The Governance Role of Institutional Investors and Outsider Directors on the Properties of Management Earnings Forecasts

Abstract

This paper investigates the relation between institutional ownership and board of directors' composition and the properties of management earnings forecasts. A firm's optimal disclosure policy is determined by a trade-off between costs and benefits of disclosure. Managers acting in their self-interest may have incentives to distort disclosure policy. Governance mechanisms, to the extent they are effective in protecting the interests of the providers of capital, should mitigate these distortions. We find evidence that institutional ownership and outsider directors are favorably associated with the properties of earnings forecasts. Firms with greater institutional ownership and outside directorship are more likely to issue a forecast and do so consistently. Further, these forecasts tend to be more specific and accurate. The governance measures also mitigate managers' tendency to issue optimistic forecasts.

JEL Classification: M41, M45, G32, G34