Industry Tournament Incentives and Risk of Stock Price Crash

Abstract

In recent years, the executive compensation in listed companies in China has increased rapidly, and the pay gap between executives has been increasing. Not only the internal pay gap of executives has been widening, but also the external pay gap of executives has been showing an increasing trend. Most of the researches on the pay gap of executives focus on the internal tournament incentives of the internal pay gap to executives. Recently, a new research field has begun to pay attention to the external tournament incentives of the external pay gap to executives. However, there is no literature on how the external tournament incentives of the external labor market affect executives’ behavior of concealing bad news and the risk of stock price crash.First of all, based on the data of Chinese listed companies from 2006 to 2018 as the research sample, this paper uses the pay gap between CEO and the highest paid CEO of companies with similar size in the same industry to measure industry tournament incentives, and examines the relationship between industry tournament incentives and the risk of stock price crash. It is found that industry tournament incentives increase the risk of stock price crash, and the research conclusion is still valid when using industry tournament incentives to replace indicators and considering endogenous problems such as missing variables and reverse causality.Secondly, this paper also tests whether the difference in the relationship between industry tournament incentives and the risk of stock price crash conforms to the tournament theory under the situation of different CEOs’ willingness to participate in industry tournament. It is found that among non-state-owned enterprises, enterprises in the eastern region and enterprises with non-newly appointed CEOs, the positive correlation between industry tournament incentives and the risk of stock price crash is more significant, indicating that when CEOs are more willing to participate in industry tournament competition, they are more likely to conceal bad news and the risk of stock price crash is higher.Finally, this paper also explores the mechanism of industry tournament incentives on the risk of stock price collapse. It is found that industry tournament incentives will increase the risk of stock price crash by improving the degree of earnings management and reducing the readability of annual reports, which indicates that CEOs will at least conceal bad news by manipulating corporate earnings and reducing the readability of annual reports, thus leading to a higher risk of stock price crash.This paper reveals how industry tournament incentives affect CEOs’ behavior of concealing bad news and the risk of stock price crash, and also enriches the research on how executive compensation incentives affect the risk of stock price crash.