Moral Hazard, Firms’ Internal Governance and Management Earnings Forecasts

Abstract

This paper investigates the role of management earnings forecasts in mitigating information asymmetry between investors and managers relating to moral hazard, and explains how earnings guidance facilitates monitoring. I demonstrate that firms that are more susceptible to moral hazard problems and more difficult to monitor are also more likely to issue annual earnings forecasts and they do so more frequently. In addition, I examine how firm internal governance drives forecasting decisions and show that stronger board governance and managerial equity incentives are associated with higher likelihood and frequency of forecast issuance. Finally, I provide robust evidence that managerial equity incentives are associated with more informative and higher quality guidance. In particular, I find that these forecasts are more accurate, unbiased, more specific and timely, consistent with equity incentives aligning shareholders’ and managers’ interests regarding disclosure decisions. However, I find mixed evidence on the association between board governance and forecast quality.