Passive Ownership and Earnings Manipulation

We examine the relation between passive ownership and financial reporting quality measured by Beneish's (1999) earnings' manipulation score (M-score). We find that passive ownership is negatively related to M-score and to the likelihood of being designated as a “manipulator” firm. However, these relations are muted when one of the four largest auditing firms audits the firm in the previous year. The evidence is consistent with the notion that passive owners act as monitors, but relinquish their monitoring role to the Big 4 auditing firms. We also find that higher passive ownership relative to total fund ownership yields higher risk-adjusted returns among firms with high M-scores. Passive ownership may offer greater monitoring benefit to the firms with high M-Scores than firms with low M-Scores