Voluntary Disclosure and Capital Structure—Evidence From Management Earnings Forecasts

Abstract

We examine associations between management earnings forecasts and capital structure. We posit that incremental information in forecasts reduces capital providers’ concerns about adverse selection. Pecking order theory suggests forecasts contribute differing amounts of information to different capital providers, shifting capital structure from trade credit to long‐term debt, and from long‐term debt to equity. Investment information risk theory submits that although creditors and equity holders share downside risk, creditors are more sensitive than equity holders to uncertainty related to the riskiness of firms’ future investments because equity holders are the sole beneficiaries of investments’ upside potential. Insomuch earnings forecasts provide investment information that is more meaningful to creditors, we expect a shift in capital structure from equity to credit as the forecast decreases outcome uncertainty. Using a sample of US‐listed firms from 2003 to 2019, we find support for the pecking order theory, that firms issuing management earnings forecasts exhibit higher levels of equity‐to‐credit financing and long‐term debt‐to‐trade credit financing. However, in cross‐sectional tests, we also find evidence supporting the investment information risk theory, that forecasts shift financing from equity to credit and among creditors, from long‐term debt to trade credit in firms with more growth opportunities. Our findings suggest firms’ voluntary disclosures provide different amounts of incremental information to different capital providers, but that the relevance of the information provided may also differ across capital providers.