Report on the firms with more informative stock prices have lower crash risk

A number of literatures are growing on this area which help in determine the stock crash risk in the firm. One new factor that is highlighting here is the firm with informative stock process have lower risk of crash. Managerial have the ability to withhold the bad news form the investors for the concern of the career. When bad news is accumulating and revealed in a jerk at its tripping point, it leads to the stock price crash increase in opacity cause managerial team to withhold the bad news of firm from the disclosure to the public. This cause the stock price crashes. Managerial team withhold the bad news for their career concern and in order to overstate the financial performance. Then news gets stock piling in the firm. Then a point come when it becomes so impossible to withhold the information and it will become too much costly. The tax avoidance of the corporate is directly related to the firm specific stock crash risk. On the other hand, firm that engage themselves often in corporate social responsibility (CSR) can avoid withholding bad news and thus can reduce the crash risks (Aman, 2013).

Literature Review of firms with more informative stock prices have lower crash risk

When there is the conflict of the agency between the shareholders and the management of the firm then there is an increase in the risk for the hoarding of the bad news. Managerial have the ability to withhold the bad news from the investors for the concern of the career. When bad news is accumulating and revealed in a jerk at its tripping point, it leads to the stock price crash increase in opacity cause managerial team to withhold the bad news of firm from the disclosure to the public. This cause the stock price crashes. Managerial team withhold the bad news for their career concern and in order to overstate the financial performance. Then news gets stock piling in the firm. When there is a strong corporate governance, they have best monitoring for the management and thus it reduces its ability to hoard the bad news which eventually save the firm from large risk of crash in stock prices in future. The firm where managers are well governed and financial constraints firm are less liable to withhold the bad news and hence in future their firm crash risk become lower than before (Aman, 2013).

Hypothesis: The positive association between financial constraints and future stock price crash

risk is weaker for firms with strong corporate governance. 

External finance is never perfect alternative for the internal capital and it is also expensive as well as difficult to access by the financial constrained firms. So, the firms that depend and face expenses on the external financing more than usual, they rely mostly on their own capital or holding of the cash. But sometimes current holding of the cash can also not meet financial constraint firms demands for their investment. In these situation firms tend to do tax avoidance in order to generate additional funds internally. Many researchers say that cutting other cost strategies when compared with increasing tax avoidance it seems that it may have less impact on the operations of the firm when they aim for building cash reserves. The main objective of financial constrained firm is to avoid tax for getting additional internal cash or funds for their investment and thus mitigate the risk for the crash. When firms face the challenge of financial constraints, they try to seek some alternatives for getting funds for their investment because the conventional way of financing become more expensive and less accessible like equity financing or debt or taking lawns. the potential source of financing is the tax saving and saving money through this strategy (Balsam, Krishnan & Yang, 2003). Managers can implement various strategies on tax planning in order to reduce their payment in tax. Thus, this can help in increasing the internal funds for the investment through the tax avoidance and also to resist and manage the potential default and eventually future crash risk of the firm stock market is reduced. It generates another hypothesis.

Hypothesis: The positive association between financial constraints and future stock price crash risk is less pronounced for firms that commit tax avoidance.  

The credit rating of the firm reveals the credit rating agency opinion about the worthiness of the firm credit and their ability to meet the obligations of the finance. The shorter distance of the default is measures when there is low credit rating. Thus, it means that those firms who have low credit rating are more possible default and thus can encounter with crash risk in future in their stock prices. Firms with low credits often go ahead to find ways for external funds. Thus, in this way they are more likely to face default and stock price crash in future.

Hypothesis: The positive association between financial constraints and future stock price crash risk is stronger for firms with low credit ratings.

The quality of the internal control in the organization is related a lot to the crash risk of the stock prices. Firms which have ineffective control system internally especially over the financial reporting, disseminate low reliable financial information. Many of the researchers say that this term is the primary driver for the crash risk in the firm. High level of the quality control in the firms greatly alleviates the crash risk from the firm stock prices. Five components are evaluated; control environment, control activities, risk assessment, information and communication and also monitoring. Corporate governance mechanism also has great and crucial importance in this regard beside the financial reporting constraints mechanism. Corporate governance mechanism helps a lot in minimizing the crash risk. Many important incentives can be known by investigating the firm level strategical choices which also include customer concentration over the services along with the crash risk of the firm. It is revealed through many researches on customer concentration that suppliers of the firm manage earnings by opportunistic use of accruals through the concentration customer base in the firm. And thus, can make low frequent earnings forecast. All these variables are related to the crash risk in the firm and future investigation can be made on this area (Campbell, Hilscher & Szilagyi, 2008).

When manager need to conceal bad news for more extended period of time, they also use voluntary disclosure opportunists. This kind disclosure can reduce the need of hoarding the bad news and along with reducing the information asymmetry. One such example of voluntary disclosure is corporate social responsibly disclosure (CSR). When manager need to conceal bad news for more extended period of time, they also use voluntary disclosure opportunists. Socially responsible firms give more better financial disclosure and it has been proved through many literatures. So, firms with much better corporate social responsibility disclosure have much less crash risk for the stock prices. But they did not test some of the channels through which the beneficial effects of CSR on crash risk can be investigated. There is another thing, corporate philanthropic action which also help in reducing the crash risk of the firm (Balsam, Krishnan & Yang, 2003).

Financial disclosure and reporting quality get highly impacted by the corporate governance attributes. Aggressive earning management is reduced by the audit committee members of the financial and governance expertise. The audit committee and the board members have the crucial impact on the earning management engagement for the managerial team. When the corporate governance policy is defined clearly it helps a lot in reducing the crash risk of the firm. Everything depends on specific attributes of the managerial like finance of the firm, investment and their other organizational policies. There is evidence that older manager seems to be more conservative while those managers are seeming to be more aggressive who hold the degree of MBA (Amihud, Mendelson &  Wood, 1990).

External corporate governance also plays a major role while mitigating the crash risk in the firm. Governance mechanism may include factors like large shareholding, institutional holding, financial analyst, external auditing and the liability of the director and the officer. Earning quality is improved a lot by monitoring the constraints of the manager’s ability that how they manage the abnormal accruals. As the better earning quality also related in reducing the crash risk also the effect of institutional monitoring system on the crash risk of the firm. For revealing the firm specific information, financial analyst also plays the major role which are very crucial for the crash risk of the firm. With the firm analyst coverage increasing, the risk in crash is also increasing. Other factors that contribute are corporate governance role and information intermediary also reduce the risk of crash. It also reveals channels like tax avoidance, accounting conservatism and opacity by which industry specialist auditors decrease the risk of crash (Amihud, Mendelson &  Wood, 1990).

The firm performance is a lot based on the earnings under the accounting systems which comprise the cash flow and most of the accruals. Management in firm is all responsible for giving the shareholders their earnings estimate and those estimates give the tools to hide bad news for the investors. Earning management is a lot associated with hoarding the bad news in the firm and with higher risk of crash in future. There are many strategies’ that are including for hoarding the bad news in the firm like understanding the provision of contingent liabilities like a responsibility to clean up the production sites and to give warranty for low quality services. Both of these can lead to the future outflow for cash of the firm (Balsam, Krishnan & Yang, 2003).

Hypothesis: The positive association between financial constraints and future stock price crash risk is more pronounced for firms that have high abnormal accruals.

Conclusion of firms with more informative stock prices have lower crash risk

It is concluded that the firms who are socially responsible has the high quality of transparency and they hoard less amount of bad news thus eventually they face fewer crash risks. But if the manager objectives to engage with corporate social responsibility is to cover the bad news and divert the attention of the shareholder, then it leads the CSR to high level of risk of crash. Firms performance with corporate social responsibly have the negative relation with future crash risk after the control of their risks of the crash. When firms have less corporate governance who is ineffective and have lower level of institutional ownership, so the mitigating effects of the CSR on crash risk could be more pronounced (Campbell, Hilscher & Szilagyi, 2008). Role of corporate social responsibility is much important when corporate governance like monitoring the mangers or investors become weak and ineffective. Firm that engage themselves often in corporate social responsibility (CSR) can avoid withholding bad news and thus can reduce the crash risks.

References of firms with more informative stock prices have lower crash risk

Aman,  H.  (2013).  An  analysis  of  the impact  of  media  coverage on  stock  price  crashes and  jumps:   Evidence from Japan. Pacific-Basin Finance Journal, 24 ,  22–38 .

Amihud, Y., Mendelson, H., &  Wood, R. A.  (1990). Liquidity and the  1987 stock market crash.  The   Journal of Portfolio Management, 16(3), 65-69.

Balsam, S.,  Krishnan, J.,  & Yang, J. S.  (2003). Auditor  industry specialization and  earnings quality. Auditing: A Journal of Practice & Theory, 22(2), 71–97

Campbell,  J., Hilscher,  J., &Szilagyi, J. (2008).  In  search  of distress  risk.  The Journal  of Finance,   63(6), 2899–2939.