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We revisit the predictive ability of dividend changes for firms’ future earnings and extend the literature by examining the effect of management forecasting ability. Although prior studies have examined the relationship between dividend changes and future earnings, the empirical evidence is mixed. The belief that dividend changes have implications for future earnings depends on the assumption that managers can accurately assess future earnings prospects. In this regard, we posit that the predictive ability of dividends can vary with managers’ forecasting ability. Analyzing a large sample of Japanese dividend-paying firms, we find that dividend changes, particularly dividend increases, are positively associated with increases in future earnings. Consistent with our hypothesis, this positive association is more pronounced for firms with high-forecasting ability managers. Our findings support the signaling theory of dividend changes and indicate that management forecasting ability has a moderating effect on the linkage between firms’ dividend changes and future earnings.

This study investigates determinants of debt covenants in Japanese loan markets. We focus on a unique monitoring mechanism by Japanese banks and hypothesise that debt covenants substitute for the traditional main bank governance. Consistently, we find that debt covenants are less likely to be used for firms with stronger ties with their main banks. We also document that such use of debt covenants results in borrower’s upward earnings management. Overall, our evidence suggests that, in the Japanese context, debt covenants are used as a substitute for the main bank system yet they alone are an incomplete monitoring mechanism.

Following Demerjian, Lev, and McVay (2012), we quantify managerial ability using a sample of Japanese listed firms for the period 2005-2015. Consistent with their findings, we find that the estimated managerial ability is strongly correlated with manager-fixed effects. Further, we find that the managerial ability is economically and significantly associated with the stock price reactions to CEO turnovers and changes in future return on assets following CEO turnovers. Our results are robust to alternative specifications of DEA models and inputs used in the estimation of firm efficiency. We contribute to the literature by generalizing the validity of the managerial ability introduced by Demerjian, Lev, and McVay (2012) to a non-US setting.

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