A Safe Haven for Retail Investors: The Influence of Passive Institutional Ownership on Analyst Optimism

• In Event: Financial Accounting and Reporting

Abstract

We investigate how passive institutional ownership affects analyst optimism. An increase in a firm’s passive institutional ownership implies that some retail investors migrate to passive funds. As prior literature shows that retail investors are most responsive to analysts’ forecasts, the migration means less audience responding to analysts’ optimistic forecasts. We predict that analysts have less incentive to issue optimistic forecasts for firms with higher passive ownership. Using the Russell index setting to isolate exogenous shocks to passive ownership, we find that higher passive ownership is associated with a lower percentage of favorable recommendations and less optimistic consensus forecasts. We also document stronger market reactions to favorable recommendations. Further tests indicate that firms have lower income-increasing discretionary accruals and a lower likelihood of restatement after increases in passive ownership, suggesting that the reduced analyst optimism weakens the incentive to manage earnings upward.

Author

• Jingxin Hu, Syracuse University