Stock price crash risk and internal control weakness: presence vs. disclosure effect

This study examines the stock price crash risk for a sample of firms that disclosed internal control weaknesses (ICW) under Section 404 of the Sarbanes‐Oxley Act (SOX). We find that in the year prior to the initial disclosures, ICW firms are more crash‐prone than firms with effective internal controls. This positive relation is more pronounced when weakness problems are associated with a firm's financial reporting process. More importantly, we find that stock price crash risk reduces significantly after the disclosures of ICWs, despite the disclosure itself signalling bad news. The above results hold after controlling for various firm‐specific determinants of crash risk and ICWs. Using an ICW disclosure as a natural experiment, our study attempts to isolate the presence effect of undisclosed ICWs from the initial disclosure effect of internal control weakness on stock price crash risk. In so doing, we provide more direct evidence on the causal relation between the quality of financial reporting and stock price crash risk.     

Impact of earnings performance on price‐sensitive disclosures under the Australian continuous disclosure regime

This study examines the relation between accounting earnings and the frequency of price‐sensitive corporate disclosure under Australia's statutory continuous disclosure requirements. Despite low litigation threats and excepting loss‐making firms, results show that firms with earnings declines (bad news) are more likely to make continuous disclosure than firms with earnings increases (good news). This suggests that market forces and regulators’ scrutiny are sufficient to induce a ‘bad news’ disclosure bias. This study also examines the ‘materiality’ requirement under the continuous disclosure requirements and finds a positive relation between disclosure frequency and the magnitude of earnings news. The earnings–return correlation is positively associated with disclosure frequency for the financial services industry.     

The effects of firm size,corporate governance quality,and bad news on disclosure compliance

Motivated by calls for increased compliance, size-based regulation, and continued exemption of small firms from internal control reporting requirements, we assess the incremental effects of firm size, corporate governance quality, and bad news on disclosure compliance. We examine compliance with the disclosure requirements of an SEC-mandated filing that requires no computations or complex judgments but is nonroutine and may reveal value-decreasing information (bad news) that otherwise would not become public. The disclosures studied are those that firms provide in Form 8-K Item 4 when changing external auditors. We find that noncompliant firms have lower quality corporate governance and less need for external financing but are not smaller than compliant control firms. Additional analyses indicate that compliance is negatively associated with bad news.     

高管持股、择时披露与市场反应

基于2001至2008年间A股公司业绩预告的样本,本文研究了高管持股对择时信息披露策略的影响,以及市场对择时披露信息的反应。研究发现,A股公司在业绩预告时存在择时披露的行为:好消息①更倾向于在交易日披露,坏消息更倾向于在休息日披露。高管持股比例会显著影响择时披露策略:高管持股比例越高的公司,进行择时披露的可能性也越高。从市场反应角度看,休息日披露的坏消息与交易日披露的坏消息没有显著差异,休息日披露的好消息反而会产生更加显著的正面市场反应。本文的研究意味着,高管持股比例会显著提高上市公司进行择时信息披露的可能性,但是市场在一定程度上能够识别择时披露策略,本文的研究结果支持了"信息消化"假说。     

The usefulness of firm risk disclosures under different firm riskiness,investor-interest,and market conditions: New evidence from Finland

To date, there is only meager research evidence on the usefulness of mandatory annual report risk disclosures to investors. Although it has been argued that corporate disclosure decreases information asymmetry between management and shareholders, we do not know whether investors benefit from high-quality risk reporting in a highly regulated risk disclosure environment. In this paper, we performed association tests to examine whether the quality of firms' mandatory risk disclosures relate to information asymmetry in the Finnish stock markets. In addition, we analyzed whether the usefulness of risk disclosures depends on contingency factors such as firm riskiness, investor interest, and market condition. We demonstrate that the quality of risk disclosure has a direct negative influence on information asymmetry. We also document that risk disclosures are more useful if they are provided by small firms, high tech firms, and firms with low analyst coverage. We also found that momentum in stock markets affects the relevance of firms' risk reports.     

Internal control reporting and market liquidity

We investigate the impact of the Sarbanes-Oxley Act of 2002 (SOX) on information asymmetry by analyzing the relation between SOX Sections 302 and 404 control reports and market liquidity using bid-ask spreads. Lower market liquidity indicates higher levels of information asymmetry implying that market participants perceive financial statement misstatement risk is higher. If SOX disclosures contain relevant information, then one would expect firms reporting internal control material weaknesses to have lower market liquidity. Accordingly, we find that market liquidity is lower (i.e., bid-ask spreads are higher) for firms reporting ineffective control compared to firms reporting effective control using either annual SOX 404 internal control reports or quarterly SOX 302 disclosure control reports, which suggests that SOX 302 and 404 reports provide useful information for identifying firms with a higher risk of financial statement misstatement. However, we do not find consistent results using two alternative liquidity measures: trading volume and market quality indices. We then examine whether changes in control reports are associated with changes in market liquidity. We generally do not find that firms with improved (deteriorated) control reports experience a larger decrease (increase) in bid-ask spreads or larger increases (decreases) in trading volume and market quality indices compared to other firms, suggesting that market participants do not discern a change in information asymmetry when the effectiveness of internal controls over financial reporting changes.     

Asymmetric effects of voluntary disclosure on stock liquidity: evidence from 8‐K filings

This paper examines whether the change in stock liquidity subsequent to voluntary disclosure is different between good news and bad news. Using voluntary 8‐K filings, we find that the increase in stock liquidity is more pronounced for firms with good news disclosure than for firms with bad news disclosure. In addition, such findings are stronger when a firm is less visible and when the short‐selling costs are high, suggesting that these two factors play an important role in increasing stock liquidity. Overall, this paper provides evidence that the tone of voluntary 8‐K news is an important determinant of stock liquidity.     

Controlling shareholder share pledging and stock price crash risk: Evidence from China

Using the unique setting of the Chinese market from 2003 to 2018, this study examines how share pledging behavior affects firms' stock price crash risk by analyzing the costs and benefits of the controlling shareholder's pledging decision to hoard bad news. We find that during the controlling shareholder share-pledging period, pledged firms exhibit significantly higher future stock price crash risk than their non-pledged counterparts. The risk is also higher during this period relative to in shareholders' own pre-pledging and post-pledging benchmark periods. Considering the internal and external information environment, we further observe a less pronounced increase in stock price crash risk for pledged firms with a strong internal control system and for those with more media attention. Together, our results reveal controlling shareholders' hedging motivations for engaging in pledging activities and the role played by the internal and external information environment in constraining the opportunistic behavior of controlling shareholders.     

Increased Disclosure Requirements and Corporate Governance Decisions: Evidence from Chief Financial Officers in the Pre‐ and Post–Sarbanes‐Oxley Periods

I study how increased internal control disclosure requirements mandated by the Sarbanes‐Oxley Act (SOX) affect annual corporate governance decisions regarding CFOs. Using non‐CEO, non‐COO executive officers as a control group, I find that CFOs of firms with weak internal controls receive lower compensation and experience higher forced turnover rates after the passage of SOX. In contrast, CFOs of firms with strong internal controls receive higher compensation and do not experience significant changes in forced turnover rates. These results are consistent with the “disclosure of type” hypothesis, which suggests that the mandatory internal control disclosures under SOX are a credible mechanism that effectively distinguishes good CFOs from bad ones by revealing the firm's internal control quality. The empirical evidence thus supports the notion that mandated increases in disclosure reduce information asymmetry in the executive labor market.     

Waiting and following: Within-industry herding behavior in annual report disclosure

Using the unique scheduled disclosure system for annual reports in China’s stock market, we examine within-industry herding behavior in annual report timing. The results reveal the waiting and following behavior strategies used in the annual reporting process within industry. Firms that originally schedule an early (late) disclosure date within their industry are more likely to reschedule to a later (earlier) date. Informational pressure is the dominant mechanism underlying herding in annual reporting, and capital market reputation incentives mainly induce the herding of bad news. Further analysis shows that delaying disclosure via the waiting strategy reduces the future occurrence of restatements, whereas bringing forward disclosure does not change the propensity of future restatements. Overall, we enrich the limited empirical studies on sequential mandatory disclosure decisions within industry.     

Voluntary Disclosures,Corporate Control,and Investment

We examine the valuation and capital allocation roles of voluntary disclosure when managers have private information regarding the firm’s investment opportunities, but an efficient market for corporate control influences their investment decisions. For managers with long‐term stakes in the firm, the equilibrium disclosure region is two‐tailed: only extreme good news and extreme bad news is disclosed in equilibrium. Moreover, the market’s stock price and investment responses to bad news disclosures are stronger than the responses to good news disclosures, which is consistent with the empirical evidence. We also find that myopic managers are more likely to withhold bad news in good economic times when markets can independently assess expected investment returns.     

Why Muddy the Water? Short selling and the disclosure of proprietary information

The conventional wisdom of voluntary disclosure literature is that the major factor preventing firms from disclosing customer-related information is firms' concern for proprietary costs. However, non-disclosure may also happen when firms have bad news to hide and are concerned about short sellers using customer information to verify bad news about the firms. By implementing a difference-in-differences research design against the backdrop of the deregulation of short selling in China, we find that increased short-selling pressure discourages firms from disclosing the identities of major customers. The findings also reveal consistent evidence supporting the bad news hoarding hypothesis rather than the proprietary cost hypothesis. Overall, our study provides an alternative explanation for firms’ lack of disclosure of customer information.     

An Empirical Analysis of Qualitative Management Earnings Forecasts

Despite efforts by the Securities and Exchange Commission (SEC) to encourage corporate disclosure of quantitative management earnings projections, only a small fraction of firms voluntarily do so. Instead of quantitative estimates, a large number of firms choose to disclose qualitative (verbal) assessments of their earnings prospects. This paper is a study of the information characteristics and the usefulness of this alternative form of forecast disclosure to investors. The study examines a sample of qualitative forecast statements from the 1979–1985 period and finds associations between these forecasts and percentage changes in realized earnings per share, the direction of financial analysts' forecast revisions following the disclosure of these forecasts, and abnormal stock returns on the date of their disclosure. These associations are, however, shown to be more significant for negative (bad news) than for positive (good news) forecasts.     

Audit opinion improvement and the timing of disclosure

Companies have been found to report positive information more quickly than they report negative information (i.e., good news early, bad news late). This paper investigates the potential impact of audit opinion change on the timeliness of financial disclosures, with improvements in audit opinion considered to be “good news.” We take both the direction and the magnitude of audit opinion change into consideration, with magnitude measuring how far the opinion is from an unqualified opinion (i.e., an unqualified opinion with explanatory paragraph is closer to an unqualified opinion than a qualified opinion is). We find that firms experiencing an improvement in their audit opinions disclose their financial results earlier, while those with audit opinion deteriorations report their financial results later, and that these effects were related to the magnitude of the opinion change. What's more, there is an asymmetric response to good audit opinion news vs. bad audit opinion news, with bad audit opinion news having a larger effect on earnings timeliness than the effect on earnings timeliness of good audit opinion news. Overall, our results support the “good news early, bad news late” notion. Finally, we also find that overall earnings timeliness has improved in China since the enactment of new reporting regulations in 2006.     

Does alternative data reduce stock price crash risk? Evidence from third-party online sales disclosure in China

This study empirically investigates the effect of releasing alternative data on firm-specific price crash risk. Using the public launch of a firm's third-party online sales data in a well-known Chinese financial database as an exogenous shock, we find that stock price crash risk significantly decreases with the disclosure of third-party online sales data. The results are robust to a series of endogeneity corrections and robustness checks. We also find that the reduction of stock price crash risk is due to the decrease in managers' bad news withholdings and the increase in the accuracy of market expectations. In addition, the negative association between third-party online sales disclosure and crash risk is more pronounced for firms with weaker external governance, higher earnings volatility, greater likelihood of sales manipulation, and lower book-to-market ratio. Our findings yield important implications for a comprehensive understanding of the information disclosure effect of online sales data in the capital market and the mechanisms to reduce stock price crash risk.     

Asymmetric impact of earnings news on investor uncertainty

We describe a model that predicts an asymmetric impact of disclosure on investor uncertainty. We show that good news tends to resolve more uncertainty than bad news, and that uncertainty can be revised upwards if the investors' prior belief is sufficiently strong and the signal is sufficiently bad. This result is in contrast to classical disclosure models, where new information always resolves uncertainty and the change in uncertainty depends only on the relative precision of the news. Using option-implied volatility as a proxy for uncertainty, we find strong support for our predictions. We also show that our results are robust to competing explanations, notably to the leverage effect and volatility feedback, as well as to the jump risk induced in anticipation of the earnings announcements.     

Firm Characteristics and Stock Price

This study examines the stock price reaction to the internal control reporting required under Section 404 of the Sarbanes‐Oxley Act of 2002 for three distinct groups of firms. After controlling for general stock price movements, we find that stock returns are most negative for firms that delay filing of their internal control reports, continue to be negative for firms with ineffective internal controls, and are positive for firms with effective internal controls. The decrease in stock prices of the first two groups is more pronounced for those with a lower return on assets, higher growth rate in sales, and no prior disclosure of their internal controls weaknesses. Our results indicate that market participants value the reliability of financial information ensuing from Section 404 compliance, irrespective of firm size and debt proportion. Thus, regulators and policymakers worldwide should consider mandating comparable SOX 404 compliance for all publicly held companies to improve the accuracy and reliability of financial reports.     

Short selling constraints and politically motivated negative information suppression

This study examines the effect of short selling constraints on politically motivated suppression of negative information. We use a unique setting in China, in which there are multiple exogenous changes in short selling constraints and firms have strong incentives to suppress negative information during politically sensitive periods. Results from Difference-in-Differences analyses and a regression discontinuity design show that removing short selling constraints can reduce politically motivated bad news suppression. Short selling can reduce negative information suppression through the channels of improved financial reporting quality, more voluntary disclosure from management, and more timely release of information by media. In addition, the effect of short selling on reducing bad news hoarding is more pronounced for more politically sensitive meetings and for state-owned firms located in regions with weaker market and institutional development.     

Corporate governance and the informativeness of disclosures in Australia: a re‐examination

We re‐examine the association between corporate governance and disclosures reported by Beekes and Brown (2006), using an extended time series of Australian data. Since the ASX corporate governance guidelines were introduced in 2003, firms generally have increased their disclosure frequency and demonstrated an improvement in the timeliness of bad news relative to good news, indicating a levelling of disclosure practices and greater transparency. Better governed firms have become more cautious in their disclosure practices. However, they continue to be more balanced with respect to good and bad news timeliness. Changes to disclosure laws have also influenced company practices.     

Pledgee competition,strategic disclosure,and future crash risk

We investigate whether pledgee competition affects the disclosure choice of firms whose controlling shareholders pledge their shares. We find that pledgee competition is positively related to pledge firms’ annual report tone management. This positive relationship is stronger for pledge firms with lower credit quality and non-state-owned enterprise pledge firms. Further corroborating our results, higher pledgee competition increases the future crash risk of pledge firms. Collectively, our results suggest that competition pressure induces pledgees to lower their monitoring incentives to remain competitive in the marketplace, thus leading to pledge firms’ bad news hoarding behavior.