Institutional monitoring and the non-linear effect on audit quality. UK evidence

Extant literature describes a monitoring role for institutional investors that aims to safeguard the value of their investments. Institutional investors with significant shareholdings are motivated to monitor management and require high-quality audits to achieve their goals. Major institutional ownership and its relationship to audit quality have attracted our interest. Institutional investors face constraints in their monitoring role. The beneficial effects of this role on audit quality cannot be sustained on an ever-increasing scale. This study aims to assess the effect of major institutional ownership on audit quality, in a UK setting, by using a non-linear approach. The level of discretionary accruals is used as an audit quality proxy. The empirical investigation employed the panel fixed effects method, and the sample comprised data for UK non-financial firms listed on the FTSE All Share Index from 2012 to 2022. A convex relationship between major institutional ownership and audit quality is documented, especially for smaller-sized firms. This relationship seems to be interrelated with auditor competition. The findings support recent UK-regulator initiatives that aim to revitalise auditor competition, while providing impetus for further interventions to secure capital market integrity.