I examine whether the over-investment influence on the stock price informativeness of the future earnings (measured by Future Earnings Response Coefficient: FERC) or not. Furthermore, I examine the role of the corporate governance on their relationship. Since the stock return is estimated by unexpected current earnings, the cumulative change in expectations about future earnings and noise, it may have a systematic relationship with the corporate over-investment propensity.
Company has the incentive to increase their growth potentiality through investment activities and to gain an edge in competition with peers. However, according to the previous studies, it was likely to happen the over-investment when manager pursue opportunistic behavior such as manager’s status, compensation and prestige. This problem may aggravate the lack of accounting information transparency. Therefore, since over-investment company has high possibility to report the low-quality accounting information, it is difficult to provide high-quality accounting information to predict future profits. In this study, I argue how investors recognize corporate over-investment propensity and how corporate over-investment propensity affects informativeness about future earnings. This study is to extend the prior studies that investigate the information content of corporate over-investment. I measure the effect of over-investment on future earnings using the FERC. FERC model examines how much information about future earnings reflected in the change in current stock price.
I empirically test how investors recognize corporate over-investment and the effect of the corporate governance on their relationship. And also I test whether there is a difference in the effect of corporate over-investment on stock price informativeness on future earnings according to the corporate governance structure measured by the foreign equity ownership, ownership, industry specialist auditors, audit fees, audit hour and managerial ability. Using the model of McNichols and Stubben(2008) and the model of Tucker and Zarowin(2006), I found several empirical results as follow: First, the over-investment decrease the informativeness of the future earnings on the stock price (measured by FERC). Second, FERC of the company is positively affected by the level foreign equity ownership and major shareholder’s ownership. Third, FERC of the company with industry specialist auditor, or paying higher audit fee, or reporting higher audit hour is relatively higher than otherwise. Finally, the level of manager’s competent positively influence on the FERC of over-investment company.
This study contribute that I examine the market’s reaction to the corporate investment decision, and the effect of investment information on the stock price as well as the non-expected earnings of the current year. In addition, I find out the role of corporate governance by revealing that there is a difference in the relationship between corporate governance expected to effectively control managers’ opportunistic behavior.