Institutional Investors, Real Earnings Management and Cost of Equity: Evidence from Listed High-tech Firms in China

ABSTRACT

This paper investigates the association between real earnings management and the cost of equity from the perspective of the heterogeneity of institutional investors. Based on a sample of publicly listed high-tech firms in China from 2008 to 2017, our empirical results suggest that there is a significant negative correlation between earnings management and the cost of equity capital. This finding is contrary to previous conclusion, indicating that, in China, real earnings management cannot be effectively identified by external investors, and the company could easily obtain financing from the capital market and reduce its cost of equity due to its masked excellent performance by manipulating the real earnings management. Furthermore, we find that compared with transient institutional investors, stable institutional investors with the intention of holding the stock for the long-term can effectively reduce the cost of equity. Our results also show that real earnings management under the supervision of stable institutional investors could be more easily identified by shareholders and stable institutional investors could diminish the impact of earnings management on the cost of equity.

KEY WORDS:

• Cost of equity
• earnings management
• high-tech enterprises
• institutional investors

JEL:

• G31
• G32

Notes

1. One of the Standards of Measure for the Identification and Management of High-tech Enterprises is that the proportion of total research and development expenditure divided by total sales income over the past three years must meet the following requirements: 1. If sales revenue is less than 50 million yuan in recent years, the proportion is not less than 5%. 2. If sales revenue is from 50 million yuan to 200 million yuan in recent years, the proportion is not less than 4%. 3. If sales revenue is more than 200 million yuan in recent years, the proportion is not less than 3%. Among them, the total R&D expenditure incurred by enterprises in China accounts for no less than 60% of the total R&D expenditure.