The effect of managers' and directors' share ownership on long-term earnings-returns association - Evidence from Finland in 2010 - 2012

The purpose of this study is to examine whether the level of managerial share ownership or board share ownership has an effect on earnings quality as measured by the long-term earnings-returns association over the financial year. The study focuses on Finnish companies in the recent years. Earlier literature in this field is abundant in Anglo-Saxon and Asian countries but fairly scarce in other European countries. Thus, this thesis sets out to increase the understanding of the effect of ownership on the earnings-returns association in a Nordic setting. Earlier literature has found two opposing effects of managerial or board ownership on the earnings-returns association. The incentive alignment effect suggests that there is a positive linear relationship between ownership and earnings-returns association. The entrenchment effect, on the other hand, proposes that when ownership levels are high enough, the effect on earnings-returns association becomes negative. Entrenchment occurs because at certain ownership levels the agency control mechanisms such as the market for corporate control and the managerial labor market stop functioning effectively. The two opposing theories can be combined to depict the effect of ownership as non-linear. The research sample consists of 102 companies listed in the NASDAQ OMX Helsinki Stock Exchange in 2010-2012, yielding 306 firm-year observations. Financial institutions are excluded because of their differing reporting practices and regulatory environment. Multivariate regression analysis with annual returns as the response variable is used to analyze the data. The effect of share ownership on the earnings-returns association is estimated by the regression coefficient of the earnings-ownership interaction variable. Alternative model specifications, such as piecewise regression, different measure for the response variable and fixed effects model are used to test the robustness of regression results. The results suggest that board ownership has a statistically significant but economically quite trivial positive effect on the earnings-returns association. Managerial ownership was not found to have a statistically significant effect on earnings-returns relationship. The results did not find support to the entrenchment effect, i.e. negative effect of ownership on earnings-returns association at higher levels for ownership, for neither management nor board. Compared to the earlier studies in this field, the earnings-returns association was found to be exceptionally strong in Finland in the research period