This paper investigates whether a firm's earnings management is affected by its institutional investors. According to the theory of"Shareholders Activism", the institutional investors should exhibit positive effect on firm's earnings management that would hurt the firm's long-term value. However, measured as the absolute value of accrual estimation errors, earnings management is found to be positively associated with institutional ownership. In another words, the institutional investors stimulate the earnings management of listed companies in China.In order to explain this result, this paper investigates further into the characteristics of institutional investors with a concentration on funds. Using eight variables to capture the investment behavior of funds during 2005 and 2006, we performed principal factor analysis and K-means cluster analysis. Finally this paper finds 647 out of 736 samples exhibit low portfolio concentration, high portfolio turnover and high trading sensitivity to current earnings news, while the other 89 samples exhibit high portfolio concentration, low portfolio turnover and low trading sensitivity to current earnings news. We define the former cluster as"negative institutional investors", the latter one defined as"positive institutional investors".Finally, this paper examines the effects of different investors on earnings management. The conclusion is negative institutional investors stimulate the earnings management while positive institutional investors mitigates. |