The Association Between Corporate Boards, Audit Committees, and Management Earnings Forecasts An Empirical Analysis

DOI: 10.1111/j.1475-679X.2005.00177.
x
Journal of Accounting Research
Vol. 43 No. 3 June 2005
Printed in U.S.A.
The Association between Corporate

Boards, Audit Committees, and
Management Earnings Forecasts: An
Empirical Analysis
I R E N E K A R A M A N O U ∗ A N D N I K O S VA F E A S ∗
Received 23 July 2004; accepted 6 January 2005
ABSTRACT
We study how corporate boards and audit committees are associated with
voluntary financial disclosure practices, proxied here by management earn-
ings forecasts. We find that in firms with more effective board and audit com-
mittee structures, managers are more likely to make or update an earnings
forecast, and their forecast is less likely to be precise, it is more accurate, and
it elicits a more favorable market response. Together, our empirical evidence
is broadly consistent with the notion that effective corporate governance is
associated with higher financial disclosure quality.
1. Introduction
Sound financial disclosure diminishes agency problems by bridging the
information asymmetry gap that exists between management and share-
holders. In contrast, poor financial disclosure often misleads shareholders
and has adverse effects on their wealth, as suggested by the wave of recent fi-
nancial reporting scandals. Given sharp differences in disclosure outcomes
∗ University of Cyprus. We are indebted to Abbie Smith (the editor) and an anonymous
referee for their insightful comments and suggestions. We thank Maria Christodoulou for
research assistance, and First Call Corporation, a Thomson Financial company, for providing
the analyst and management forecast data free of charge. The University of Cyprus provided
funding for this research.
453
Copyright
C , University of Chicago on behalf of the Institute of Professional Accounting, 2005
454 I. KARAMANOU AND N. VAFEAS
across firms, the reasons some firms opt to exercise sound disclosure prac-
tices and others do not is not a priori clear. Therefore, identifying the fac-
tors affecting management’s voluntary disclosure decisions is a fundamental
research problem with implications for policy makers, the business commu-
nity, and academics.
In response to recent financial disclosure scandals, the U.S. Congress,
the Securities and Exchange Commission (SEC), and the major stock ex-
changes focused on corporate boards as primary vehicles for improving the
quality of financial information provided by firms. In particular, standing
board audit committees have come to the forefront of public attention be-
cause they are the core decision-making body that is expected to monitor
financial reporting practices. An initiative by the stock exchanges resulted
in the Blue Ribbon Committee’s (1999) report, a code of best practice for
the functioning of corporate audit committees. As a result, the New York
Stock Exchange (NYSE) has recently approved new corporate governance
rules (SR-NYSE-2002-33). In parallel, motivated by the Sarbanes-Oxley Act
of 2002, the SEC adopted new standards relating to listed company audit
committees (rule 33-8220).
Drawing on these regulatory reforms, we suggest that corporate gover-
nance structure, as expressed by corporate boards, audit committees, and
ownership characteristics, is associated with financial disclosure decisions,
and specifically we hypothesize that effective governance mechanisms are
positively associated with the quality of financial disclosure practices. Prior
work shows that heightened disclosure is beneficial to the market. Among
other things, disclosure is shown to be positively related to firm liquidity and
negatively related to the cost of capital.1 Despite these benefits, managers
have incentives to withhold information because lack of information hinders
the ability of the capital and labor markets to monitor managers effectively.2
The effect of corporate governance on this disclosure agency problem is
not extensively examined in the literature even though the effect of corpo-
rate governance is examined in several other issues. For example, Dechow,
Hutton, and Sloan [1996] examine the effect of corporate governance on
SEC enforcement actions, Klein [2002] examines the effect of corporate
governance on earnings management, and Anderson and Bizjak [2003] ex-
amine corporate governance in the context of executive compensation.
Prior work examines the impact of various aspects of compensation and
ownership on corporate disclosure practices. Nagar, Nanda, and Wysocki
[2003] find that stock-based incentives mitigate the disclosure agency prob-
lem. Healy, Hutton, and Palepu [1999] find that institutional investors are
more attracted to firms with higher disclosure rankings. Bushee and Noe
[2000] find that it is mostly transient institutions that positively react to
increases in disclosure rankings. Finally, Bamber and Cheon [1998] study
1 See, for example, Diamond and Verrecchia [1991], Welker [1995], Botosan [1997], and
Leuz and Verrecchia [2000].

2 See, for example, Shleifer and Vishny [1989] and Edlin and Stiglitz [1995].
BOARDS, AUDIT COMMITTEES, AND EARNINGS FORECASTS 455
the effects of block ownership on forecast precision, their proxy for finan-
cial disclosure. We extend this line of research by illuminating corporate
boards and their standing audit committees as another potentially important
monitoring mechanism being associated with corporate financial disclosure
practices.
Like Bamber and Cheon [1998], we choose management forecasts as the
testing stage for studying the relation between governance and financial
disclosure. This choice is advantageous for two main reasons: Theoretically,
unlike other more regulated forms of disclosure, management has consid-
erable discretion in terms of whether to make a forecast, and in deciding
its timing, form, and specificity. This discretion allows “good” managers to
separate themselves more clearly from “bad” managers through their fore-
cast choices. Empirically, given that forecasts contain several discrete and
well-defined features pertaining to their timing, form, and specificity, the
study of the link between disclosure choices and corporate governance prac-
tices is more feasible. Furthermore, unlike financial statement disclosures,
a management forecast is usually an isolated event that can be evaluated
by the stock market with less noise. Even though extant research examines
management earnings forecasts extensively, the relation between corporate
governance and this voluntary disclosure mode is not thoroughly examined.
To this end, our study addresses the following specific questions: How is
the structure of a firm’s governance related to the likelihood that manage-
ment makes an earnings forecast? How is governance structure related to
the level of precision in a management forecast and to the accuracy of the
forecast? Is the reaction to a management forecast announcement by the
stock market and by equity analysts related to the announcing firm’s gov-
ernance structure? How does the nature of the forecast (i.e., good news vs.
bad news) affect the answers to these questions?
In our tests we consider management forecasts made by 275 Fortune
500 firms between 1995 and 2000, and variables proxying for how boards,
audit committees, and institutional shareholders monitor management. We
initially find that firms with effective governance mechanisms are more
likely to make a management forecast, especially when that involves bad
news. This evidence suggests that better governance in public corporations
is associated with less information asymmetry between management and
shareholders, especially when shareholders are most likely to be at risk of
suffering wealth losses. We also find that among forecasting firms, forecast
precision decreases with better governance, but only when bad news is con-
veyed. One possible explanation for this result is that well-governed firms
are more mindful of their obligation not to mislead shareholders. The dan-
ger of misleading shareholders is greater when a firm performs worse than
expected, and issuing more vague forecasts reduces this danger. Also, the
soundness of corporate governance is related to forecast accuracy and,
more weakly, to forecast bias. Finally, we find evidence that the market
reaction to management forecast announcements is related to board and
audit committee characteristics, especially when the forecast releases good
news. This evidence suggests that investors have greater confidence in good
news forecasts that undergo the scrutiny of more effective boards and audit
committees.
Against the backdrop of recent efforts to regulate the structure and oper-
ations of corporate boards and their standing audit committees, our results
are likely to be of interest to policy makers because they are consistent with
certain board and audit committee attributes being systematically associated
with the quality of financial disclosure. Furthermore, these results are likely
to be of interest to investors and equity analysts because they provide a basis
for evaluating the quantity and quality of information contained in manage-
ment forecasts. Third, these results extend academic research by furthering
our understanding of the link between financial disclosure, boards, and au-
dit committees, and, more broadly, by providing further evidence on the
role of corporate governance mechanisms in alleviating conflicts of inter-
est between management and shareholders. Last, our results are potentially
useful to managers because they suggest that the credibility, and ultimately
the value relevance, of their forecasts is assessed, in part, in the backdrop
of the structure of their firm’s board of directors and audit committee. Our
results broadly suggest a potential path for managers wishing to enhance
the quality and credibility of their financial disclosures.
The article proceeds as follows. Section 2 describes the corporate gov-
ernance measures considered in this study, section 3 discusses our four
research propositions linking corporate governance mechanisms to man-
agement forecasts, section 4 describes the data and methods used, section 5
presents the results, and section 6 provides discussion and concluding
remarks.
2. Measures of Corporate Governance

Corporate boards are responsible for monitoring managerial perfor-
mance in general, and financial disclosures in particular, a task that is dele-
gated to audit committees. The prior literature suggests several board and
audit committee attributes as determinants of monitoring performance. In
this article we draw from this literature to consider a plethora of alternative
measures of good governance and discuss each of these measures.
2.1 MEASURES OF GENERAL FIRM GOVERNANCE

Drawing from Fama and Jensen [1983], a large body of empirical evi-
dence finds that outside directors who are independent of management’s
influence help enhance shareholder value by protecting shareholder inter-
ests against managerial opportunism (see Hermalin and Weisbach [2001]
for a review of the literature). Focusing on financial reporting issues in
particular, Dechow, Hutton, and Sloan [1995], Beasley [1996], and Klein
[2002] find that outside directors are effective monitors of managerial ac-
tions. Second, board size is also likely to be related to board performance
because adding more people to the board enhances its knowledge base, yet
larger boards are less flexible and more inefficient. Given that boards in
most public firms are fairly large, the second effect seems to dominate the
first (Yermack [1996]). Third, Vafeas [1999] suggests that board meeting
frequency is a proxy for the time directors have to monitor management.
He finds empirical evidence that boards meet more frequently after crises
and that performance increases as a result. Carcello et al. [2002] find that
boards meeting more frequently pay higher audit fees and conclude that
board activity complements auditor oversight. Drawing from these studies,
we expect that a board’s degree of independence, size, and meeting fre-
quency are related to its monitoring performance.
Ownership structure is also likely to be related to greater alignment of in-
terests between management and shareholders. Jensen and Meckling [1976]
theorize that managerial ownership helps alleviate manager-shareholder
conflicts in public corporations. Early work by Morck, Shleifer, and Vishny
[1988] and McConnell and Servaes [1990] supports this notion empirically.
Warfield, Wild, and Wild [1995] find evidence that earnings are more in-
formative when insiders have a greater ownership stake in the firm.3 In
addition to manager-owners, large institutional stockholders are likely to
be well suited to monitor management because they usually have better
information about the firm and can thus deter management from behav-
ing opportunistically. Also, their equity investment in the firm is usually
higher, providing them with a stronger incentive to monitor management,
unlike small shareholders who are frequently free riders because of insuf-
ficient information and incentives. We thus expect that higher ownership
by insiders and institutions is likely to be related to better monitoring over
management.
2.2 AUDIT COMMITTEE MEASURES
The Blue Ribbon Committee [1999] prescribes a series of characteristics
an effective audit committee should possess. The Blue Ribbon Committee
extends the notion of director independence that has been widely applied
to boards to emphasize that audit committees should also be independent.
The rationale is that independent directors serving on audit committees
are more likely to be free from management’s influence in ensuring that
objective financial information is conveyed to shareholders. Second, to mon-
itor effectively the quality of financial information that is disclosed by the
firm, committee members should have essential skills in understanding and
interpreting that information correctly. The Blue Ribbon Committee sug-
gests that audit committees should be composed of directors who are, or
become within a reasonable time, financially literate, and that at least one
committee member should have accounting or related financial manage-
ment expertise. The importance of financial knowledge by audit committee
3 It is also possible that the relation between insider ownership and performance is not
monotonic and that high inside ownership levels are associated with managerial entrenchment
and exploitation of minority shareholders.
members is highlighted by Bull and Sharp [1989] and empirically supported

by Kalbers and Fogarty [1993] and DeZoort [1998]. Third, committee size
is likely to have an ambiguous effect on the committee’s monitoring per-
formance. Larger audit committees have a wider knowledge base on which
to draw but are likely to suffer from process losses and diffusion of respon-
sibility. In practice, audit committees are usually understaffed and usually
comprise four to five members (see Klein [1998]), leading the Blue Ribbon
Committee to suggest that audit committees should have at least three mem-
bers. Fourth, committees that meet more frequently allow directors more
time, on average, to carry out their monitoring duties and are more likely
to exercise effective control over the quality of financial information that
is conveyed to shareholders (see Menon and Williams [1994]). In sum, we
expect that more independent, expert, larger, and active audit committees
exhibit better monitoring performance over management.
3. Research Propositions
The following section reviews the relevant literature on management fore-
casts and develops arguments linking management forecasts to corporate
governance. Given that we examine a plethora of governance mechanisms,
we present our expectations in this section in the form of four general re-
search propositions.
3.1 THE LIKELIHOOD OF MAKING A MANAGEMENT EARNINGS FORECAST

In deciding whether to issue a forecast, management has to weigh the
forecast benefits against the forecast costs. Prior research suggests several
reasons that may render an earnings forecast beneficial to a firm. For ex-
ample, Trueman [1986] argues that forecasts give investors a favorable as-
sessment of the managers’ ability to anticipate economic events and thus
translate into higher market values. Frankel, McNichols, and Wilson [1995]
document evidence that is consistent with the notion that management
earnings forecasts aid the firm in eliciting funds from the capital markets.
Skinner [1994] suggests that managers are likely to make a forecast to con-
vey bad news to investors. A bad news warning protects management against
the potential danger of litigation and reduces reputation costs. Kasznik and
Lev [1995] find that managers are more likely to make an earnings forecast
preceding a significant negative, rather than a significant positive, earnings
surprise. Finally, Coller and Yohn [1997] argue that management forecasts
are more likely in the face of information asymmetry between management
and investors, as captured by bid-ask spreads, whereas Clement, Frankel,
and Miller [2003] find that forecasts that confirm the market’s beliefs about
earnings are also received favorably, possibly because they reduce uncer-
tainty about future earnings.
Nevertheless, casual observation suggests that most firms do not issue
forecasts, possibly because heightened disclosure entails costs as well. Costs
stem from a greater risk of litigation and the disclosure of proprietary
information to competitors. In line with the presence of disclosure costs,

Francis, Philbrick, and Schipper [1994] find that the likelihood of issuing
a forecast is inversely related to the risk of litigation, whereas Bamber and
Cheon [1998] and Baginski, Hassell, and Kimbrough [2004] find that liti-
gation risk is associated with lower forecast specificity. Finally, Bamber and
Cheon document evidence that firms facing higher proprietary costs issue
less specific forecasts that target a narrower immediate audience.
We posit that effective corporate governance is an additional factor that
may determine the likelihood that management will make a forecast. It
is well documented that voluntary disclosures, among other mechanisms,
help reduce agency conflicts by bridging the information asymmetry gap
that exists between management and shareholders (e.g., Healy and Palepu
[2001]). Management forecasts are one such disclosure tool, whose useful-
ness is likely to be determined, to a large extent, by the incentives man-
agers have to protect shareholders. Specific governance mechanisms such
as boards and audit committees are bestowed the responsibility of providing
managers with these incentives by monitoring the quality of financial disclo-
sures conveyed by management. Nevertheless, there is wide variation in the
structure and effectiveness of boards, committees, and ownership in pub-
lic firms, suggesting that the quality of monitoring over managerial actions
varies across firms. We therefore expect that more effective boards, more
effective audit committees, and better ownership incentives are related to
a higher likelihood of high-quality disclosure and thus to the likelihood of
management earnings forecasts.
Furthermore, firms with effective boards and audit committees may be
more sensitive to litigation risk stemming from failure to disclose value-
relevant information, especially if that information is unfavorable (Skinner
[1994]). Therefore, such firms may be more likely to generate a fore-
cast to reduce litigation risk. (It is also possible, however, that when di-
rectors who are mindful of their obligation to shareholders abstain from
making a forecast to reduce the risk, they somehow mislead sharehold-
ers through that forecast.) On balance, we deem that effective governance
would be associated with more disclosure and suggest that corporate gov-
ernance mechanisms complement disclosure practices in reducing agency
conflicts.
Research proposition 1: The likelihood of a management earnings forecast is

higher for firms with a more effective governance structure
in place.
3.2 MANAGEMENT FORECAST PRECISION

After deciding whether to issue an earnings forecast, managers must de-
cide on the amount of information they wish to provide to investors, via the
specificity of the forecast. Management forecasts may be precise estimates of
future earnings, define an expected range of estimated earnings, provide an
open interval, or give an altogether qualitative estimate of future earnings.
Other things being equal, providing more precise information is expected

to be more valuable to investors. Baginski, Conrad, and Hassell [1993] find
evidence that investors react more to point versus less precise forecasts,
whereas Pownall, Wasley, and Waymire [1993] report mixed evidence on
this issue. Hirst, Koonce, and Miller [1999] find experimental evidence to
side with the notion that forecast precision interacts with forecast accuracy
to provide more useful information to investors.
Prior work also studies the reasons managers issue forecasts of different
specificity. Baginski and Hassell [1997] find that managers produce more
precise forecasts of annual earnings in firms with a greater analyst following,
and thus more private information, and in smaller firms, for which there
is less publicly available information. Bamber and Cheon [1998] find that
managers are less likely to issue specific forecasts when exposure to legal
liability is high and when proprietary information costs are high. They also
find that poor earnings are also predicted in less precise terms.
The preceding discussion suggests that managers being guided by effec-
tive boards, effective audit committees, and active shareholders have greater
pressures to provide better information, in terms of forecast precision, to
investors. More precise information is relatively more revealing about man-
agement’s expectations and allows investors to make more informed in-
vestment decisions. Therefore, conditional on managers making a forecast,
and other things being equal, it is possible that firms with more appropriate
governance structures will be more likely to issue more precise forecasts.
On the other hand, Bamber and Cheon [1998] use nonaffiliated block
ownership as a proxy for legal exposure and find this variable to be inversely
related to management forecast precision. In a related vein, Carcello et al.
[2002] find that more effective board characteristics are positively associated
with greater audit fees, their proxy for audit quality. McMullen [1996] finds
that the presence of an audit committee is associated with more reliable fi-
nancial reporting—in particular, less errors, fewer irregularities, and fewer
illegal acts. One interpretation of these findings is that firms with more ef-
fective corporate governance structures in place are more sensitive to legal
liability issues. This, in turn, leads to an expected negative relation between
forecast precision and the effectiveness of boards, audit committees, and
ownership structures. Essentially, what we argue is that failing to disclose
value-relevant information may expose managers to litigation risk. There-
fore, managers may decide to guide the market’s expectations by issuing a
forecast (Skinner [1994]) but, conditioned on that, may be cautious in the
amount of specificity they provide through that forecast. In sum, there exist
counterveiling theoretical arguments about the relation between forecast
precision and governance structures. Therefore, we ultimately address this
question empirically.
Research proposition 2: The precision of a management earnings forecast is asso-

ciated with the effectiveness of the issuing firm’s corporate
governance structure.
3.3 THE ACCURACY OF MANAGEMENT FORECASTS

Prior research suggests that the accuracy of management forecasts pro-
vides a clear indication regarding management credibility. For example,
Williams [1996] documents that managers establish a forecasting reputation
based on the accuracy of prior earnings forecasts and that accuracy serves
as an indicator about the believability of a current management forecast.
Similarly, Tan, Libby, and Hunton [2002] argue that the accuracy of man-
agement forecasts captures management competence. Rogers and Stocken
[2002] document that the forecast error is not random and that it varies
with management incentives and the market’s ability to detect the forecast
bias.
In addition to the magnitude of the absolute forecast error, the error sign
is the topic of much prior research. Skinner [1994] suggests that managers
have incentives to be conservatively biased in their forecasts because the
risk of litigation is greater when managers are erroneously optimistic (i.e.,
litigation risk is asymmetric). In line with this notion, Bamber and Cheon
[1998] find that management forecasts convey bad news relative to analysts’
expectations. Rogers and Stocken [2002] also argue that overly pessimistic
forecasts may be intended to discourage firms from entering the industry,
especially when that industry is more concentrated and thus more profitable.
In contrast, it is also possible that managers behaving opportunistically have
incentives to portray an overly optimistic picture of the firm’s earnings,
consistent with the well-documented tendency of managers to disclose good
news and delay or withhold bad news. Managers whose firms are in financial
distress, in particular, may issue optimistic forecasts to convince temporarily
investors that they are implementing a sound business plan to keep their job
and to reduce the probability of bankruptcy or a hostile takeover (Rogers
and Stocken [2002]).
We probe further into the determinants of forecast accuracy and bias by
positing that the quality of a firm’s governance mechanisms is associated
with the magnitude and sign of the forecast error. We expect that the qual-
ity of boards and audit committees will be inversely related to the extent of
misinformation (the absolute value of the forecast error). Furthermore, we
expect this effect to be asymmetric. To protect the firm from litigation, all
else being equal, managers in firms with sound governance structures are
expected to make more conservative forecasts. That is, we expect the hypoth-
esized inverse relation between the effectiveness of governance mechanisms
and the forecast error to be more pronounced among good news forecasts.
Research proposition 3a: The accuracy of a management earnings forecast is

higher for firms with a more effective corporate gover-
nance structure in place.
Research proposition 3b: A management earnings forecast is more conservative
for a firm with a more effective corporate governance
structure in place.
3.4 THE MARKET REACTION TO MANAGEMENT FORECASTS

The information content of management forecasts is well documented
by prior research (e.g., Pownall and Waymire [1989]). Other work focuses
on explaining the reasons investors value these announcements differently
across firms and in time. For example, Jennings [1987] suggests that forecast
credibility and believability, measured by subsequent analyst forecast revi-
sions, explain the market reaction to management forecasts. More recently,
Williams [1996] documents that analyst response to a current forecast is
partly determined by the usefulness of a prior forecast by management.
Rogers and Stocken [2002] report that the market responds as if it under-
stands the good news bias in forecasts. The market eventually identifies the
bias in bad news forecasts as well. Finally, Hutton, Miller, and Skinner [2003]
find that although bad news forecasts are always informative, good news
forecasts are only informative when accompanied with verifiable forward-
looking information.
The credibility and believability of a forecast is likely to be related to the
independence of the monitors that oversee this mode of voluntary disclo-
sure. We therefore expect that an important determinant of how investors
react to a management forecast will be the effectiveness of the firm’s cor-
porate governance structure. This point is especially relevant given recent
evidence by Kasznik [1999] that some managers will manipulate earnings
to meet their forecasts. When a good news forecast is released, it will be
more believable if screened by an effective governance team. When bad
news is conveyed through the forecast, investors are likely to view the new
information with greater suspicion when coming from a poorly monitored
management team. Such a team may be conceived as less than fully truthful,
potentially hiding the full extent of the negative information it possesses.
Therefore, on balance, we expect that the market reaction to both positive
and negative forecasts will be more favorable in the presence of an effective
governance structure.
Research proposition 4: The market reaction to a management earnings forecast is
more favorable for firms with a more effective governance
structure in place.
4. Method and Data Sources

4.1 METHOD
4.1.1. Corporate Governance and the Likelihood of Making a Forecast. Con-
sistent with our discussion in section 2, in examining our four research
propositions we capture corporate governance structures using the percent-
age of outside directors, board size, board meetings, inside ownership, and
institutional ownership. We capture audit committee structure and func-
tioning with the percentage of committee outsiders, the percentage of com-
mittee members with financial expertise, committee size, and committee
meetings. All variables are defined in the appendix.
In the forecast likelihood tests we control for the effects of the in-
formation environment using analyst following (Lang and Lundholm
[1996], Abarbanell, Lanen, and Verrecchia [1995]) and firm size (Brown,
Richardson, and Schwager [1987], Collins, Kothari, and Rayburn [1987],
Lang and Lundholm [1996]). We expect firms that are more generous in
terms of the information they supply to the market to also be more in-
clined to release earnings forecasts. We also control for the dispersion in
analyst forecasts. In previous studies dispersion is used as a proxy for the
information environment (Lang and Lundholm [1996]) and as a proxy for
earnings uncertainty (Abarbanell, Lanen, and Verrecchia [1995], Barron
and Stuerke [1998]). We thus expect that firms will be more likely to is-
sue a forecast in periods with greater dispersion in analyst forecasts, that
is, when there is greater uncertainty regarding their earnings.4 Following
Kasznik and Lev [1995], we also control for high-technology industry mem-
bership. Finally, we control for the sign of the news that management has
the discretion of conveying. If actual earnings for the period are less than
the consensus analyst forecast, we deem the news as bad. For nonforecasting
firms, we measure the nature of the news, analyst forecast dispersion, and
analyst following on the forecasting sample’s mean management forecast
date, measured relative to the end of the forecasted period.
4.1.2. Corporate Governance and Forecast Precision. Next, we code forecast

precision as 1 if the forecast is a point estimate of earnings, and 0 other-
wise. We use logistic regression to link forecast precision to the corporate
governance and control variables outlined in the forecast likelihood tests.
There are three notable differences, however. First, the dummy variable we
construct for bad news is based on the difference between the management
forecast (midpoint for a range forecast) and the consensus analyst forecast.5
As in Bamber and Cheon [1998], we include a bad news dummy to capture
greater exposure to legal liability. Second, we include a variable measuring
the number of days from the forecast date to the end of the relevant period
to control for the fact that forecasts that substantially precede the end of the
fiscal period for which earnings are forecasted are less likely to be precise
(e.g., see Baginski and Hassell [1997], Bamber and Cheon [1998]). We ex-
pect that the earlier the forecast is made, the less is the precision because of
greater uncertainty regarding actual earnings. Third, we include a forecast
update dummy and expect first-time forecasts to be less precise than forecast
updates.
4 We only keep the most recent forecast of each analyst made in the period to minimize the
effects of stale forecasts.

5 The sign of news is captured in different ways in the existing literature. Baginski and
Hassell [1997], for example, use the sign of the three-day cumulative abnormal return around
the management forecast date, whereas Bamber and Cheon [1998] use the sign of the change
in actual earnings.
4.1.3. Corporate Governance and the Absolute Value of the Management Forecast
Error . Next, we focus on the sample of firms issuing a point forecast. We
measure forecast accuracy by the absolute value of the forecast error, thus
greater accuracy is related to a smaller absolute forecast error. We define the
absolute forecast error as the absolute difference between the actual earn-
ings and the management forecast deflated by the forecast. In this model we
control for the same variables as in the precision model. We estimate three
ordinary least squares (OLS) regressions studying the link between the ab-
solute forecast error and corporate governance for the full sample and for
good news and bad news subsamples separately. In a fourth regression we
address the link between forecast bias, defined as signed forecast error, and
corporate governance for the full sample of point forecasts.
4.1.4. Corporate Governance and the Market Reliance on Management Forecasts.

Finally, we examine the reliance of the market on released management fore-
casts in relation to corporate governance characteristics. We regress cumu-
lative market-adjusted returns over the three-day window (−1,0,1) around
the management forecast date on all governance and control variables de-
scribed earlier. We base the bad news dummy on the difference between
the value of the forecast and the consensus analyst forecast, following the
results in Skinner [1994] who finds that the market reaction to a bad news
forecast is in absolute terms greater than the reaction to a good news fore-
cast. However, because this model captures the market reaction to the fore-
cast, we also include a variable capturing the magnitude of the surprise,
which is based on the difference between the management forecast and
the consensus analyst forecast deflated by beginning-of-period price. To be
consistent with the result in Kasznik and Lev [1995], we interact the sign
of news variable with the difference variable to capture possible slope dif-
ferences in the magnitude of the surprise due to the sign of the surprise.
Finally, following Baginski, Conrad, and Hassell [1993], we include the pre-
cision of the released forecast as another control variable in the model
because it is possible that the market relies more on point forecasts. Last,
as an alternative test of the information contained in the forecast, we study
how equity analysts revise their own forecasts in response to a management
forecast.
4.2 DATA SOURCES AND SAMPLE

We collected information on corporate governance from annual proxy
statements except for the institutional ownership data, which we gathered
from Compact Disclosure. Furthermore, we obtained information regarding
management and analyst forecasts as well as actual earnings from First Call,
return data from the Center for Research in Security Prices (CRSP) database,
and financial information from Compustat.
In selecting our sample, we initially considered firms that are listed in
the 1995 Fortune 500 survey. These firms are usually widely held, exhibit-
ing great separation between ownership and control. Voluntary disclosure
is likely to play an important role in bridging the information asymmetry

gap that exists between their management and shareholders. We excluded
financial institutions and utilities from the sample because their regula-
tory environment could confound the effect of governance practices on
disclosure. We identified 325 of these firms in both the Edgar database,
where we located proxy statements, and First Call, where we retrieved data
on management forecasts. We then reduced the sample by firm-year ob-
servations for which First Call does not provide sufficient analyst forecast
data, Compustat does not provide sufficient financial data, and CRSP does
not have returns available in the three days around the forecast announce-
ment date. Last, we deleted foreign firms. This leaves a final sample of
275 firms that announced 1,621 forecasts in 1,274 firm-years between 1995
and 2000.
5. Discussion of Results
5.1CORPORATE GOVERNANCE AND THE LIKELIHOOD OF MAKING
A MANAGEMENT EARNINGS FORECAST
To assess the association between corporate governance mechanisms and
management’s decision to issue an earnings forecast, we initially compare
the governance characteristics of 517 firm-years that had at least one man-
agement forecast with the respective characteristics of 757 firm-years that
had no management forecasts. We assess statistical differences using both
the parametric t-test and the nonparametric Wilcoxon z-test, and present
the results in table 1. Consistent with our first research proposition, firms
making forecasts have a greater fraction of institutional ownership, and their
audit committees meet more frequently. In contrast, the forecast years are as-
sociated with lower inside ownership levels. Management is also more likely
to make an earnings forecast when analyst forecasts are less dispersed, and
when the firm is followed by more analysts, belongs in a high-tech industry,
and is larger.
In table 2 we present Pearson (Spearman) pairwise correlations above
(below) the diagonal among the governance variables and the forecast like-
lihood dummy. Results between Pearson and Spearman correlations are
generally similar. Board and audit committee efficacy variables and institu-
tional ownership are generally positively related, suggesting that these mea-
sures serve as complements in disciplining management. Nevertheless, the
correlation coefficients are always below 0.40, suggesting that each measure
captures a sufficiently distinct dimension of the monitoring process. Inside
ownership is negatively related to board and audit committee measures,
consistent with the notion that it is a substitute monitoring mechanism;
that is, there is a greater need for effective boards and audit committees in
firms with low managerial ownership levels. Last, there is weak evidence that
management forecasts are correlated with relatively more active boards and
audit committees and with lower inside ownership levels.
TABLE 1
Univariate Comparisons of 275 Fortune 500 Firms in 517 Management Forecast Years and
757 Nonforecast Years
All variables are defined in the appendix. The mean (median) value for each variable is pro-
vided in the top (bottom) row. ∗ , ∗∗ , and ∗∗∗ indicate significance at the 10%, 5%, and 1%
levels, respectively (two-tailed).
All Forecast Nonforecast Wilcoxon

Periods Periods Periods Difference t-test z-test
Sample size 1,274 517 757
Firm governance variables
Pct. of outside directors 78.16 78.25 78.09 0.16 0.25 1.10
80.00 80.00 80.00
Board size 11.60 11.59 11.60 −0.01 −0.05 0.87
11 11 11
Board meetings 7.63 7.81 7.50 0.31 2.00∗∗ 1.12
7 7 7
Insider ownership (%) 5.79 4.79 6.47 −1.68 −3.35∗∗∗ −1.77∗
2.19 2.00 2.28
Institutional ownership (%) 58.38 60.22 57.13 3.09 2.41∗∗ 2.91∗∗∗
63.96 65.80 62.65
Audit committee variables
Pct. of committee outsiders 97.04 97.02 97.05 −0.03 −0.04 −0.57
100.00 100.00 100.00
Pct. committee members 20.90 21.05 20.80 0.25 0.19 −0.41
with financial expertise 20.00 20.00 20.00
Committee size 4.55 4.51 4.58 −0.07 −0.88 −1.64
4.00 4 5
Committee meetings 3.58 3.64 3.53 0.11 1.40 2.32∗∗
3 3 3
Control variables
Bad news 0.52 0.54 0.51 0.03 0.95 0.95
1.00 1.00 1.00
Forecast dispersion 0.15 0.07 0.21 −0.14 −7.89∗∗∗ −2.68∗∗∗
0.04 0.03 0.04
Analyst following 13.53 14.07 13.17 0.90 2.21∗∗ 1.44
13 13 12
High-tech industry 0.12 0.15 0.11 0.04 2.10∗∗ 2.15∗∗
0.00 0.00 0.00
Total assets 12,241 14,280 10,849 3,431
5,564 5,889 5,361
In table 3 we present results from the logistic regression model described

previously that is estimated three times: on the full sample of 1274 firm-years
for which all data are available, and on bad news and good news subsamples
separately. When there is more than one forecast in a year we consider
the first forecast of the year to compute our bad news dummy, forecast
dispersion, and analyst following variables. The fourth model in table 3
focuses on all management forecasts made over the sample period and,
given that a forecast is made, assesses the likelihood that the forecast is
subsequently revised.
TABLE 2
Pearson (Spearman) Correlations Above (Below) the Diagonal among Variables Approximating Board and Audit Committee (AC) Structure, and the Likelihood
of Management Earnings Forecasts for 1274 Firm-Year Observations
All variables are defined in the appendix. ∗ , ∗∗ , and ∗∗∗ indicate significance at the 10%, 5%, and 1% levels, respectively (two-tailed).
1 2 3 4 5 6 7 8 9 10
1. Forecast dummy 1.00 0.01 −0.01 0.06∗∗ −0.09∗∗∗ 0.07∗∗ −0.01 0.01 0.01 −0.02
2. Board outsiders 0.02 1.00 −0.08∗∗∗ 0.21∗∗∗ −0.17∗∗∗ 0.04 0.30∗∗∗ 0.15∗∗∗ 0.29∗∗∗ 0.07∗∗∗
3. Board size −0.01 0.03 1.00 0.09∗∗∗ −0.04 −0.14∗∗∗ −0.01 0.04 0.34∗∗∗ 0.05∗
4. Board meetings 0.05∗ 0.14∗∗∗ 0.14∗∗∗ 1.00 −0.25∗∗∗ 0.04 0.14∗∗∗ 0.13∗∗∗ 0.15∗∗∗ 0.19∗∗∗
5. Insider ownership −0.06∗∗ −0.16∗∗∗ −0.15∗∗∗ −0.39∗∗∗ 1.00 −0.25∗∗∗ −0.13∗∗∗ −0.10∗∗∗ −0.21∗∗∗ −0.05∗
6. Institutional ownership 0.07∗∗ 0.05∗ −0.16∗∗∗ 0.06∗∗ −0.18∗∗∗ 1.00 0.03 −0.01 0.01 0.02
7. AC outsiders −0.01 0.24∗∗∗ 0.15∗∗∗ 0.15∗∗∗ −0.09∗∗∗ 0.06∗∗ 1.00 0.08∗∗ 0.05∗ 0.03
8. AC experts −0.01 0.18∗∗∗ 0.19∗∗∗ 0.19∗∗∗ −0.20∗∗∗ 0.03 0.07∗∗ 1.00 0.01 0.07∗∗∗
9. AC size −0.04 0.28∗∗∗ 0.20∗∗∗ 0.20∗∗∗ −0.25∗∗∗ −0.01 −0.03 0.08∗∗∗ 1.00 0.06∗∗
10. AC meetings 0.06∗∗ 0.09∗∗∗ 0.09∗∗∗ −0.12∗∗∗ −0.12∗∗∗ 0.01 0.01 0.11∗∗∗ 0.11∗∗∗ 1.00
BOARDS, AUDIT COMMITTEES, AND EARNINGS FORECASTS
467
TABLE 3
Logit Regressions Examining the Impact of Corporate Governance and Control Variables
on the Likelihood of Making or Updating a Management Earnings Forecast
In the three left-hand models, the dependent variable equals 1 if management issued at least
one earnings forecast in the year, and 0 otherwise. In the right-hand model, the dependent
variable equals 1 for management forecast updates, and 0 for first-time forecasts. All variables
are defined in the appendix. For each variable, coefficient estimates (p-values) are reported
in the top (bottom) row. ∗ , ∗∗ , and ∗∗∗ indicate significance at the 10%, 5%, and 1% levels,
respectively (two-tailed).
All Bad News Good News Forecast

Firm-Years Years Years Updates
Intercept −0.734 1.655 −2.923∗ −7.560∗∗∗
(0.47) (0.22) (0.08) (<0.01)
Pct. of outside directors 1.361∗∗ 1.352 1.653∗ 3.247∗∗∗
(0.04) (0.17) (0.10) (<0.01)
Board size 0.025 0.011 0.032 0.061∗∗
(0.37) (0.78) (0.41) (0.01)
Board meetings 0.003 0.007 −0.01 0.030
(0.91) (0.85) (0.79) (0.18)
Insider ownership (%) −0.030∗∗∗ −0.017 −0.041∗∗∗ 0.019∗∗∗
(<0.01) (0.13) (<0.01) (<0.01)
Institutional ownership (%) 0.007∗∗∗ −0.002 0.014∗∗∗ 0.012∗∗∗
(<0.01) (0.59) (<0.01) (<0.01)
Pct. of committee outsiders −0.868 −0.982 −0.755 0.564
(0.23) (0.32) (0.52) (0.44)
Pct. committee members −0.070 0.601 −0.408 0.918∗∗∗
with financial expertise (0.81) (0.16) (0.32) (<0.01)
Committee size −0.154∗∗∗ −0.160∗∗ −0.133 −0.035
(<0.01) (0.04) (0.10) (0.47)
Committee meetings 0.048 0.007 0.070 0.035
(0.31) (0.91) (0.32) (0.41)
Control variables
Bad news 0.300∗∗ 0.054
(0.02) (0.64)
Forecast dispersion −2.205∗∗∗ −2.091∗∗∗ −2.400∗∗∗ −0.609∗∗
(<0.01) (<0.01) (<0.01) (0.04)
Analyst following 0.083∗∗∗ 0.099∗∗∗ 0.069∗∗∗ 0.018∗
(<0.01) (<0.01) (<0.01) (0.08)
High-tech industry −0.513∗∗ −0.600∗ −0.354∗ 0.630∗∗∗
(0.02) (0.07) (0.06) (<0.01)
Log(Total assets) 0.063 −0.095 0.224∗∗ 0.125∗
(0.40) (0.37) (0.04) (0.05)
Annual forecast −2.036∗∗∗ −2.300∗∗∗ −1.792∗∗∗ 1.789∗∗∗
(<0.01) (<0.01) (<0.01) (<0.01)
Forecast years 517 281 237 710
(forecast updates)
Zero forecast years 757 391 366 916
(first forecast)
χ 2 for covariates 307.08∗∗∗ 203.07∗∗∗ 123.90∗∗∗ 392.31∗∗∗
Each of the four models in table 3 is jointly significant in explaining the

likelihood of making a forecast at the 0.001 level or better, as signified by the
χ 2 statistic for the covariates. Focusing first on the sample studying forecast
likelihood, firms are more likely to make a forecast when their boards are
more independent from management’s influence, when managerial own-
ership is lower (Ruland, Tung, and George [1990]), and when institutions
own a greater fraction of the firm’s stock. Finally, the results suggest that
the likelihood of making a forecast is inversely related to committee size.
Together, these results generally agree with the first proposition and the no-
tion that better incentive alignment between management and shareholders
is associated with the provision of more information from management to
shareholders.
Management is also more likely to issue a forecast when anticipating bad
news and when analyst forecasts are less dispersed. Firms with greater analyst
following are also more likely to issue a management forecast, whereas firms
in high-tech industries are less likely to issue a forecast.
In the bad news subsample, among the governance variables, only audit
committee size is significant in explaining the likelihood of a forecast. In con-
trast, in the good news subsample, board independence, insider ownership,
and institutional holdings are all significant in explaining the likelihood of
a forecast. Results on the control variables are generally consistent across
the two models.
Finally, to gain further insight into the relation between corporate gov-
ernance and management forecasts, we study the likelihood of updating a
forecast. The results suggest that forecast updates are more likely in firms
with more independent and larger boards, firms with a greater fraction of
experts in their audit committee, and firms in which insiders and institutions
own a higher fraction of equity. The likelihood of management forecast up-
dates is also higher for larger firms, firms with greater analyst following, and
firms belonging in a high-tech industry, and it is lower for firms with greater
analyst forecast dispersion. In sum, although some of the evidence from
table 3 is different from the univariate comparisons presented in table 1,
the overall findings generally suggest that better governance leads to more
disclosure flowing from management to shareholders.6
5.2CORPORATE GOVERNANCE AND THE PRECISION OF MANAGEMENT
EARNINGS FORECASTS
Focusing next on forecast precision, we partition the 1621 forecasts in
our sample into 609 forecasts that make a point estimate of the firm’s future
earnings and 1,012 forecasts that do not. (These include range forecasts that
specify upper and lower bounds for future earnings, open-ended forecasts
that specify either of the bounds but not both, and qualitative forecasts that
do not provide any numeric guidance on future earnings.) In table 4 we
6 Reported results implement 1% outlier elimination based on the Pearson residual. Not
eliminating outliers does not meaningfully change the interpretation of results.

TABLE 4
Univariate Comparisons of 1,621 Management Forecasts Partitioned by Degree of Precision
All variables are defined in the appendix. Other forecasts comprise range, open-ended, and
qualitative forecasts. The mean (median) value for each variable is provided in the top (bottom)
row. ∗ , ∗∗ , and ∗∗∗ indicate significance at the 10%, 5%, and 1% levels, respectively (two-tailed).
All Wilcoxon
Forecasts Point Other Difference t-test z-test
Sample size 1,621 609 1,012
Dependent variable
Forecast-induced return −2.09 −1.09 −2.69 1.70 3.57∗∗∗ 5.30∗∗∗
−0.79 0.07 −1.51
Pct. of outside directors 79.33 77.83 80.16 −2.33 −4.18∗∗∗ −3.92∗∗∗
80.00 80.00 81.81
Board size 11.69 11.73 11.66 0.07 0.44 0.26
12 12 12
Board meetings 7.80 7.50 7.98 −0.48 −3.38∗∗∗ −1.96∗∗
7 7 8
Insider ownership (%) 5.53 5.55 5.52 0.03 0.07 0.17
1.93 1.98 1.93
Institutional ownership (%) 60.34 60.25 60.41 −0.16 −0.14 0.60
65.71 65.90 65.54
Pct. of committee outsiders 97.15 96.84 97.00 −0.16 −0.34 −0.70
100.00 1.00 1.00
Pct. committee members 22.76 20.90 23.90 −3.00 −2.55∗∗ −1.92∗
with financial expertise 20.00 20.00 20.00
Committee size 4.65 4.52 4.73 −0.21 −2.87∗∗∗ −2.84∗∗∗
5 4 5
Committee meetings 3.68 3.72 3.66 −0.06 −0.72 −0.66
4 4 4
Control variables
Bad news 0.57 0.43 0.66 −0.23 −8.91∗∗∗ −8.79∗∗∗
1.00 0.00 1.00
Forecast dispersion 0.06 0.04 0.07 −0.03 −3.92∗∗∗ −5.55∗∗∗
0.02 0.02 0.03
Analyst following 15.10 15.21 15.03 0.18 0.49 1.02
14 14 14
High-tech industry 0.18 0.18 0.18 0.00 0.22 0.22
0.00 0.00 0.00
Days to end of financial 111.4 111.2 111.9 −0.7 −0.14 −0.13
reporting period 78 79.5 77
Total assets (in $millions) 16,989 13,249 19,239 −5,990 −4.21∗∗∗ −0.85
7,490 7,170 7,867
employ both the parametric t-test and the nonparametric Wilcoxon z-test
to assess cross-sample univariate differences in each of the governance and
control characteristics.
We find that firms with a higher fraction of independent directors serving
on their boards, with boards that meet more frequently, with larger audit
committees, and with a higher fraction of financial experts tend to make less
precise forecasts. Thus, better corporate governance is associated with lower

forecast precision. Moreover, the content of the message is a significant
determinant of the level of specificity in the forecast; that is, bad news is
conveyed in less precise terms. Last, more precise forecasts are more likely
when analyst forecasts are less dispersed.
To probe further into the variation in the level of precision in manage-
ment earnings forecasts, we estimate logistic regression models of the deci-
sion to issue a point forecast on corporate governance and control charac-
teristics and present the results in table 5. We estimate three models: one
on the full sample of 1,621 forecasts, and two on subsamples of bad news
and good news forecasts.7 Each of the models is statistically significant in
explaining the likelihood of issuing a point forecast.
Focusing first on the full model, firms with independent boards, greater
insider ownership, and more expert and larger audit committees are less
likely to issue a point forecast, suggesting that these firms actually provide
less guidance to the market. Institutional ownership is positively related to
forecast precision. Finally, we find that bad news is conveyed in less pre-
cise terms, consistent with greater legal liability being associated with lower
forecast precision (Bamber and Cheon [1998]).
Next, we observe that the full-sample results are driven by the bad news
forecasts. Well-governed firms issue less precise forecasts in the face of bad
news. Specifically, among the subsample of bad news, point forecasts are less
likely for firms with more independent directors and a greater fraction of
inside ownership. The only significant variable in the good news sample is
institutional ownership. In sum, we find that less precise forecasts are more
likely among well-governed firms conveying negative news to investors.8
5.3 CORPORATE GOVERNANCE AND THE ACCURACY AND BIAS
OF MANAGEMENT EARNINGS FORECASTS
Table 6 presents results of OLS regressions addressing the link between
forecast accuracy and bias to corporate governance characteristics. To
obtain a precise measure of the forecast error, we focus on the 553 point
forecasts in our sample for which data are available. (Alternatively, employ-
ing both point and range forecasts in the tests produced qualitatively similar
results.) Results from the full sample of point forecasts suggest that the abso-
lute value of the forecast error (forecast accuracy) declines (increases) with
increases in board independence, consistent with our third research propo-
sition. Thus, boards with a greater fraction of outside directors make more
accurate forecasts. Also, in firms with greater insider ownership managers
7 If the management forecast is less than the consensus analyst forecast, we deem the news
as bad.
8 Reported results implement 1% outlier elimination based on the Pearson residual. Not
eliminating outliers in the overall sample increases the significance of insider ownership to
the 1% level but decreases the significance of committee size to the 10% level. Committee
expertise is no longer significant.
TABLE 5
Logistic Regressions Examining the Impact of Corporate Governance and Control Variables
on the Precision of Management Earnings Forecasts
The dependent variable is set to 1 for point forecasts and 0 for range, open-ended, and qualita-
tive forecasts. All variables are defined in the appendix. For each variable, coefficient estimates
(p-values) are reported in the top (bottom) row. ∗ , ∗∗ , and ∗∗∗ indicate significance at the 10%,
5%, and 1% levels, respectively (two-tailed).
All Bad News Good News

Firm-Years Forecasts Forecasts
Intercept 1.457∗∗∗ 3.729∗∗∗ −1.672
(<0.01) (<0.01) (0.27)
Pct. of outside directors −1.602∗∗∗ −3.382∗∗∗ −0.186
(<0.01) (<0.01) (0.83)
Board size 0.017 0.026 −0.005
(0.46) (0.40) (0.90)
Board meetings −0.034 −0.024 −0.049
(0.13) (0.44) (0.14)
Insider ownership (%) −0.014∗ −0.059∗∗∗ 0.012
(0.05) (<0.01) (0.27)
Institutional ownership (%) 0.007∗∗ −0.003 0.016∗∗∗
(0.03) (0.47) (<0.01)
Pct. of committee outsiders −0.047 −0.633 0.467
(0.94) (0.47) (0.64)
Pct. committee members −0.420∗ −0.429 −0.366
with financial expertise (0.09) (0.23) (0.30)
Committee size −0.124∗∗∗ −0.101 −0.108
(<0.01) (0.13) (0.11)
Committee meetings 0.068 0.082 0.025
(0.11) (0.22) (0.65)
Control variables
Bad news −1.038∗∗∗ – –
(<0.01)
Annual forecast 0.135 0.098 −0.093
(0.93) (0.67) (0.70)
Forecast dispersion −0.923 −1.449 −0.856
(0.14) (0.13) (0.34)
Analyst following 0.010 −0.007 0.027∗
(0.30) (0.58) (0.07)
High-tech industry −0.095 0.031 −0.344
(0.58) (0.89) (0.19)
Days to end of financial −0.001 0.001 −0.001
reporting period (0.41) (0.79) (0.34)
Forecast update −0.139 −0.109 −0.140
(0.30) (0.57) (0.44)
Log(Total assets) −0.001 −0.072 0.124
(0.99) (0.39) (0.23)
Point forecasts 584 252 332
Range and qualitative forecasts 1,007 673 335
χ 2 for covariates 135.34∗∗∗ 54.71∗∗∗ 27.88∗∗
TABLE 6
Ordinary Least Squares Regressions Examining the Impact of Corporate Governance and Control
Variables on the Accuracy and Bias of Management Earnings Forecasts
Forecast accuracy (bias) is the absolute value of the difference (signed difference) between
actual earnings and the management forecast. All variables are defined in the appendix. Co-
efficient estimates (p-values) are reported in the top (bottom) row. ∗ , ∗∗ , and ∗∗∗ indicate
significance at the 10%, 5%, and 1% levels, respectively (two-tailed).
Absolute Forecast Error

Forecast Bias
All Forecasts Bad News Good News All Forecasts
Intercept 0.210 −0.447∗ 0.402 −0.252
(0.24) (0.06) (0.18) (0.32)
Pct. of outside directors −0.229∗∗ −0.015 −0.368∗∗ 0.001
(0.03) (0.93) (0.02) (0.99)
Board size 0.002 0.003 −0.001 −0.017∗∗∗
(0.71) (0.70) (0.86) (<0.01)
Board meetings −0.001 0.001 −0.006 0.005
(0.77) (0.98) (0.33) (0.90)
Insider ownership (%) 0.006∗∗∗ 0.007∗∗ 0.005∗∗∗ −0.004∗
(<0.01) (0.02) (<0.01) (0.06)
Institutional ownership (%) −0.001 0.001 −0.001 0.001
(0.33) (0.96) (0.31) (0.28)
Pct. of committee outsiders 0.201 0.337∗ 0.171 0.001
(0.11) (0.06) (0.37) (0.99)
Pct. committee members 0.076 0.017 0.145∗∗ −0.042
with financial expertise (0.13) (0.85) (0.03) (0.54)
Committee size 0.012 −0.022 0.035∗∗∗ −0.016
(0.18) (0.14) (<0.01) (0.20)
Committee meetings −0.001 0.018 −0.004 0.014
(0.92) (0.20) (0.64) (0.15)
Control variables
Bad news −0.164∗∗∗ – – 0.247∗∗∗
(<0.01) (<0.01)
Annual forecast −0.057∗ −0.058 −0.081∗ 0.093∗∗
(0.08) (0.26) (0.08) (0.04)
Forecast dispersion 0.150 1.270∗∗∗ −0.232 0.103
(0.19) (<0.01) (0.15) (0.51)
Analyst following 0.005∗∗∗ 0.004 0.006∗∗ −0.007∗∗∗
(<0.01) (0.28) (0.04) (<0.01)
High-tech industry 0.103∗∗∗ −0.062 0.172∗∗∗ −0.081∗
(<0.01) (0.29) (<0.01) (0.09)
Days to end of financial 0.001∗∗∗ 0.001 0.001∗∗ −0.001∗∗∗
reporting period (<0.01) (0.44) (0.03) (<0.01)
Forecast update −0.028 0.042 −0.027 0.024
(0.28) (0.29) (0.49) (0.61)
Log(Total assets) −0.014 0.007 −0.020 0.030∗
(0.29) (0.71) (0.31) (0.09)
Sample size 553 217 335 557
F -statistic 9.90∗∗∗ 3.20∗∗∗ 5.19∗∗∗ 9.07∗∗∗
Adjusted R 2 (in pct. points) 21.65 13.96 16.68 19.79
make less accurate forecasts, possibly because of the entrenchment effect of

ownership. This result is consistent with earlier findings presented in this
article that higher inside ownership is associated with a lower likelihood of a
management forecast and with lower forecast precision. The sample break-
down reveals that independent boards are more accurate when making good
news forecasts, whereas higher ownership is associated with a greater forecast
error in both subsamples. For the good news subsample, absolute forecast
error increases with committee size and, counterintuitively, with commit-
tee expertise. Neither result appears in the full-sample tests. Results on
the control variables suggest that management forecasts are more accurate
when conveying bad news and when pertaining to annual earnings. Fore-
casts are less accurate in firms with a high analyst following and in high-tech
firms.
Last, governance measures are not generally associated with any systematic
bias in management forecasts, proxied by the signed forecast error, except
for board size and inside ownership levels, both of which are associated
with more optimistic forecasts. Management forecasts are more pessimistic
when bad news is disclosed, when annual earnings are forecasted, and when
issued by a larger firm, whereas forecasts are more optimistic for high-tech
firms, for firms with greater analyst following, and for firms with a longer
time from the forecast to the end of the reporting period. In sum, the results
in table 6 pertaining to our third proposition suggest that effective boards
and audit committees are related to forecast accuracy but not to forecast
bias.
5.4CHANGES IN CORPORATE GOVERNANCE AND MANAGEMENT

EARNINGS FORECASTS
One issue that has to be addressed regarding our results is the possibil-
ity that board and audit committee characteristics are endogenously deter-
mined, depending on factors that are not controlled for in this study—for
example, on each firm’s managerial labor, corporate control, and other
factor and product markets; ownership structure; regulation intensity; and
volatility in the operating environment (e.g., Demsetz and Lehn [1985]).
The related concern is that unobserved omitted variables could be corre-
lated with both governance structures and forecast attributes, leading to
a spurious relation between the governance and forecast variables. To ad-
dress empirically the endogeneity problem, prior work has modeled these
relations in systems of equations (e.g., Agrawal and Knoeber [1996]) to rec-
ognize the possibility that each of the corporate governance characteristics
depends on another set of firm attributes.
Alternatively, another set of studies addresses endogeneity by com-
plementing tests associating various phenomena to levels of corporate
governance with tests linking such phenomena to changes in corporate
governance (e.g., see Klein [2002]). The intuition behind the focus on gov-
ernance changes is that there is likely to be much lower temporal fluctuation
in any omitted variable for a given firm than there is fluctuation of such a
variable across firms at a given time. One drawback of this approach is that
it is more data intensive, a thorny issue when working with hand-collected
governance data. Also, governance structures remain relatively unchanged
through time. Such stickiness reduces the statistical power of the tests on
changes. These limitations notwithstanding, we exploit the six-year panel
structure of our data set and repeat our analysis on the likelihood, preci-
sion, and accuracy of management forecasts, focusing on changes in boards
and audit committees rather than on the respective variable levels. Our
results are presented in table 7.
The forecast likelihood regression focuses on firms with at least one man-
agement forecast in the prior year. The dependent variable equals 1 if the
firm issues a management forecast in the current year as well, and 0 oth-
erwise, thus separating forecasting firms from firms switching to the non-
forecasting group. We find that 369 firm-years exhibit such a change in
forecasting policy and use them in the tests. Given that a change in the
binary forecast variable is examined, we use first differences in the control
variables as well. Consistent with earlier results and our first proposition, we
find that as boards become more independent, management is significantly
more likely to continue making forecasts. Other governance effects are in-
significant, whereas committee independence is weakly negative. Among
the controls, we find that firms with lower analyst forecast dispersion and
smaller firms are less likely to switch to a nonforecasting status.
The results on the model estimating the relation between forecast preci-
sion and governance changes are generally similar to the results from table 5
on governance levels. Specifically, as board independence and board activity
rise, boards make less precise forecasts, a finding that is consistent with our
earlier conclusion. As boards become more effective, they are less likely to
risk providing precise forecasts to the market. Similarly, increases in insider
ownership are also associated with less precise forecasts. Last, less precision
is associated with bad news and greater uncertainty (dispersion) among
analysts.
Results linking forecast accuracy to governance changes are weak. Coun-
terintuitively, increases in audit committee independence are associated
with lower accuracy. Given the relative rarity of intertemporal changes in
that variable (the vast majority of audit committees include all outsiders
throughout the sample period), this finding is best seen as anecdotal. Bad
news, greater analyst following, greater firm size, and greater time proximity
to the end of the financial reporting period are all associated with greater
forecast accuracy. Also, forecast updates are more accurate than first-time
forecasts after controlling for the time to the end of the financial report-
ing period. Compared with earlier results based on variable levels, results
from variable changes are weakly aligned for likelihood tests, more strongly
aligned for tests on forecast precision, and not aligned for tests on forecast
accuracy.
TABLE 7
Governance Changes and Management Forecast Likelihood, Precision, and Accuracy
The nonforecasting status regression focuses on firms switching from forecasting in the prior
year to nonforecasting in the current year, and it considers the changes in, rather than levels
of, the control variables. Nonforecasting status and forecast precision are explained using
logistic regression; accuracy is explained using ordinary least squares regression. All variables
are defined in the appendix. The p-values are in parentheses. ∗ , ∗∗ , and ∗∗∗ indicate significance
at the 10%, 5%, and 1% levels, respectively (two-tailed).
Nonforecasting Forecast Forecast

Status Precision Accuracy
Intercept 0.248 0.749 0.405∗∗∗
(0.12) (0.11) (<0.01)
Pct. of outside directors 4.815∗∗ −3.798∗∗∗ −0.060
(0.03) (<0.01) (0.79)
Board size 0.043 0.072 0.015
(0.65) (0.16) (0.13)
Board meetings 0.003 −0.072∗∗ −0.001
(0.96) (0.01) (0.88)
Insider ownership −0.150 −0.070∗∗ 0.005
(0.14) (0.04) (0.38)
Institutional ownership −0.006 −0.001 0.001
(0.47) (0.81) (0.30)
Pct. of committee outsiders −3.505∗ 1.073 −0.313∗∗
(0.06) (0.25) (0.04)
Pct. committee members 0.329 −0.064 −0.046
with financial expertise (0.65) (0.85) (0.49)
Committee size 0.065 −0.035 0.005
(0.72) (0.68) (0.76)
Committee meetings 0.055 0.018 0.001
(0.61) (0.74) (0.92)
Control variables
Bad news 0.217 −0.96∗∗∗ −0.180∗∗∗
(0.24) (<0.01) (<0.01)
Annual forecast – −0.001 −0.032
(0.98) (0.37)
Forecast dispersion −3.376∗∗∗ −2.273∗∗∗ −0.168
(<0.01) (<0.01) (0.24)
Analyst following 0.007 0.007 0.007∗∗∗
(0.76) (0.44) (<0.01)
High-tech industry – −0.141 0.051
(0.40) (0.16)
Log(Total assets) −0.001∗∗ −0.073 −0.023∗
(0.03) (0.23) (0.06)
Days to end of financial – −0.001 0.001∗
reporting period (0.69) (0.09)
Forecast update – −0.20 −0.068∗∗∗
(0.13) (<0.01)
Sample size 369 1,516 532
−2 log-likelihood (F -statistic) 452.42∗∗∗ 121.4∗∗∗ (7.88)∗∗∗
Pct. adjusted R 2 (pseudo-R 2 ) (9.6%) (7.1%) 18.0%
5.5CORPORATE GOVERNANCE AND THE MARKET REACTION

TO MANAGEMENT EARNINGS FORECASTS
5.5.1. Price Reaction Tests. In the first three models in table 8 we address
our fourth research proposition, studying the relation between corporate
governance structures and forecast-induced abnormal returns. Again, we
partition the sample of management forecast announcements into bad news
and good news to study the relation between governance structures and
announcement-related returns for the two samples separately. Each of the
models in table 8 is jointly significant at the 5% level or better, as signified
by the respective model F -statistics. Furthermore, a χ 2 test suggests that het-
eroskedasticity is not a significant problem for our results (White [1980]).
Focusing first on the full sample of announcements, the three-day an-
nouncement return is positively related to the number of independent di-
rectors serving on the board. Also, the forecast-induced return is negatively
related to board size and audit committee size. In addition, the fraction
of directors with financial expertise serving in the audit committee is posi-
tively associated to the announcement return. These results are consistent
with the predictions of our fourth proposition, supporting the notion that
forecasts are assessed more favorably when screened by more effective gov-
ernance mechanisms. The sample breakdown reveals that most of these
results hold in both the bad and good news subsamples. Specifically, in
the bad news sample board independence and financial expertise are both
positively related to announcement returns, as expected, while committee
size is negatively related to returns. Among the sample of good news an-
nouncements, the market reacts more favorably when the announcement
comes from a smaller but less active board, and a more independent audit
committee that meets more frequently.
In the full-sample model, the return is significantly lower for bad news
announcements while the magnitude of the surprise matters more in the
case of bad news. Last, the market reacts more positively to annual forecasts,
to forecasts by larger firms, and to more precise forecasts, probably because
of skepticism toward more vague forecasts. Also, precision is rewarded only
for bad news, probably because greater information asymmetry reduces in-
vestor trust in firms that issue vague forecasts. In the good news subsample
the market is more positive toward annual forecasts and toward forecasts by
firms with a lower analyst following. Finally, firm size is positively related to
returns in both samples.9 In sum, the results from table 8 suggest that fore-
casts by firms with effective boards and audit committees are received more
favorably by the market, consistent with our fourth research proposition.
5.5.2. Equity Analyst Reaction. To shed further light on the relation

among boards, audit committees, and the informativeness of management
9 Outliers are eliminated based on the studentized residual using a cutoff of |3.0|. Results
are not sensitive to the cutoff used.

TABLE 8
Corporate Governance and the Market Reaction to Management Earnings Forecasts
All variables are defined in the appendix. The models are estimated using ordinary least squares.
The p-values are in parentheses. ∗ , ∗∗ , and ∗∗∗ indicate significance at the 10%, 5%, and 1%
levels, respectively (two-tailed).
Forecast-Induced Return Analyst Reaction

All Forecasts Bad News Good News All Forecasts
Intercept −0.083∗∗ −0.199∗∗∗ −0.081∗ −0.010∗∗∗
(0.03) (<0.01) (0.08) (<0.01)
Pct. of outside directors 0.054∗∗ 0.094∗∗ −0.031 0.001
(0.03) (0.04) (0.33) (0.81)
Board size −0.002∗∗ −0.002 −0.001∗ 0.001
(0.01) (0.11) (0.09) (0.66)
Board meetings −0.001 −0.001 −0.002∗∗ −0.001∗
(0.16) (0.40) (0.02) (0.08)
Insider ownership (%) −0.001 0.001 −0.001 −0.001
(0.35) (0.80) (0.97) (0.71)
Institutional ownership (%) 0.001 0.001 0.001 0.001∗∗∗
(0.49) (0.51) (0.54) (<0.01)
Pct. committee outsiders 0.029 0.022 0.088∗∗∗ −0.001
(0.23) (0.61) (<0.01) (0.89)
Pct. committee members 0.022∗∗ 0.041∗∗ 0.014 0.001
with financial expertise (0.03) (0.03) (0.19) (0.78)
Committee size −0.003∗ −0.006∗ −0.004∗ 0.001
(0.06) (0.08) (0.07) (0.29)
Committee meetings 0.002 −0.006∗∗ 0.004∗∗ 0.001
(0.53) (0.04) (0.01) (0.49)
Control variables
Bad news −0.049∗∗∗ −0.001
(<0.01) (0.53)
Management forecast − 0.025 1.003∗ 0.031 0.007
Analyst expectations (0.53) (0.08) (0.42) (0.24)
(Management − Analyst forecast)× 1.126∗∗ 0.522∗∗∗
Bad news (0.01) (<0.01)
Annual forecast 0.019∗∗∗ 0.023∗ 0.021∗∗∗ 0.001
(<0.01) (0.05) (<0.01) (0.33)
Forecast dispersion 0.019 0.036 0.013 0.003
(0.27) (0.19) (0.62) (0.36)
Analyst following −0.001 0.001 −0.001∗∗ −0.001
(0.95) (0.31) (0.04) (0.60)
High-tech industry 0.006 0.014 0.011 −0.001
(0.37) (0.30) (0.19) (0.58)
Forecast update −0.001 −0.012 0.007 –
(0.84) (0.21) (0.25)
Log(Total assets) 0.005∗ 0.011∗∗ 0.007∗∗ 0.001∗∗∗
(0.06) (0.04) (0.02) (<0.01)
Point forecast 0.007∗ 0.020∗∗ 0.002 0.001∗∗∗
(0.08) (0.02) (0.67) (<0.01)
Sample size 1,149 535 618 363
F -statistic 10.38∗∗∗ 2.98∗∗∗ 2.88∗∗∗ 8.13∗∗∗
Adjusted R 2 (in pct. points) 14.05 6.24 5.19 27.23
forecasts, we study the likelihood and extent of equity analysts’ forecast revi-
sions in response to earnings forecasts made by management (see Gift and
Yohn [1998], and Koch [2002]). Our expectation is that the magnitude of
analyst forecast revisions will be positively related to the quality of a firm’s
governance because forecasts screened by well-governed firms will be seen
as more credible. Because of stringent data requirements pertaining to the
study of only the first forecast in the year, and to the construction of the
forecast revision variable, our sample for this test is limited to 363 man-
agement forecasts. This model is significant in explaining forecast revisions
(F = 8.13, p < 0.001, adjusted R 2 = 27.23%). Nevertheless, there is little
evidence to suggest that boards and audit committees are associated with
the way analysts react to these forecasts. Analysts respond more favorably to
management forecasts when institutions own a larger fraction of company
shares (t = 4.37). Also, analysts respond more positively to management
forecasts by larger firms that convey more favorable news and are more
precise.
In further tests (results not tabulated), we find a significant increase in the
number of analysts issuing a forecast for the firm in the 90 days following
the management forecast. We further find that increase to be positively
related to a firm’s level of inside ownership but unrelated to other board
and audit committee characteristics. Thus, a management forecast sparks
more attention for the firm, especially if the firm is closely held.
5.6 ADDITIONAL SENSITIVITY CHECKS

We perform several analyses to check the robustness of our results. The
models in table 5 are alternatively estimated using ordinal logit analysis by
allowing precision to take four different values representing point, range,
open-interval, and qualitative forecasts. Board independence and insider
ownership continue to be highly significant in both the overall sample and
the bad news subsample. In addition, dispersion is negatively related to pre-
cision in both models. In the good news subsample, corporate governance
variables continue to be insignificant. Analyst following is positively related
to precision, consistent with the results of Baginski and Hassell [1997], and
membership in a high-tech industry is negatively related to precision.
We also perform two sensitivity tests to account for the use of multiple
observations for the same firm in some of the tests. Specifically, we perform
cross-sectional, by-year, logistic and OLS regressions explaining the likeli-
hood, precision, and accuracy of management forecasts. We then test for
the significance of the average coefficient for each explanatory variable in
two ways: we construct a t-statistic (see Fama and MacBeth [1973]) and a
log-likelihood statistic of the p-values (see Fisher [1970]). The results from
these tests are generally consistent with the results presented in our main
analysis.
To examine the extent to which multicollinearity presents a problem in
the estimation of the relation between corporate governance and manage-
ment forecasts for the regressions relating the board and audit committee
characteristics to forecast accuracy and forecast-induced returns (tables 6

and 8), we compute the variance inflation factors (VIFs) for each of the
independent variables. VIFs for the governance variables are always below
1.6, suggesting that multicollinearity is not likely to be a major factor driving
our results.
We also estimate the mitigating role of good news and bad news on forecast
properties by pooling all observations together and using interactive terms
to capture the difference in the relation between governance structures and
forecast features across good news and bad news subsamples. This approach
constrains the coefficients on the control variables to be the same for the
two subsamples and provides direct evidence on any statistically significant
difference in the hypothesized relations across subsamples. As is shown in
the results in table 3, inside ownership is more positively, and institutional
ownership is more negatively, related to the likelihood of a forecast in the
bad news subsample. In the regression estimating the likelihood of forecast
precision, the slopes of the coefficients for inside ownership and committee
expertise are significantly more negative for the bad news subsample. Fi-
nally, in the market reaction regression, except for the committee meetings
variable, which is more negative for the bad news subsample, there do not
appear to be significant differences across subsamples.
6. Discussion and Conclusion

We study the relation between the board of directors, the audit commit-
tee, and ownership structure with the occurrence, precision, and accuracy
of management’s earnings forecasts, and the market’s perception of their
value. We initially find that firms with effective governance mechanisms
are more likely to make or update a management forecast. Effective gover-
nance is more strongly related to the likelihood of a management forecast
in the face of bad news. This evidence is consistent with the notion that
governance matters and that better governance in public corporations is as-
sociated with less information asymmetry between management and share-
holders. The evidence on bad news in particular, when shareholders are
at most risk of suffering wealth losses, suggests that in well-governed firms
managers shape their disclosure policy to protect their shareholders. When
management possesses good news, audit committee expertise is important
to the decision of whether to issue a forecast.
We also find that among forecasting firms, forecast precision decreases
with better governance, but only when bad news is conveyed. One possi-
ble explanation for this result is that well-governed firms are more mindful
of their obligation not to mislead shareholders. The danger of misleading
shareholders is greater when the firm performs worse than expected, and
issuing more vague forecasts reduces this danger. The finding of less precise
forecasts by well-governed firms could also be coupled with the earlier find-
ing that well-governed firms are more likely to make forecasts, especially
in the presence of bad news. Therefore, although in well-governed firms
managers are more likely to voluntarily disclose bad news to shareholders,

given the added risk managers undertake, they have to sacrifice some preci-
sion in making these additional disclosures. An alternative explanation for
these results is that well-governed firms may be more sensitive to the dan-
ger of legal action against management and the board; thus, forecasts are
conveyed in less precise terms.
Effective corporate boards and audit committees are also related to
greater forecast accuracy. This finding is consistent with effective governance
being associated with high-quality information flowing from management
to investors. This effect is partly supported in both the good news and bad
news subsamples.
Finally, we find some evidence that the market reaction to management
forecast announcements is related to board and audit committee character-
istics. For the full sample, board independence and committee expertise are
positively related, whereas board and audit committee sizes are negatively
related to the market reaction to a forecast. The market places greater em-
phasis on board independence and committee expertise when bad news is
announced. The evidence from these tests generally suggests that investors
have greater confidence in forecasts that undergo the scrutiny of what are
commonly perceived as more effective governance mechanisms.
In a study completed independently of our own, Ajinkya, Bhojraj, and
Sengupta [2004] study the relation between institutional investors and out-
side directors with the properties of management forecasts and find similar
results. In line with our evidence, they also find that institutional ownership is
associated with greater forecast occurrence and precision. Both studies also
find that outside directors are associated with greater forecast occurrence.
We additionally find that outside directors are related to greater forecast
accuracy. However, neither we, nor Ajinkya, Bhojraj, and Sengupta find the
hypothesized positive association between forecast precision with outside
directors: Ajinkya, Bhojraj, and Sengupta find an insignificant relation be-
tween the two, and we find a negative relation. Finally, Ajinkya, Bhojraj,
and Sengupta find evidence that outside directors and institutional owner-
ship mitigate the bias in earnings forecasts, whereas we find that smaller
boards issue less biased forecasts. One possible explanation is that any dif-
ferences in results stem from the fact that the association between corporate
governance and management forecasts may be captured well by board char-
acteristics other than just outside director representation. Board size and
meetings, inside ownership, and audit committee structure and function-
ing are generally correlated with board independence and may account
for the difference in results between the two studies. A second potential
source of differences is our sampling of larger Fortune 500 firms compared
with Ajinkya, Bhojraj, and Sengupta’s sampling of a broader cross-section
of firms. Firm size is likely to be related to both governance structures and
disclosure policies. In the forecast precision tests in particular, the fear of
litigation against directors is likely to be stronger in the larger firms sam-
pled here. Any differences notwithstanding, the general conclusion in both
studies is that corporate boards and ownership structure are systematically

associated with the properties of management earnings forecasts.
In closing, the results in our study are in line with the active role of the
board of directors, the audit committee, and institutional shareholders in
improving voluntary information disclosure practices. These results are also
consistent with the notion that policy makers can achieve improvements in
the quality of financial disclosure by encouraging public firms to implement
sound governance practices.
APPENDIX
Variable Definitions
Dependent Variables
Forecast likelihood (update) = 1 if management issued at least one earnings
forecast in the year (updated a previous forecast), and 0 otherwise
Point forecast = 1 for point forecasts, and 0 for range, open-ended, and qual-
itative forecasts
Forecast accuracy (bias) = the absolute difference (signed difference) between
actual earnings and the management forecast deflated by the median
analyst forecast
Forecast-induced return = the three-day market-adjusted return centered
around the forecast announcement date
Analyst reaction = the change in the consensus analyst forecast from 90 days
before to 90 days after the management forecast date, deflated by price
Firm Governance Variables
Pct. of outside directors = the fraction of nonexecutive to total directors
Board size = the total number of corporate directors on the proxy statement
date
Board meetings = the number of meetings held by the board in the year,
excluding telephonic meetings and actions by the written consent of the
board
Insider ownership = the fraction of common stock owned by all officers of the
corporation and directors as a group
Institutional ownership = the fraction of common stock owned by qualified
institutions
Audit Committee Variables
Pct. of committee outsiders = the fraction of committee members who are not
current or past firm employees and who do not have a fiduciary relation
to the firm
Pct. of committee members with financial expertise = the fraction of committee
members who served on another Fortune 500 audit committee between
1995 and 2000
Committee size = the number of committee members as of the proxy statement
date
Committee meetings = the annual number of meetings by the audit committee
Control Variables
Bad news = 1 in the likelihood (precision, accuracy, market reaction) test if
actual earnings (the management forecast) for the period is less than the
consensus forecast, and 0 otherwise
Forecast dispersion = the standard deviation of all forecasts made in the
90 days before the management forecast
Analyst consensus = the mean analyst forecast made in the 90 days before the
management forecast
Analyst following = the number of analysts issuing at least one forecast for the
firm in the year ending 30 days before the management earnings forecast
High-tech industry = 1 for SIC 2833–2836, 8731–8734, 7371–7379, 3570–3577,
and 3600–3674, and 0 otherwise
Annual forecast = 1 for forecasts of annual earnings, and 0 otherwise
Days to end of financial reporting period = the number of days from the man-
agement forecast date to the end of the period for which the forecast is
made
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The Association Between Corporate Boards, Audit Committees, and Management Earnings Forecasts An Empirical Analysis

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DOI: 10.1111/j.1475-679X.2005.00177.

The Association between Corporate

Received 23 July 2004; accepted 6 January 2005

Leuz and Verrecchia [2000].

2. Measures of Corporate Governance

2.1 MEASURES OF GENERAL FIRM GOVERNANCE

members is highlighted by Bull and Sharp [1989] and empirically supported

3.1 THE LIKELIHOOD OF MAKING A MANAGEMENT EARNINGS FORECAST

information to competitors. In line with the presence of disclosure costs,

Research proposition 1: The likelihood of a management earnings forecast is

3.2 MANAGEMENT FORECAST PRECISION

Other things being equal, providing more precise information is expected

Research proposition 2: The precision of a management earnings forecast is asso-

3.3 THE ACCURACY OF MANAGEMENT FORECASTS

Research proposition 3a: The accuracy of a management earnings forecast is

3.4 THE MARKET REACTION TO MANAGEMENT FORECASTS

4. Method and Data Sources

4.1.2. Corporate Governance and Forecast Precision. Next, we code forecast

effects of stale forecasts.

4.1.4. Corporate Governance and the Market Reliance on Management Forecasts.

4.2 DATA SOURCES AND SAMPLE

is likely to play an important role in bridging the information asymmetry

All Forecast Nonforecast Wilcoxon

In table 3 we present results from the logistic regression model described

All Bad News Good News Forecast

Each of the four models in table 3 is jointly significant in explaining the

eliminating outliers does not meaningfully change the interpretation of results.

precise forecasts. Thus, better corporate governance is associated with lower

All Bad News Good News

Absolute Forecast Error

make less accurate forecasts, possibly because of the entrenchment effect of

5.4CHANGES IN CORPORATE GOVERNANCE AND MANAGEMENT

Nonforecasting Forecast Forecast

5.5CORPORATE GOVERNANCE AND THE MARKET REACTION

5.5.2. Equity Analyst Reaction. To shed further light on the relation

are not sensitive to the cutoff used.

Forecast-Induced Return Analyst Reaction

5.6 ADDITIONAL SENSITIVITY CHECKS

characteristics to forecast accuracy and forecast-induced returns (tables 6

6. Discussion and Conclusion

managers are more likely to voluntarily disclose bad news to shareholders,

studies is that corporate boards and ownership structure are systematically

ABARBANELL, J. S.; W. N. LANEN; AND R. E. VERRECCHIA. “Analysts’ Forecasts as Proxies for

BROWN, L. D.; G. D. RICHARDSON; AND S. J. SCHWAGER. “An Information Interpretation of Fi-

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