Open AccessThis paper investigates the role that institutional investors play in the market reaction to accounting restatements. We show that transient institutional investors, defined as institutions with short investment horizons and high portfolio turnover, significantly reduce their holdings in a restating firm at least one quarter prior to the quarter of the restatement announcement. This result holds after controlling for factors such as return momentum, unexpected earnings, size, book-to-market, and the portfolio weight of the firm to the institution. Second, using previously identified predictors of earnings manipulation, we show that institutional investors react most negatively to an increase in the days sales in receivables and high accruals. Finally, we demonstrate that the market reaction to accounting restatements for firms with higher levels of transient institutional ownership is more negative in the period prior to the restatement announcement. Taken together, these results suggest that institutional investors act as though they partially anticipate potential accounting irregularities and adjust their holdings downward prior to the restatement announcement.
Keywords: Institutional investors, Accounting restatements
JEL Classifications: G30, M41