Download The Impact of Institutional Ownership on the Extent to Which Stock

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The Impact of Institutional Ownership on the Extent to Which Stock
Prices Reflect Future Earnings
SONG Yu1, 2
1. School of Business, Nanjing University, China, 210093
2. School of Economics and Management, Nanjing University of Science and Technology, China,
210094
[email protected]
Abstract: This paper empirically examines the impact of institutional ownership on the extent to which
stock prices reflect future earnings of listed companies in China from 2004 to 2009. It hypotheses the
stock prices reflect future earnings earlier for firms with high institutional holdings than for other firms.
The results find that the extent to which stock prices reflect future earnings is positively related to the
percentage of institutional ownership. That is, institutional ownership accelerates the pricing of future
earnings, which indicates they take account of the listed companies’ future information in China when
institutional investors make decisions.
Keywords: Institutional Ownership, Stock Price, Future Earnings, Information Content
1
Introduction
In general, stock prices are a comprehensive reflection of all kinds of information of the listed
companies, which not only includes the information confirmed in the listed companies’ financial
statements, and also includes those that related to the company's future expectations of market
participants and valuation information that don’t reflect in the financial statements. So the information
reflected in stock prices tends to be more abundant than the accounting information. Roll (1988) found
that public information only interprets a fraction of share price volatility, and the return volatility likely
related to the firm-specific information. The phenomenon of prices leading earnings also provides
evidence for this.
What are factors that affect the information content of stock prices? Some foreign scholars had empirical
tests from the information environment of listed companies. For example, the size of listed companies
(Collins, 1987), the following number of analysts (Brennan, et al., 1993; Chan and Hameed, 2006), the
decision behavior of institutional investors (Bartov, Radhakrishnan, and Krinsky, 2000; Jiambalvo et al.,
2002; Ayers and Freeman, 2003; Piotroski and Roulstone, 2004). Will institutional investors affect the
information content of stock prices in China capital markets? Relevant scholars had some theoretical
analysis and empirical researches from different perspectives, including the impacts of institutional
ownership on financial information decision-making usefulness (especially accounting earnings) (Hu
Zhiyong and Wei Minghai, 2005; Tang Shengpei, 2006; Yu Lisheng and Wang Yanyan, 2006; Cheng
Shuqiang, 2006; Song Yu and Li Zhuo, 2007), the synchronicity of stock price (You Jiaxing, 2007; Yin
Lei, 2010). These results prove that institutional investors play a positive role as a whole, and there has a
significant difference among different type of institutional investors in China. But there are few direct
empirical evidences of the impacts of institutional ownership on the extent to which stock prices reflect
different periods of earnings of listed companies.
This paper empirically examines the role of different periods of earnings in the pricing of stock and
investment decision-making. More importantly, I pay attention to the impact of institutional ownership
on the extent to which stock prices reflect future earnings of listed companies in China. The results find
that the extent to which stock prices reflect future earnings is positively related to the percentage of
institutional ownership. That is, institutional ownership accelerates the pricing of future earnings, which
indicates they take account of the companies’ future information in China when institutional investors
make decisions.
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The rest of this paper is structured as follows. Section 2 examines the institutional background and
extant literature, outlines the theoretical analysis, and sets out research hypotheses. Section 3 is research
design and describes sample, variables, and model. Section 4 describes descriptive statistics and
empirical results. I present the conclusions of this study in section 5.
2
Background and Theoretical Analysis
Ball and Brown created Empirical Study precedent about the relationship between stock price and
accounting earnings in 1968. Since then, the field become a common topic of concern in accounting and
finance field. Many scholars conduct innovative research from a variety of perspectives, and constantly
made breakthroughs in research methods. Beaver et al. (1980) examined the relationship between price
changes and earnings changes. The results indicated prices may be useful in forecasting future earnings
and price-based forecasting models are more accurate than the random walk with a drift model. Beaver
et al. (1987) used a reverse regression to assess the information content of security prices and found the
incremental explanatory power of lagged values of percentage change in prices with respect to
accounting earnings.
Some foreign scholars had empirical tests from the information environment of listed companies.
Collins et al., (1987) explored the information content of prices with respect to earnings by focusing on
firm size and its relation to the predictive accuracy of price-based earnings forecasts. The empirical
results suggested that price-based earnings outperformed univariate time series forecasts by a greater
margin for larger firms than for smaller firms. Meanwhile, based on considerations of reducing the
proprietary information costs and legal litigation risks, and establishing good relations, corporate
managers tend to disclose information to specific groups (eg, analysts and institutional investors), rather
than the public. Professional traders may have information advantages of an enterprise. Holden and
Subrahmanyam (1992) indicated that the response speed of stock price to new information showed an
upward trend with the increase of informed investors’ number. Brennan et al (1993) found the more the
number of analysts following is, the quicker of the adjustment of stock prices to common information
even considering the impact of company size. Chan and Hameed (2006) also found that stock price
volatility related to the number of analysts to following.
Given the influence of institutional investors in the stock market and their advantages of collecting and
processing information, some scholars began to explore the impacts of behavior of institutional investors
on the information content of stock prices. El-Gazzar (1998) found price volatility at earnings
announcements declined with institutional ownership after controlling for analyst following. Bartov,
Radhakrishnan, and Krinsky (2000) tested whether the observed patterns in stock returns after quarterly
earnings announcements were related to the proportion of firm shares held by institutional investors, and
found the institutional holdings variable was negatively correlated with the observer post-announcement
abnormal returns. Ayers and Freeman (2003) investigated whether security prices of firms followed by
sell-side analysts and favored by institutional investors incorporate future earnings earlier than prices of
other firms. They found price leads increased as institutional ownership increase. Jiambalvo et al.,(2002)
found current stock prices reflected less current and more future earnings information as institutional
ownership increased. Piotroski and Roulstone (2004) found institutional trading accelerated the
incorporation of the firm-specific component of future earnings news into prices.
According to foreign research results about institutional investors holding and the information content of
prices reflecting future earnings information, it is important to pay attention to the type and the maturity
of institutional investors. The role and type of institutional investors is increasing with the development
of capital market in transitional economy China. Institutional investors have become the important force
in the process of stock market construction and improvement of corporate governance. Have there really
differences in China about the institutional investors? Scholars tested from different perspectives. For
example, the research of the relationship between institutional investors and securities market volatility,
the quality of corporate governance, source allocation, which increasingly supported the conclusions of
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the positive impact of institutional investors. Wu Donghui (2001), Wang Kun and Xiao Xing (2005)
found that the proportion of institutional investors holding is negatively correlated to discretional
accruals and funds occupation by related parties respectively. Wu Xiaohui and Jiang Yanfu (2006)
found institutional investors had the positive role in promoting the roles of independent directors. Li
Wei’an and Li Bin (2008) showed that institutional investors played an important role in improving the
quality of corporate governance of listed companies. Li Gang and Zhang Haiyan (2009) found that when
the institutional investors hold the listed companies’ shares they tended to reduce agency costs.
However, there is lack of direct empirical evidence of the relationship between institutional ownership
and the information content of prices with respect to earnings in China. There only have relevant study
findings. Hu Zhiyong and Wei Minghai (2005) found closed-end securities investment funds have a
strong ability to interpret financial information. Tang Shengpei (2006) found that the relevance of
accounting information enhanced with the increase of institutional ownership. Yu Lisheng and Wang
Yanyan (2006) showed that the PEAD of shares holding by the fund companies is less than by
individual investors. Cheng Shuqiang (2006) showed that: the timeliness of earnings information and the
proportion of institutional investors holding had a positive correlation. Song Yu and Li Zhuo (2007)
empirically examined the relationship between institutional holding and market reaction to company
earnings announcements in China 2001-2004. The results indicated that institutional investors have
advantages in reading and understanding the accounting information. The higher their holding in a
company, the lower the price volatility and information content was after corporate release. You Jiaxing
(2007) and Yin Lei (2010) found that institutional investors used firm-specific information to trade,
which reduced the stock price synchronicity and increased the information content of stock price.
According to the above analysis, I propose the following hypothesis:
H1: The stock prices reflect future earnings earlier for firms with high institutional holdings than for
other firms in China.
3
Research Design
3.1 Sample
This paper selects the A-share listed companies in 2004-2009 as the sample in China. The data of
institutional ownership and related financial data are mainly from the WIND database of the Shanghai
Wind Information Technology Co., Ltd., and the data of month return data from CCER database (China
Center for Economic Research). There are some principles when selecting the samples: (1) Net book
value is negative; (2) Removing the missing data sample of listed companies; (3) Excluding financial
listed companies in the sample.
3.2 Model and Variables
I use multivariate analysis to test the effect of institutional ownership on the information content of
stock prices.
The OLS regression model to be estimated is specified as follows:
1
RET
i ,t
=α0 +
∑ λ τ EPS i,t +τ +
τ = −1
1
∑ β EPS INST
τ = −1
i ,t +τ
τ
3
+ ∑δ
i ,t
j =0
j
EPS × C
i ,t
i ,t
+ ε i ,t
The dependent variable is RET representing the cumulative rate of return on stocks. C represents control
variables, including LEV, PB and BETA. The specific definition of the variables is shown in Table 1.
I also include YEAR variable to control the effect of different year. When the year is 2005, 2006, 2007,
2008 or 2009, this variable is 1, otherwise is 0.
I mainly care the coefficient of interaction between EPS and INST. It means institutional ownership
increasing the extent to which stock prices reflect the future earnings if 1 is positive, and the
hypothesis is hold.
β
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Table 1 Selection and Definition of Variables
Definition of variables
Method of calculation
Cumulative rate of return on stocks from May this year
annual return ratio
to April the following year
Net profit/total shares, adjusted by closing price of
earnings per share
individual stocks at the end of last year, including lead
contemporaneous, and lag earnings
Institutional ownership of the whole institutional
institutional ownership
investors
Average asset-liability ratio=average total liabilities/
financial leverage
average total assets
Variables
RET
EPS
INST
LEV
PB
Price to book value ratio
BETA
systematic risk coefficient β
Price/net book value
β value of last 24 months
I investigate the correlation coefficient of main variables. The variable of institutional ownership has a
positive relation with stock return, which shows the behavior of institutional investors has some rules.
For example, they prefer to the higher return of stock. The correlation coefficient is often below 0.6, the
variables don’t have the serious collinearity problem.
4
Empirical Results
4.1 Data Description
Table 2 lists the descriptive statistics for the main regression variables. As a whole, the stock return and
EPS of different listed companies have large difference. For example, the maximum value of stock
return is 1400%, the minimum value is -84.5%, the standard deviation is 1.185, and the difference is
also quite large. The maximum value of institutional ownership reach 98.5%, minimum is 0.0001%, and
mean is 21.6%, which difference is very large. But the mean of ratio of financial leverage is 50.4%,
which shows the level of liability ratio is high.
variables
mean
Table 2 Descriptive statistics of main variables
median
Std deviation
minimum
maximum
RET
0.462
0.097
1.185
-0.845
14.024
INST
0.216
0.142
0.222
0.000001
0.985
EPS
0.228
0.180
0.583
-21.860
6.280
LEV
0.504
0.515
0.187
0.002
0.999
PB
4.858
2.768
18.543
0.260
998.119
BETA
0.977
0.988
0.382
-2.912
5.715
4.2 Regression Results
Table 3 shows the regression results. I examine the extent to which stock prices reflect different period
earnings in the first three columns, and the impact of institutional ownership on the extent to which
stock prices reflect future earnings in the latter three are examined.
From the specifications (1) to (3) in Table 3, I find the contemporaneous earnings haven’t a significantly
positive impact on current stock return. The lead earnings have a significantly positive impact on current
stock return, which stock prices reflect the future earnings of listed companies in China's securities
market to a certain extent.
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When only considering the impact of institutional investors on the relationship between current earnings
and return, I find that the coefficient of β0 is 1.977 and significantly positive, which indicating that the
reflection of current earnings in current return increases with the institutional ownership. However,
when considering the impact of the next period earnings, the results of specifications (5) show that the
coefficient of β0 is not significant, but the coefficient of β1 is significantly positive, which indicates that
stock prices reflect more future earnings of listed companies. And institutional investors enhance the
reflection of future earnings information d in stock price, consistent with hypothesis 1-The stock prices
reflect future earnings earlier for firms with high institutional holdings than for other firms in China.
I consider the impact of PEAD in specifications (6), Hypothesis 1 is still holding. The behavior of
institutional investors accelerates the reflection of future earnings.
Constant
(1)
-0.358***
(-14.24)
Table 3 Regression results
(2)
(3)
(4)
-0.352***
-0.338***
-0.350***
(-13.95)
(-13.41)
(-13.81)
-1.224***
(-9.62)
-0.687
0.108
-2.056***
(-1.34)
(0.21)
(-3.43)
1.447***
1.564***
(13.05)
(14.19)
EPSt-1
λ-1
EPSt
0.306
λ0
(0.60)
EPSt+1
λ1
EPSt-1×INSTt
β-1
EPSt×INSTt
1.977***
β0
(3.20)
EPSt+1×INSTt
β1
EPSt×LEVt
0.494
0.661
0.336
0.500
δ1
(0.70)
(0.94)
(0.49)
(0.68)
EPSt×PBt
-0.00409
-0.00485
-0.00574
-0.00493
δ2
(-0.91)
(-1.09)
(-1.32)
(-0.81)
EPSt×BETAt
0.439**
0.567***
0.412**
2.391***
δ3
(2.12)
(2.76)
(2.04)
(6.75)
YEAR
Control
Control
Control
Control
Adj. R2
0.634
0.644
0.652
0.639
F Value
1206.4***
1124.26***
1046.62***
1064.18***
Note: ***, **, and * indicate significance at 1%, 5%, and 10% respectively.
（
（
（
（
（
（
（
（
（
）
）
）
）
）
）
）
）
）
5
Conclusion
(5)
-0.347***
(-13.64)
-2.652***
(-4.36)
1.037***
(7.14)
-0.781
(-0.97)
2.549***
(4.13)
0.564
(0.77)
-0.00462
(-0.76)
2.567***
(7.22)
Control
0.649
922.1***
(6)
-0.330***
(-12.98)
-1.192***
(-6.74)
-1.738***
(-2.88)
1.056***
(7.29)
-0.185
(-0.25)
-0.833
(-0.99)
3.006***
(4.89)
0.314
(0.44)
-0.00117
(-0.20)
2.235***
(6.36)
Control
0.656
804.14***
People usually consider institutional investors as sophisticated investors. Because institutional investors
have scale (Wilson, 1975) and wealth (Cready, 1988) advantages, they can acquire timely information
including public and private information. For example, institutional investors can participate companies’
meeting through conference calls, and talk to executives face to face. More importantly, institutional
investors have a strong searching and processing capabilities, and give a correct interpretation to all
kinds of information relatively based on their professional level. Will they consider the company's future
information when they make decision since institutional investors have the information advantage? This
paper empirically examines the impact of institutional ownership on the extent to which stock prices
reflect future earnings of listed companies in China from 2004 to 2009. The results find that the extent to
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which stock prices reflect future earnings is positively related to the percentage of institutional
ownership. That is, institutional ownership accelerates the pricing of future earnings, which indicates
they take account of the companies’ future information when institutional investors make decisions. So
the regulator should make policies to support the development of institutional investors in China.
Acknowledgement:
This paper is supported by the Humanities and Social Science Young Researchers Fund of the Ministry
of Education of PRC (grant no. 10YJCZH131), China Postdoctoral Fund (grant no. 20080441025),
Jiangsu Planned Projects for Postdoctoral Research Funds(grant no. 0901101C), Jiangsu Education
Planned Projects of Philosophy and Social Science (grant no. 09SJD790031), and NUST Research
Funding (grant no. 2010ZYTS038).
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