Firm-specific corporate governance and analysts’ earnings forecast characteristics. Evidence from Asian stock markets

• Published date: 06 August 2018
• DOI: https://doi.org/10.1108/IJAIM-03-2017-0040
• Pages: 335-361
• Date: 06 August 2018
• Author: Minna Yu,Yanming Wang
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

Firm-specific corporate

governance and analysts’

earnings forecast characteristics

Evidence from Asian stock markets

Minna Yu

Department of Accounting, Monmouth University, West Long Branch,

New Jersey, USA, and

Yanming Wang

School of Accounting, Shanghai University of Finance and Economics,

Shanghai, China

Abstract

Purpose –The purposeof this paper is to examine the impact of corporate governance onthe capital market

participants’abilities to forecast future performance, as measured by the properties of analysts’earnings

forecastsin Asian stock markets.

Design/methodology/approach –This paper hypothesizes that higher corporate governance is

associated with lower forecast errors, lower forecast dispersion and lower forecast revision

volatility.

Findings –These predictions are supported with a sample of companies across eleven Asian economies

over 2004-2012. The results of this paper suggest that corporate governance plays a significant role in the

predictability of firm’sfuture performance and, therefore, improves the financial environmentin Asian stock

markets. Furthermore, the impact of corporate governance on analysts’forecast properties is more

pronouncedin countries with strong investor protection.

Research/limitations/implications –The authors acknowledge the following limitations of this

paper.First,theresultsofthispapermaybesubjectto omitted-variable bias and endogeneity issue.

The authors have used control variables in the regressions to reduce the omitted variable bias. The

authors have run lead-lag regressions to address causality issue. Second, CLSA corporate governance

scores are collected for largest companies in each jurisdiction. Therefore, thesampleisbiasedtowards

the largest companies in those jurisdictions and may not be representative of the average firm in the

Asia.

Originality/value –The results of this paper speakto the benefit of having strong corporate governance

in terms of reducingthe information asymmetry between investorsand corporate management.

Keywords Corporate governance, Asian stock markets, Analysts’earnings forecast characteristics

Paper type Research paper

The authors thank Credit Lyonnais Securities Asia (CLSA) for providing corporate governance

ratings data. They appreciate valuable inputs from our discussant, Luminita Enache and other

conference participants at American Accounting Association’s 2014 Mid-Atlantic Region Meeting as

well as conference participants at 2014 Accounting Conference at Temple University. Minna Yu

acknowledges the summer research support from Business Council of Leon Hess Business School. In

addition, this work was supported, in part, by a Creativity and Research Grant from Monmouth

University.

Firm-specific

corporate

governance

335

Received26 March 2017

Revised6 August 2017

22November 2017

Accepted16 February 2018

InternationalJournal of

Accounting& Information

Management

Vol.26 No. 3, 2018

pp. 335-361

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-03-2017-0040

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

1. Introduction

In this paper, we investigate whether effective corporate governance enhances the

predictability of firms’future performance, measured by financial analysts’earnings

forecast characteristics.As noted in La Porta et al. (2000),firm-specific corporate governance

is a set of mechanisms through which outside investors protect themselves against

expropriation by the management.Weak corporate governance has been considered a major

contributor of Asian financial crisis during 1997-1998. In fact, the weak corporate

governance systems explain the extent of stock market decline better than macroeconomic

factors (Johnson et al., 2000). After the financial crisis, firms in the Asian capital markets

have actively implemented good corporate governance structures and processes. Prior

research documents that, during the post-crisis period, Asian firms with good corporate

governance tend to have higher market value and lower cost of capital (Klapper and Love,

2004;Chen et al., 2009). Are these positive capital market consequences of good corporate

governance because of the reduced information asymmetry between investors and

management? Until now, we lack evidence on the impact of good corporate governance on

such information asymmetry.

Byard et al. (2006) document the positiveassociation between analysts’earnings forecast

accuracy and attributes of corporate governance in the USA. However, in a US setting and

most regions in the globe, corporategovernance systems remain unchanged for long periods

of time, which has been referred to as “stickiness”(Brown et al., 2011). The stickiness of

corporate governance measure has posed significant challenges for research. The post-

financial-crisis period in Asia is a desirable setting for examining the impact of corporate

governance. Studying the association between analysts’forecast characteristics and

corporate governance practices enhances our understanding as to whether corporate

governance reduces information asymmetry between investors and management in the

Asian setting.

We use analysts’earnings forecasts as proxies[1] for investors expectation for future

earnings because investor’prediction about firm’s performance is not observable. We use

three measures of analyst forecast characteristics in earnings forecasts that have been

commonly studied in prior research (Lang and Lundholm, 1996;Ali et al., 2007): forecast

accuracy, forecastdispersion and volatility in forecasts.

We obtain the corporate governance rating scores developed by Credit Lyonnais

Securities Asia (CLSA) as a measure of the firm-level corporate governance quality.

CLSAcorporategovernancescoreshavebeenwidelyusedasaproxyforthequalityof

firms’internal corporate governance mechanisms by prior studies (Klapper and Love,

2004;Shen and Chih, 2007;Chen et al., 2009;Yu, 2010). Extant research on the impact of

corporate governance on analyst behavior has concentrated on a single corporate

governance dimension, such as ownership structure (Lang et al., 2004;Ali et al., 2007).

The composite score of corporate governance is superior to a single dimension because

the composite score measures the overall strength of all corporate governance

mechanisms (Brown et al., 2011) and using a parsimonious index is more effective than

including all individual corporate governance characteristics (Brown and Caylor, 2006;

Bebchuk et al., 2009).

Investors and regulators increasingly view effective corporate governance as crucial to

mitigating the agency problem as high levels of corporate governance reduce conflicts by

better aligning managers’interest with that of investors. In contrast, in firms that lack

adequate monitoring systems, managers are more likely to obscure or manipulate

disclosures and make inefficient operating, investing and financing decisions, which make

future performance less predictable. Therefore, good corporate governance mechanisms

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