Stable Shareholdings, the Decision Horizon Problem, and Patterns of Earnings Management

Prior studies argue that stable shareholders do not encourage firm managers to manage their earnings to achieve short-term earnings goals. They also state that firm managers with stable shareholders have an incentive to report smooth earnings to maintain long-term relationships with such shareholders. We focus on cross-shareholdings and stable shareholdings owned by financial institutions as stable shareholdings in Japan, and investigate the effect of these ownership structures on earnings management patterns. Specifically, we hypothesize that stable shareholdings are positively associated with the informational components of earnings smoothing, and negatively associated with big bath. Consistent with our hypotheses, we first find that as stable shareholdings increase, managers are more likely to conduct earnings smoothing that provides useful information to stable shareholders. Second, we reveal that managers are less likely to engage in big bath behavior as stable shareholdings increase. Finally, our additional analysis shows that stable shareholdings reduce incentives for managers to cut discretionary expenditures to meet short-term earnings benchmarks, implying that stable shareholdings could reduce the possibility of a myopic problem. These results suggest that managers with stable shareholdings tend to report smoother and less volatile earnings, and do not tend to pursue earnings management to attain short-term earnings targets.