Management Forecasts of Capital Investment and Earnings, the Cost of Equity Capital and Corporate Governance in Japan

Abstract

This paper examines how management forecasts, the cost of equity capital and corporate governance are related, using Japanese data. As management forecasts, capital investment forecasts as well as earnings forecasts are comprehensively available in Japan. They reveal the following: First, better corporate governance systems enhance the quality of earnings forecasts, but do not improve that of capital investment forecasts. Second, firms with more precise earnings forecasts can enjoy lower cost of equity capital. Meanwhile, the precision of capital investment forecasts has no relation with the cost of equity capital. Finally, the precision of capital investment forecasts has a negative influence on the cost of capital as long as corporate governance is poorly built. These findings suggest that capital investment forecasts provide informativeness that is totally different from that in earnings forecasts to investors’ valuation. The precision of earnings forecasts is a substitute for the quality of corporate governance and that of capital investment forecasts plays a complementary role, making up for the information shortcomings arising out of the low quality of corporate governance.