Stewardship regulation and earnings quality: evidence from Japan

Purpose - This paper aims to examine if compliance with the Japanese Stewardship Code by institutional investors is related to the earnings quality of their investee companies. It extends the study by Luet al.who considered this question for large UK companies with high-quality board governance and a rich information environment. This study provides new insights by exploiting the contrasting Japanese setting. Design/methodology/approach - The association between Code-compliant institutional investor shareholding and discretionary accruals is examined for Japanese companies in the Nikkei 225 Index. The study period is from the introduction of the Code in 2015 to 2017. Findings - A negative association is found between the level of institutional investor Code-compliant shareholding and discretionary accruals, which is robust to tests that address endogeneity. The findings suggest Code-compliant institutional investor shareholding mitigates opportunistic income-increasing earnings management and promotes conservative accounting. Consistent results are found for benchmark beating and accruals quality as alternative earnings quality measures. Originality/value - This study offers new insights regarding the efficacy of the Stewardship Code’s policy approach. The findings suggest the stewardship regulatory model is effective when internal governance is weak and external monitoring by institutional investors is a viable substitute or complement.