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Stock price crash risk and internal control weakness: presence vs. disclosure effect
Author(s) -
Kim JeongBon,
Yeung Ira,
Zhou Jie
Publication year - 2019
Publication title -
accounting and finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.645
H-Index - 49
eISSN - 1467-629X
pISSN - 0810-5391
DOI - 10.1111/acfi.12273
Subject(s) - stock price , business , crash , stock (firearms) , weakness , accounting , actuarial science , medicine , computer science , engineering , biology , programming language , anatomy , mechanical engineering , paleontology , series (stratigraphy)
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 ICW s, despite the disclosure itself signalling bad news. The above results hold after controlling for various firm‐specific determinants of crash risk and ICW s. Using an ICW disclosure as a natural experiment, our study attempts to isolate the presence effect of undisclosed ICW s 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.