Internal Control Effectiveness and Stock Price Crash Risk: Evidence from China

Abstract

Stock price crash is the extreme negative values of price distribution which can make investors suffer from huge losses and harm the stability of security market. Because of the heavy consequences, how to avoid stock price crash is a topic of significant importance. According to the “bad news hoarding” theory, transparency is a key determinant to restrain stock price crash risk. This is because transparent firms can fairly and comprehensively transfer information to investors, thus reduce the information asymmetry between the two parties. Internal control is an intergraded institutional arrangement and aims at improving reporting quality. In theory, internal control plays a role in impacting transparency and further affects stock price crash risk. Selecting companies listed on China’s main board from 2008 to 2019 and conducting mediating effect tests, this paper explores the mechanism on how internal control effectiveness influences stock price crash risk. Findings show that: (1) internal control effectiveness is negatively correlated to stock price crash risk; (2) internal control effectiveness is positively correlated to transparency; (3) transparency is negatively related to stock price crash risk; and (4) internal control effectiveness has a partial mediating effect on the relationship between internal control effectiveness and stock price crash risk. The findings indicate that effective internal control can decrease stock price crash risk via enhancing transparency. This paper extends extant literature by investigating the mechanism on how internal control effectiveness affects stock price crash in the emerging market of China.