Abstract
PurposeThe authors provide a comprehensive empirical examination on the impact of earnings quality on stock price crash risk in China.Design/methodology/approachThe authors acknowledge and distinguish two-dimensional proxies for earnings quality – accounting-based (earnings management degree) and market-based (earnings transparency) known in accounting and finance literature.FindingsThe authors find that both generally indicate that better earnings quality is associated with less crashes. However, extremely high earnings transparency interacted with insider trading profit can also actually exacerbate stock price crashes.Originality/valueThis study is the first to highlight the pertinence of accounting-based measures to proxy for earnings quality in a fast-growing emerging market environment such as China.
Highlights
The stock market crash in China started on 12th June 2015 and lasted until early February 2016 and has caused its market capitalization to reduce by one-third in a short period of time
Using a sample of listed Chinese stocks during the 2006–2013 period, we show that earnings quality is strongly associated with stock price crash risk as hypothesized in finance literature
Confirming the implicit assumption made by previous studies, we provide empirical evidence that earnings management significantly increases the crash risk in China, whereas earnings transparency reduces the crash risk
Summary
The stock market crash in China started on 12th June 2015 and lasted until early February 2016 and has caused its market capitalization to reduce by one-third in a short period of time. Studying all valid A-share listed sample companies in both Shanghai and Shenzhen (largely perceived as China’s Nasdaq) exchanges during the 2006–2013 period, we find that earnings quality decreases stock price crash risk in China. This finding is consistent for both earnings manipulation (estimation of earnings management degree through discretionary accruals as per the modified Jones (1991) model) and earnings transparency (explanatory power of earnings numbers on stock returns as per Barth et al (2013) model) metrics.
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