Do Monitors Induce Pressure? Mutual Fund Transparency and Financial Reporting Quality

I use a difference-in-differences design around the SEC’s 2004 mandate that increased mutual fund portfolio disclosure frequency from semi-annual to quarterly to test whether shortened investor incentive horizons influence portfolio firms’ accrual-based earnings management (AEM). I provide evidence that institutional investors, typically viewed as monitors of financial reporting quality, can encourage financial statement manipulation when their own incentives become short term. I find that firms with greater ownership by affected mutual funds exhibit higher levels of AEM post regulation. Mechanism tests reveal that this pressure is transmitted through the threat of exit, providing novel evidence that exit threats can reduce financial reporting quality. Other cross-sectional tests show that the effect is stronger among firms owned by funds with lower-skill managers, consistent with greater career concerns under increased scrutiny. The effect is also concentrated among firms with higher ownership by transient and growth-oriented institutional investors. I further find that treated firms experience a broader deterioration in financial reporting quality, including more going concern opinions, out-of-period adjustments, and restatements. My findings highlight how efforts to improve investor transparency can have unintended consequences for firm-level accounting behavior.