degree of anticipation of future earnings displayed in stock prices.…”

“…In general, studies have shown that these factors affect the informational non-synchronization of X t and P t (Ayers & Freeman, 2000, 2003Jiambalvo, Rajgopal, & Venkatachalam, 2002;Lee, 2007).…”