Product Market Competition and Stock Price Crash Risk: Evidence from China

Abstract

Synopsis The research problem This study analyzes the relationship between product market competition (PMC) and stock price crash risk in China, especially for firms with weak corporate governance and a lower-quality information environment. Motivation Emerging capital markets like China have less-developed financial systems and institutions compared to developed capital markets like Europe and the United States, making them more susceptible to stock price crash risk. The impact of product market competition (PMC) on corporate decision-making has attracted considerable attention from scholars, especially given the increasingly intense and complex strategic competition in global markets and uncertainty in the world today. However, the effect of PMC on a firm’s stock price crash risk has not been thoroughly explored. Therefore, this study investigated how PMC affects managers’ tendency to hoard bad news and how this behavior contributes to the risk of stock price crashes. The test hypotheses We tested two competing hypotheses: PMC is negatively correlated with crash risk, and PMC is positively correlated with crash risk. Target population This study should be of interest to stakeholders, including firm managers, practitioners, regulatory authorities, policymakers, and investors. Adopted methodology This study employed ordinary least squares (OLS), difference-in-differences analysis (DID), and path analysis. Analysis Using a sample of Chinese A-share listed manufacturing firms from 2000 to 2021, this study found that competitive pressure from the product market encouraged managers to hide bad news, thereby increasing future stock price crash risk. Moreover, we performed additional tests to examine how PMC affected stock price crash risk. Findings We found robust evidence that PMC significantly increases stock price crash risk. Further tests showed that the effect of PMC on crash risk is more pronounced for firms with weak corporate governance and a lower-quality information environment. We also provide evidence that firms in highly competitive industries tend to disclose fewer negative words in the management discussion and analysis section of the annual report and fewer risk factors in the internal control report. Moreover, we show that operational risk is the underlying driver through which PMC affects crash risk.