Hoard Bad News Research Articles

Do statutory internal auditors influence stock price crash risk? Firm-level evidence from Korea

PurposeBased on 1,798 firm-year observations from 2009 to 2013, using publicly available disclosure data for Korean listed firms, this study aims to examine whether statutory internal auditors influence firm-level stock price crash risk.Design/methodology/approachBased on the bad news hoarding theory of crash risk, the authors investigate the association between the quality of statutory internal auditors and one-year-ahead stock price crash risk. The quality of statutory internal auditors is measured as the compensation of statutory internal auditors and the financial expertise of statutory internal auditors. Stock price crash risk is measured as an indicator variable whether a firm experiences one or more crash weeks during the fiscal year period.FindingsThe authors find that higher quality of statutory internal auditors – measured through greater compensation and greater financial expertise – is associated with lower possibilities of future stock price crash risk. These results indicate that high-quality statutory internal auditors mitigate bad news hoarding of managers because of their greater capability and stronger incentive to lower litigation risk and preserve their reputation. The results are mostly robust to different measures for stock price crash risk and the quality of statutory internal auditors.Practical implicationsThe findings of this study regarding stock price crash risk are important for investors because such risk can significantly affect investor welfare. The results indicate that statutory internal auditors play an important role in controlling future stock price crash risk and maintaining stability in the equity market.Originality/valueThis study adds to the extant literature on the determinants of stock price crash risk and is the first to examine the impact of internal auditors on stock price crash risk. Moreover, this study also contributes to the existing literature on internal auditor quality by showing that high-quality statutory internal auditors reduce risks in financial markets.

Attention! Distracted Institutional Investors and Stock Price Crash

Using the extreme returns of firms in unrelated industries of institutional shareholders’ portfolios as exogenous variations in institutional investor distraction (Kempf et al., 2017), we find a positive and significant relation between institutional shareholder distraction and stock price crash risk. The effect is associated with weakened monitoring, and it becomes stronger when alternative corporate governance is weaker and when managers’ incentives to hoard bad information are stronger. Managers reduce firms’ accounting conservatism when institutional investors become distracted, which is evidence of an increased motivation to hoard bad news. Overall, our findings shed additional light on the important monitoring role of institutional investors in corporate governance.

CEO Early-Life Disaster Experience and Stock Price Crash Risk

We study the impact of CEO early-life disaster experience on stock price crash risk. Using a longitudinal sample of U.S. firms, we document that firms led by CEOs with early-life disaster experience have higher stock price crash risk. Our findings are consistent with CEOs who experienced early-life disasters being more risk tolerant, and thus more willing to accept the risks associated with bad news hoarding, engendering formation of stock price crashes. In cross-sectional analyses, we find that the effect of CEO disaster experience is amplified when a CEO has greater equity compensation-based incentives and power over corporate board to hoard bad news. Reinforcing bad news hoarding narrative, we also find that stocks of the firms led by CEOs with early-life disaster experience exhibit stronger asymmetric response to bad versus good news disclosures and are more likely to experience crashes accompanied by breaks in the strings of uninterrupted earnings increases. Further, consistent with early-life disaster experience making CEOs more risk tolerant, we find that firms led by CEOs with early-life disaster experience tend to have higher cash-flow volatility and stock return volatility. Evidence from supplemental analysis suggests that the impact of CEO early-life disaster experience on crash risk varies in a curvilinear manner with the severity of disaster.

Foreign Investors, External Monitoring, and Stock Price Crash Risk

We investigate whether foreign investors help to reduce local firms’ future stock price crash risk through their external monitoring. We find that the entrance of foreign investors is associated with a significant reduction in local firms’ future crash risk. Further investigation reveals that foreign investors help to improve local firms’ financial reporting quality from the perspectives of accrual quality, conservatism, and annual report tone management. The evidence is consistent with our conjecture that foreign investors play an important external monitoring role, which reduces managerial bad-news hoarding and thereby lowers local firms’ future crash risk. We also find that the crash risk–reducing role of foreign investors is more pronounced when foreign investors are more familiar with the institutional background of the host country, when they have stronger incentives to monitor local firms, and when local firms have higher governance efficacy. A variety of robustness checks reveals that our results are unlikely to be driven by potential endogeneity.

Media Attention and Selective Managerial Bad News Hoarding

This paper investigates whether media attention impacts the extent to which managers hoard bad news in general and whether the effect applies to conspicuous news, such as earnings news. We find that greater media attention escalates managerial bad news hoarding; however, such an effect does not apply to bad earnings news. These findings imply that managers selectively hoard bad news that is not as regulated and as conspicuous as earnings news. In the cross-sectional analyses, we find that typical corporate governance mechanisms are not effective in mitigating bad news hoarding; rather, we find that the effect of media attention on bad news hoarding is amplified when management is more short-term oriented.

Does Crackdown on Corruption Reduce Stock Price Crash Risk? Evidence from China

This study examines whether crackdown on political corruption in China affects future stock price crashes. Using data from corruption-related prosecutions, we find that firms under prosecuted official jurisdictions experience a significant decrease in crash risk after the crackdown. Cross-sectional tests show that results are more pronounced for firms with higher political dependence on governments and for firms with worse information environment. Moreover, channel tests provide direct evidence that crackdown decreases crash risk by reducing political risk and bad news hoarding. Overall, our study offers novel evidence on how crackdown on corruption benefits firms.

Does crackdown on corruption reduce stock price crash risk? Evidence from China

This study examines whether crackdown on political corruption in China affects future stock price crashes. Using data from corruption-related prosecutions, we find that firms under prosecuted official jurisdictions experience a significant decrease in crash risk after the crackdown. Cross-sectional tests show that results are more pronounced for firms with higher political dependence on governments and for firms with worse information environment. Moreover, channel tests provide direct evidence that crackdown decreases crash risk by reducing political risk and bad news hoarding. Overall, our study offers novel evidence on how crackdown on corruption benefits firms.

Do Dividend Payments Mitigate Stock Price Crash Risk Through Curbing Bad News Hoarding and Curtailing Overinvestment?

We examine the economic benefits of paying dividends. We find that dividend payments mitigate stock price crash risk. In addition, we show that dividend payments reduce bad news hoarding (overinvestment) while bad news hoarding (overinvestment) is positively associated with stock price crash risk, suggesting that curbing bad news hoarding and curtailing overinvestment are two channels through which dividends mitigate crash risk. Finally, our main results are robust to a battery of sensitivity checks including controls for potential endogeneity concerns. Our paper extends a recent literature about dividends enhancing earnings quality (e.g., Skinner and Soltes, 2011) by adding that dividend payments generate economic benefits in the form of mitigated bad news hoarding, overinvestment, and stock price crash risk.

Seeing is not necessarily the truth: Do institutional investors' corporate site visits reduce hosting firms' stock price crash risk?

This study examines the impact of institutional investors' corporate site visits (CSVs) on stock price crash risk. We find that the frequency of institutional investors' CSVs is positively associated with hosting firms' future stock price crash risk. This association is robust to an array of sensitivity checks, including alternative measures of interaction intensity, alternative samples, additional control variables, firm fixed effects model, two-stage instrumental approach, Heckman two-stage sample selection procedure and propensity score matching (PSM) procedure. Further analysis shows that the impact of institutional investors' CSVs on future crash risk is more pronounced when firm managers have higher bad-news hoarding incentives and less information disclosure monitoring, and when firms are plagued more by information asymmetry. Moreover, the economic mechanism analysis shows that the average cumulative abnormal return (CAR) around the announcement day of institutional investors' CSVs is significantly positive, that CSVs have larger effect for firms with higher CARs and that firms visited more by institutional investors are more likely to make financial restatement in future. Overall, our findings are consistent with the notion that institutional investors' CSVs exacerbate managers' incentives to withhold bad news, which leads to bad news accumulation and future stock price crash risk.

Does Stock Price Crash Risk Subside When the IRS Imposes Stricter Corporate Tax Enforcement?

We analyze whether tough IRS monitoring generates a positive externality by constraining managers’ bad news hoarding activities. Supporting this prediction, we find a negative relation between the threat of an IRS audit and stock price crash risk. Our evidence is consistent with recent theory that outside investors learn more about firms when tax enforcement is stricter. Additionally, path analysis suggests that the monitoring channel (direct path) plays a critical role in shaping crash risk relative to information asymmetry channels of tax planning and accruals manipulation (indirect paths). Consistent with other predictions, we find that the monitoring role of IRS audits intensifies when firms experience worse agency conflicts stemming from CEO power and incentives. Collectively, our research implies that external monitoring by tax authorities protects shareholders against managers suppressing negative firm-specific information that engenders stock price crash risk, particularly when CEOs have wider scope and stronger incentives to hoard bad news.

Can Shareholders Be at Rest After Adopting Clawback Provisions? Evidence from Stock Price Crash Risk

Using a propensity score matched sample for the period from 2003 to 2012 and a difference-in-difference research design, we find that stock price crash risk increases after firms voluntarily adopt clawback provisions in managers’ compensation contract. Our results reveal that total upward (but not downward) earnings management increases for clawback adopters, and the increase in crash risk is driven by firms with more income-increasing total earnings management after adopting clawback provisions. These results suggest that the heightened crash risk is attributable to the increased magnitude of total upward earnings management subsequent to clawback adoption. In addition, we find that the positive association between clawback adoption and crash risk is more pronounced for firms with low institutional holdings and with high equity incentive for CEOs, where the opportunity and incentive to hoard bad news are higher.

Does the cutoff of “red capital” raise a red flag? Political connections and stock price crash risk

Using a Chinese exogenous regulatory setting that forbids political officials from sitting on boards, we investigate whether disruption to political connections induced by independent director’s forced resignation increases the firm’s stock price crash risk. The results show that firms announcing resignations of politically-connected independent directors after the regulation experience a significant increase in crash risk, suggesting that disruption to political connections intensifies managers’ bad-news hoarding behavior and makes firms more crash-prone. We further find that the negative impact of disrupted political connections on crash risk is less pronounced in state-owned enterprises (SOEs) than that in non-state-owned enterprises (non-SOEs). Moreover, the association is more salient when the resigned director has a geographic and industrial working background overlapping with the firm’s operation. Our findings are consistent with the notion that heightened resource acquisition pressure caused by disruption to political networks increases stock price crash risk.

Do Innovations Hoard Bad News? Evidence from Stock Price Crash Risk

We study the influence of the innovations, proxied by the number of patent grants and citations as well as the R&D investments on the stock price crash risk. Using a large sample of U.S. firms, we show that the innovation related activities reduce the likelihood to experience future stock price crashes with significant magnitude. This finding is consistent with the argument that the innovations facilitate information dissemination and decrease the probability of hoarding negative news. Further, we find that such influence on stock price crash risk is more pronounced for firms with weak external monitoring mechanism and high information asymmetry.

Takeover protection and stock price crash risk: Evidence from state antitakeover laws

We exploit the passage of state antitakeover laws to examine the relation between takeover protection and stock price crash risk. We find that firms incorporated in states that passed the laws are negatively associated with future stock price crash risk in the post-law periods, suggesting that takeover protection mitigates bad news hoarding activities. Further analysis shows that the mitigating effect is more pronounced when firms have severe information asymmetry or face strong product market competition. Together, our findings shed new light on the impact of takeover threats on managerial incentives to engage in bad news hoarding.

Accruals and price crashes

I investigate the relation between accruals and firm-level price crashes, representing extreme price decreases in weekly returns. I find that high accruals predict a higher price crash probability than low accruals. This finding can be explained by managers’ use of income-increasing accrual estimates to hoard bad news. Once accumulated bad news crosses a tipping point, it is released all at once and results in a price crash. Consistent with this explanation, I find the observed relation to be the strongest for operating assets (the least reliable accrual components). Cross-sectional analyses further support the bad news hoarding explanation.

National Culture and Stock Price Crash Risk

We study how cultural norms along the dimensions of individualism and uncertainty avoidance affect stock price crash risk. Using a sample of 36 countries, we find that firms headquartered in countries with higher levels of individualism (uncertainty avoidance) are associated with higher (lower) stock price crash risk. These findings suggest that individualism encourages managerial bad-news hoarding while uncertainty avoidance curbs such behavior. We also find that these effects are more pronounced in more opaque firms or countries. Overall, our findings suggest that national culture is an important determinant of stock price crash risk.

Dividend Payments and Stock Price Crash Risk

Using a large sample of U.S. firms over the period of 1991-2011, this study examines whether and how cash dividend payments affect stock price crash risk. We predict and find that dividend payments are negatively associated with stock price crash risk. In addition, we find that the effect of dividend payments on lowering crash risk is more pronounced for firms with higher information asymmetry (proxied by higher market-to-book ratios or positive R&D expenditures) and for those with larger free cash flows. Moreover, we document that dividend payments reduce bad news hoarding (overinvestment) whereas bad news hoarding (overinvestment) leads to crash risk, suggesting that dividend payments (1) enhance financial reporting quality and investment efficiency and (2) mitigate stock price crash risk through two channels: curbing bad news hoarding and curtailing overinvestment. Our main results are robust to various sensitivity checks including controls for endogeneity concerns. Our findings are important to investors, policy makers, and academics, because they (1) suggest that dividend payments are an easily observable indicator that investors can use to assess firms’ financial reporting quality and crash risk and (2) support some policymakers’ proposition that dividends mitigate earnings manipulation and fraud.

Crashes and Jumps in Price and Earnings: The Role of Accruals

I investigate the relation between accruals and firm-level price crashes, representing extreme price decreases in weekly returns. I find that high accruals predict a higher price crash probability than low accruals. This finding can be explained by managers’ use of income-increasing accrual estimates to hoard bad news. Once accumulated bad news crosses a tipping point, it is released all at once and results in a price crash. Consistent with this explanation, I find the observed relation to be the strongest for operating assets (the least reliable accrual components). Cross-sectional analyses further support the bad news hoarding explanation.

Seasoned Equity Offerings and Stock Price Crashes

Using a large sample of U.S. firms during 1987-2011, we find robust evidence that the issuance of seasoned equity is associated with abnormally high future stock price crash risk. The association between seasoned equity offerings and crash risk is stronger among offerings that involve the sale of secondary shares (existing shares sold by insiders or large blockholders). We also find that recent seasoned equity issuers are far less likely to experience sudden positive price jumps relative to firms that have not recently issued equity. Our findings of elevated crash risk and diminished jump risk, when taken together, are consistent with a heightened propensity for firms to hoard bad news but not good news when issuing equity. In analyses of open market insider trading prior to crashes, we find that net selling by CEOs and CFOs is abnormally high in years succeeded by crashes relative to years not succeeded by crashes and is especially high among seasoned equity issuers that subsequently crash, which is consistent with crashes, especially those that occur after SEOs, resulting from bad news hoarding.

Short interest and stock price crash risk

Abstract Using a large sample of U.S. public firms, we find robust evidence that short interest is positively related to one-year ahead stock price crash risk. The evidence is consistent with the view that short sellers are able to detect bad news hoarding by managers. Additional findings show that the positive relation between short interest and future crash risk is more salient for firms with weak governance mechanisms, excessive risk-taking behavior, and high information asymmetry between managers and shareholders. Empirical support is provided showing that the relation between short interest and crash risk is driven by bad news hoarding.