Corporate governance, earnings quality and idiosyncratic crash risk during the 2007–2008 financial crisis

Abstract

This study explores the time-varying nature of the association between financial disclosure quality, corporate governance, and crash risk. Specifically, it evaluates the relevance of the above-mentioned variables in alleviating the abnormal components of crash risk that emerge during periods of mounting mistrust. Our empirical design takes advantage of the 2008 financial crisis as a sudden and negative exogenous shock that affected overall trust in capital markets. This near-natural experiment enables the examination of the influence of accounting quality and corporate governance on abnormal crash risk arising during distress periods, using a sample of 1361 firms from developed countries. While pre-crisis accounting opacity fueled the abnormal component of crash risk associated with the crisis, corporate governance practices had virtually no effect. Our interpretation is that perceived integrity compounded by firms by way of financial disclosure quality bolsters investor confidence in the firms’ financial information during a crisis, thereby attenuating crash risk.