Institutional Investors' Monitoring Roles in State Controlled Firms and Income Smoothing Analysis for Stable Growth and Sustainability: Focusing on China Stock Market

: The purpose of this study is to examine the relationship between the institutional investors which can affect financial performance for corporate sustainability on the income smoothing. Therefore, this study focus on the connection between the nature of stock rights and income smoothing in China. For this study, hypotheses were established on the relationship each state-controlled companies, income smoothing, and information equilibrium of individual investors, and empirical analysis was conducted through related variables. The analysis results are summarized in three categories as follows. First, this research finds that state-controlled firms (CONTs) prefer income smoothing activities compared to non-state-controlled firms for the long-term sustainable development of firms using data from 2011 to 2019. Second, this study found out that Institutional investors support the behavior of CONTs to smooth their earnings because this behavior is seen as an attempt by CONTs to convey valuable private information to other investors. Third, we was able to discover that institutional investors' monitoring effect is predominantly driven by pressure-resistant institutional investors. This research complements the lack of empirical research on income smoothing and enable to give a guid e line that the type of stock rights is a critical key determinant of participation in income smoothing activities for stable growth and sustainability in the future.

state-controlled firms are the bellwether of implementing government policies in China. When investing in CSR activities, they are under more pressure from governments and assume greater social responsibilities, leading to higher costs and lower financial efficiency. As a country with a unique political system, China also needs to take into account the differences caused by differences in equity properties of listed companies when researching corporate performance and sustainability issues.
Through the above introduction, we carry on the following discussion on this paper. Firstly, this study explores whether the nature of stock rights is related to the smooth returns of enterprises. According to the political cost hypothesis, reputation theory, and information transmission hypothesis, whether state-controlled firms prefer smooth incomes. Chwee Ming Tee [13] conducted a study on the capital market of Malaysia and found that politically connected firms have a significant positive relationship with income smoothing, and politically connected firms with long-term political relations are more likely to smooth incomes. The second research question examines whether institutional investors' shareholding ratio can adjust the relationship between equity nature and income smoothing. There is evidence that institutional investors are more inclined to companies with stable income streams [14,15]. When managers' motivation for income smoothing is to convey useful private information to investors, investors can learn more about the real performance of companies, and institutional investors will encourage companies to smooth income [2,16]; When managers' motivation for income smoothing is for self-interest, the interests of investors will be harmed, and institutional investors will play an effective supervisory role to restrain the income smoothing behavior of companies [1]. Therefore, if the behavior of company smoothing income is to convey useful information to investors, institutional investors prefer income smoothing, otherwise, it will weaken the company income smoothing motivation. This study examines the main motivation of company income smoothing through the moderating effect of institutional investors on income smoothing in CONTs. Finally, considering the heterogeneity of the main body of institutional investors, this paper examines whether different types of institutional investors affect the income smoothing in CONTs.
To verify the above research issues, this paper uses 5,049 annual observed values of 561 Ashare listed companies in China's Shanghai and Shenzhen stock exchanges from 2011 to 2019 and draws the following conclusions. Firstly, we find that there is a significant positive correlation between CONTs and income smoothing, which shows that income smoothing is more common in CONTs than in non-CONTs. It can be explained that CONTs, considering their political relevance, are more likely to reduce the excessive attention of the outside world through stable earnings for the sake of long-term development goals. Secondly, this correlation is more prominent in CONTs where institutional investors hold a high proportion of shares.
That is, the supervisory duties of institutional investors have a positive effect on the smoothing income of CONTs, which means that the motivation of CONTs smooth income is primarily to convey useful private information to investors and other stakeholders, and institutional investors encourage this behavior. Finally, when considering the independence of institutional investors, we found that institutional investors' regulatory effect is mostly realized through PRII and that PRII and PSII are sensitive to income smoothing in distinct ways. Considering China's unique political system, this research not only complements the shortcomings of China's capital market in the study of income smoothing but also expands the related research scope of institutional investors.

Nature of stock rights and income smoothing
In China, because the local government (competent department) is deeply involved in managing CONTs, CONTs have the function of showing their political achievements. Local governments also provide subsidies, tax breaks, and other support to stimulate the growth of listed companies. In this case, to obtain financial support, CONTs will reduce profit fluctuations and create a stable profit flow to meet the requirements of the sustainable development of firms.
However, under political protection, CONTs suffer from opaque financial reports, resulting in a serious loss of management efficiency, and are insensitive to changes in the macroeconomic and market environments. Yang Jisheng and Yang Jianhui [17] pointed out that the sensitivity of private controlled firms to environmental factors is 5.5 times that of CONTs. In addition, many managers of CONTs are appointed by competent authorities and have a certain administrative level. Therefore, the business performance of the company plays a very important role in the political future of these managers. Especially in the information age, when the media promotes social topics and guides public opinion, CONTs may adopt the phenomenon of stable earnings to improve their corporate reputation. Watts and Zimmerman's [18] political cost hypothesis assumes that companies with high political relevance will be subject to strict supervision by regulators and attention from the public and media. Wang Peng et al. [19] found that due to fear of administrative intervention, CONTs managers are more motivated to cover up their earnings management behavior through the media to maintain their "positive" image. Wu Gaobo and He Fangfang [20] believed that compared to the management of non-CONTs, the management of CONTs has a stronger desire to reduce earnings management. Chwee Ming Tee [13] discovered that politically associated firms prefer smooth income. According to the reputation theory, managers of politically associated firms with a long history are more motivated to smooth income to maintain a positive reputation in capital markets. In addition, the study of Zhou Hui [21] pointed out that the salary and remuneration of middle and senior managers of CONTs are linked to the performance of firms. A greater degree of earnings management results in a closer relationship between managers' remuneration and business performance. Therefore, to reduce the unnecessary attention of CONTs from the public, managers need to cover up poor business performance through smoothing earnings and create a positive social image. Second, managers of CONTs may gain further political prospects or higher salaries by smoothing out corporate incomes. But this kind of opportunistic behavior covers up fluctuations in corporate performance, which will hurt other shareholders and affect enterprise value.
However, from the signal theory, income smoothing can also be seen as a way for managers of CONTs to convey private information to users. Many theoretical studies support income smoothing as a means of communicating private information about future earnings. They believe that income smoothing sends signals of performance and play an effective role in information communication. Subramanyam [22] found that managers used income smoothing to reveal private information about future earnings. Tucker and Zarowin [2] pointed out that if managers use their discretion to convey their assessment of future earnings, return smoothing may help investors obtain information concerning earnings. Some scholars also believe that compared with enterprises that do not engage in income smoothing, income smoothing firms have better performance. Michelson et al. [23] proposed that companies with smooth incomes tend to have higher excess returns compared with companies without smooth income characteristics. Zheng Xincheng [24] found through empirical analysis, income smoothing could improve the sustainability and predictability of earnings data, thus improving the decision-making relevance of earnings. In China, there is a natural internal connection between CONTs interfered with by the government. Such a "relationship bond" enables holding firms to receive greater financing opportunities and greater advantages in the process of resource allocation by governments [25,26]. But managers can use a steady income as a precautionary measure if they are unable to sustain performance due to special reasons (such as a financial crisis or the absence of relevant government departments). CONTs then smooth out incomes to convey more valuable information to investors concerning business sustainability. So regardless of the purpose of smoothing incomes of CONTs, our first hypothesis is as follows: H1: State-controlled firms are more likely to smooth income.

Nature of stock rights, income smoothing, and institutional investor's monitoring
Compared with individual investors, institutional investors have the advantage of obtaining and effectively processing timely information to make efficient investment decisions. Moreover, when corporate performance declines or fluctuates, institutional investors can make use of their advantage of capital scale to alleviate the operation fluctuations of the firm. If institutional investors can better monitor opportunistic earnings reports when the management's investment decision violates the corporate value, the quality of earnings will improve with the increase of institutional investor holdings, which reflects the monitoring role of institutional investors. Chakravaty [27] found that the information advantage of institutional investors is significantly correlated with their shareholding ratio. In other words, the higher institutional investors' shareholding ratio in listed companies, the more non-public information they have access to, and the more supervision they exert. Velury and Jenkins [6] found through empirical analysis that higher institutional investors' shareholding ratios led to higher-quality accounting information, and institutional investors can play a monitoring role in the management. Hideaki Sakawa and Naoki Watanabel [28] showed that institutional investors' monitoring role plays an effective role in Japanese firms, and institutional investors' shareholding is conducive to improving sustainable corporate performance. Song Yu and Fan Minhong [29] found that the institutional investors' shareholding ratio is positively correlated with the degree to which the stock price reflected future earnings information, and institutional investor holdings accelerated the degree to which the future earnings information was reflected in the stock price.
Miao Luo et al. [30] investigated the institutional investor behavior in the Japanese stock market and discovered its presence increased the information content of stock prices, which could weaken irrational investment behaviors and thus stabilize stock prices.
If institutional investors are regarded as ineffective supervisors, it will have a bad impact on their image and thus lose the support of investors. Evidence shows that institutional investors are more inclined to enterprises with stable income streams when the motivation of companies to smooth earnings is to deliver useful information to investors [14,15], the regulatory role of institutional investors is considered effective; when the manager's motivation for smoothing earnings is for self-interest, income smoothing will disrupt the effectiveness of information transmission in the capital market and harm the interests of investors, and institutional investors will restrain the income smoothing behavior of companies [1].
When considering the nature of institutional investors in company equity, Bo XianHui and Wu Liansheng's [31] study found that institutional investor holdings in private listed companies and CONTs' earnings management effect differs. That is, the type of controlling shareholder will affect the relationship between institutional shareholding and corporate earnings management. Li Zengfu and Lin Shengtian et al. [32] found that institutional investors are beneficial to corporate governance. Both CONTs and non-CONTs can effectively inhibit real earnings management, but institutional investors of CONTs have significantly less inhibitory effects on real earnings management than non-CONTs. Shleifer and Vishny [33] believed that institutional investors have strong information processing ability and access to inside information, and they play the role of information transmission in capital markets. Menkhoff and Schmeling [34] found that more information held by institutional investors resulted in lower trading volume in stock markets and the more inclined they are to conduct secret transactions, which is conducive to stock market stability. Chwee Ming Tee [13] pointed out that institutional investors who convey valuable private information can strengthen the relationship between politically connected companies and income smoothing. Therefore, if institutional investors can deliver useful information through personal advantages, the relationship between CONTs and income smoothing will be strengthened. Our second hypothesis is as follows: H2: Institutional investors improve the relationship between CONTs and income smoothing if income smoothing is used to convey private information.

Nature of stock rights, income smoothing, and institutional investor's heterogeneity
Existing studies have found that institutional investors are not homogenous and have significant differences in their supervision and corporate governance effects. Therefore, this paper classifies institutional investors reasonably in consideration of the heterogeneity of CONTs and income smoothing if income smoothing is used to convey private information.

Data and Sample Selection
This paper selects all A-share listed companies in China's Shanghai and Shenzhen stock markets from 2011 to 2019 as our research sample. We used the following steps to screen the sample: 1)Excluded listed companies in the financial industry; 2)Excluded listed companies that were ST or * ST during the study period; 3)Excluded listed companies with incomplete information disclosure. States), and SPSS26 was used for data analysis.

Income Smoothing (IS)
Income smoothing is a form of earnings management that refers to the use of accounting adjustment methods, such as accruals, to smooth earnings within the scope permitted by accounting policies. Its purpose is to show a sustainable and stable profit trend in financial statements. Earnings smoothing was first proposed by Hepworth [42]. Companies deliberately smooth corporate earnings and the formation of stable earnings will enhance the confidence of shareholders and creditors in the company. Michelson et al. [23] proposed that companies with smooth incomes tend to have higher excess returns compared with companies without smooth income characteristics. Huang Shengzhong, Chan Lyu, and Lin Xiaojun [43] pointed out that the role of income smoothing is informational; that is, the informative effect of income smoothing can improve the firm's future earnings informativeness. Income smoothing plays a dual role in determining earnings quality, which is the garbling or effective communication of private information [2].
In this paper, the method of Tucker and Zarowin [2] was used to measure the existence and smoothness of income smoothing; that is, to calculate the correlation coefficient between the change in discretionary accruals and the change in profit before manipulation in the current year and the past four years. The method used in this study is as follows: 1) The discretionary accruals, DA t , and the change in discretionary accruals, ∆DA, were calculated using the modified Jones model 2) We calculated profit before manipulation PDI t = NI t /A t−1 − DA t and the change in profit before manipulation ∆PDI 3) We calculate the correlation coefficient ρ(∆DA, ∆PDI) between the change in discretionary accruals and the change in profits before manipulation over 5 years (t-4~t). If the correlation was negative, it indicates that the sample company has carried out income smoothing. The closer the coefficient is to -1, the greater the income smoothing degree is present.
4) According to the method of Tucker and Zarowin [2], the correlation coefficient is given a negative (-) sign to measure income smoothing so that the direction of the correlation coefficient is consistent with the intuitive direction of income smoothing; that is, IS= -Corr (∆DA,∆PDI).

State-controlled firm (CONT)
The nature of the management control of companies can be divided into CONTs and non-CONTs. CONTs are firms in which the state capital equity accounts for a higher proportion and is controlled by the state. Specifically, it refers to listed companies in which the government or state-controlled firms own more than 50% of the share capital, and these control rights or shares are enough to have a significant impact on the decisions at shareholder meetings. In this paper, nature stock right is set as a dummy variable. If the actual controller of the listed company is state-controlled, it is represented as 1; otherwise, it is 0.

Institutional investors shareholding ratio (INST)
Institutional investors refer to professional organizations or enterprises that use their funds to obtain investment income as their main business purpose. Institutional investors are not homogeneous, and they can be classified into different categories, as shown in Table 1.
Referring to the practice of Brickley et al. [11], Yi Zhihong et al. [44], and Yang Haiyan et al. [45], this paper classified securities investment fund, social security fund, and QFII as pressureresistant institutional investors and denotes the sum of their shareholding ratio as PRII.
Insurance companies, trust companies, securities companies, and financial companies are classified as pressure-sensitive institutional investors, and the sum of their shareholding ratios is referred to as PSII.

Control variables
(1) Firm Size (SIZE) Firm size is calculated by the natural logarithm of the total assets of the firm. Large firms are often seen as politically more visible, and it's easy to catch public attention if there are big swings in income. Watts and Zimmerman [18] believed that larger firms are more likely to be noticed by the general public and relevant departments and will usually reduce the "cost of political attention" by smoothing income. Li Zengfu and Zhou Ting [56] found that to reduce their political costs, large-scale CONTs have a strong incentive to manipulate earnings. As a result, managers at big firms are more likely to use accounting discretion to reduce political concerns by reporting smooth earnings trends. Wagner and Wootton [23] found that smoother firms are larger than non-smoothing firms.
(2) Asset-liability ratio (LEV) The ratio of a firm's total liabilities to its total assets at the end of the year, also known as Aggarwal et al. [51] Kim et al. [52] Chwee Ming Tee [13] Monitoring cost Active institutional investors

Passive institutional investors
Almazan et al. [53] Chen et al. [54] M Wang [55] Preprints (www.preprints.org) | NOT PEER-REVIEWED | Posted: 28 August 2021 doi:10.20944/preprints202108.0531.v1 financial leverage, is used to measure how close a company is to defaulting on its debts. When companies are closer to defaulting on their debt obligations, managers were more likely to exercise their accounting discretion. Firms with higher leverage ratios are more likely to engage in income smoothing to reduce borrowing costs. The debt contract hypothesis proposed by Watts and Zimmerman [18] points out that, under equal conditions, the higher the debt level of a firm, managers will have an incentive to choose accounting methods or policies that can adjust future earnings to the schedule.
(3) Return on Assets (ROA) The return on total assets of a listed company represents the company's operating performance. Watts and Zimmerman [18] believed that when a company is in a particularly good financial standing, earnings management will be carried out to reduce the "political cost." When the company loses money, to turn a loss into a profit, the company will also carry out upward earnings management. Lei Guangyong, Liu Huilong [57], and Chen Donghua et al. [58] all found that ROA was positively correlated with earnings management.
(4) Book-to-market ratio (BM) The ratio between book value and market value of a company is the book-to-market ratio.
Lakonishok et al. [59] believed that the book-to-market ratio is an effective index to predict future stock performance, and companies with a high book-to-market ratio will have better performance in the future. Abdalla [60] found that the book-to-market ratio could reflect market growth opportunities and effectively predict macroeconomic growth trends.

Establish research models
In this paper, industry and year processing are set as dummy variables to control industrylevel differences and year changes, respectively, and the upper and lower 1% of all continuous variables are Winsorized to reduce the impact of extreme outliers. To test the above hypotheses and verify the relationship between variables, the following model is established.
Hypothesis 1 is tested using the following model: IS I,t = α 0 + α 1 CONT i,t + α 2 SIZE I,t + α 3 LEV I,t + α 4 ROA I,t + α 5 BM I,t + Year and Industry Fixed Effects + ε i,t Where: the subscripts i and t represent firm and year, respectively, IS: income smoothing, which we compute using the negative correlation between the change in discretionary-accruals proxy (ΔDA) and pre-discretionary income(ΔPDI) [2], CONT: a dummy variable set to 1 if the firm is a state-controlled listed firm, and 0 otherwise, SIZE: natural log of total assets, LEV: financial leverage, the ratio of the company's total liabilities to total assets at the end of the year, ROA: return on total assets, calculated as income before extraordinary items to total assets, BM: book-to-market value ratio, the ratio of a company's book value to market value.

INST: institutional investors shareholding ratio, calculated by the percentage of shares held by
institutional investors compared to the total shares outstanding, Hypothesis 3 is tested using the following model: IS i,t = γ 0 + γ 1 CONT i,t + γ 2 PRII i,t + γ 3 CONT i,t * PRII i,t + γ 4 PSII i,t + γ 5 CONT i,t * PSII i,t + γ 6 SIZE i,t + γ 7 LEV i,t + γ 8 ROA i,t + γ 9 BM i,t + Year and Industry Fixed Effects + ε i,t Where: PRII: pressure-resistant institutional investors shareholding ratio, calculated by the percentage of shares held by the total number of securities investment funds, social security funds, and QFII compared to the total shares outstanding, PSII: pressure-sensitive institutional investors shareholding ratio, calculated by the percentage of shares held by the total number of insurance companies, trust companies, securities companies, financial companies compared to the total shares outstanding, The definitions and calculations for all variables are presented in Appendix A.     Table 3. The observed value of PRII is 4905, and the mean shareholding ratio is 4.85%, which is significantly higher than the mean shareholding ratio of PSII (1.75%). This indicates that PRII occupies the main force in the shareholding of institutional have the smallest sample size, and the maximum shareholding is only 0.68%, which indicates that the development of FCIIs is limited.  Table 4 shows the correlation between the research variables. Through the correlation analysis results, it can be seen that IS has a significant positive correlation with CONT, INST, PRII, PSII, which is consistent with the predicted symbolic direction of the previous hypothesis. We find that CONT is significantly negatively correlated with INST, PRII, and PSII, indicating that compared with non-CONTs, the proportion of shares held by institutional investors in CONTs is lower. Therefore, it is valuable to study the role of institutional investors in CONTs. We find that income smoothing is positively correlated with SIZE, LEV, and BM and negatively correlated with ROA. These correlations indicate that when examining the relationship between income smoothing activities, the nature of stock rights, and institutional investors' shareholding, these control factors may affect the importance of managers making income smoothing decisions.

Nature of stock rights and income smoothing
From the regression results in Table 5, the coefficient of CONT is positive and significant, indicating that CONTs are more likely to smooth income than non-CONTs. This finding is consistent with the prediction of Hypothesis 1. We can understand this result from two aspects.
First, due to the unique political and social relations of CONTs, they will reduce the attention of the public and reduce the cost of political attention by utilizing income smoothing. Secondly, CONTs are usually able to obtain a lot of information and financing advantages, but when the relevant government departments are unable to support the enterprises due to special reasons, managers can use stable income as a preventative measure. CONTs then smooth earnings to communicate private information to investors about business sustainability. The coefficient of SIZE is significantly positively correlated, which is consistent with the analysis results of Watts and Zimmerman [18] that found large companies are more likely to attract the attention of the public and relevant departments, and usually, reduce the "cost of political attention" by smoothing income. The coefficient of LEV is significantly positively correlated, indicating that higher debt levels result in greater motivation for managers to engage in income smoothing. This is consistent with the assumption of a debt contract. The relationship between ROA and IS is significantly positive, indicating that enterprises with high business performance are usually more likely to receive attention, to reduce political cost or tax burden through income smoothing.

Robustness test
To  [61] believe that institutional investors' holding could restrain the plunder of minority shareholders by major shareholders. Xia Bo [62] found that the greater the degree of checks and balances of foreign institutional investors, the more able they are to participate in corporate governance and improve corporate performance. When CONTs convey useful private information through income smoothing, institutional investors play a positive regulating role, and this positive regulating role is largely driven by PRII.

5.Conclusion
To the best of our knowledge, this study is the first to examine the link between the nature of stock rights and income smoothing in China. Under the special institutional background in China, CONTs have a close relationship with government agencies and have a strong political connection. Although they have many advantages in obtaining resources, they also need to undertake corresponding economic and social responsibilities for the sustainable economic development and social stability of the country. Although market-oriented reform has improved the governance structure of CONTs and non-CONTs, there are still differences. And many of China's listed companies are controlled by the state, which is not negligible. In addition, although there are studies on the nature of stock rights and earnings management, there is a lack of empirical research on income smoothing. Therefore, this paper believes that it is necessary to consider the nature of stock rights and distinguish the relationship between research on CONTs and non-CONTs and earnings smoothing. Considering whether institutional investors, as an important part of capital markets, play an active supervisory role, it is of certain practical significance to explore the regulatory role of institutional investors in the relationship between the nature of stock rights and income smoothing.
The empirical results of this paper provide evidence both in a practical sense and for academic research and fill in several gaps in the literature, which can be explained mainly from Preprints (www.preprints.org) | NOT PEER-REVIEWED | Posted: 28 August 2021 doi:10.20944/preprints202108.0531.v1 the following aspects: First, the empirical research results show that compared with non-CONTs, CONTs are more likely to conduct income smoothing. This result is consistent with the political cost hypothesis [18], reputation theory, and signal theory. It is believed that the public pays relatively greater attention to CONTs, so managers may use income smoothing strategies to reduce public attention. Secondly, usually, stable income represents the effective operation of the company. Institutional investors prefer the stable income flow of CONTs. On the one hand, it can reflect the correct choice of institutional investors and maintain their reputation.
On the other hand, it can reflect the active monitoring role of institutional investors and shareholders. The most important thing is that only when the income smoothing behavior is considered to convey useful information to investors and other stakeholders, this approach will be supported by institutional investors. Finally, this paper suggests that the heterogeneity of institutional investors takes the independence of institutional investors as the classification standard and concludes that the positive moderating effect of institutional investors on CONTs and income smoothing mainly comes from the PRII. Therefore, this paper not only expands on the dimensions of China's nature of stock rights and institutional investors but also fills in the shortcomings of empirical research on income smoothing.
Overall, these findings have added to our knowledge of the income smoothing strategy, why different researchers hold different attitudes toward income smoothing because it is impossible to consider all factors, the institutional structure and investors to participate in the attitude of different countries, and management characteristics will affect the income smoothing approach.
In addition, according to different characteristics, the main body of institutional investors can be divided into different types, so this paper only considers the independence of institutional investors' business links, and there is still room for further research.