Stock Price Crash Risk and Firms’ Operating Leverage

49 Pages Posted: 5 Oct 2022 Last revised: 23 Nov 2022

See all articles by Xin Chang

Xin Chang

Nanyang Business School, Nanyang Technological University

Louis T. W. Cheng

The Hang Seng University of Hong Kong - Department of Economics and Finance

Wing Chun (Kaz) Kwok

The Hang Seng University of Hong Kong

George Wong

The Hong Kong Polytechnic University

Date Written: November 9, 2022

Abstract

We extend Jin and Myers’ (2006) model to derive the relation between stock price crash risk and operating leverage (i.e., the fraction of fixed costs in total costs). The model predicts that (i) firms’ operating leverage decreases as stock price crash risk increases, and (ii) the negative effect of crash risk on operating leverage is more pronounced when firms are closer to the crash threshold or when managers face higher costs of stock price crashes. We empirically test the model predictions using a large sample of manufacturing firms in the United States and find consistent results. Further analysis shows that higher crash risk leads to a less sticky cost behavior. In addition, crash-risk-driven operating deleveraging effectively reduces stock return volatility and enhances operating performance in subsequent years. Collectively, our findings reveal that crash-prone firms adopt a more flexible cost structure and technology to delay stock price crashes and mitigate adverse outcomes.

Keywords: Crash risk, Operating leverage, Cost structure, Opacity, Operating deleveraging, Cost Stickiness

JEL Classification: D24, G10, G30, M41

Suggested Citation

Chang, Xin and Cheng, Louis T. W. and Kwok, Kaz and Wong, George, Stock Price Crash Risk and Firms’ Operating Leverage (November 9, 2022). Journal of Financial Stability, Forthcoming, Nanyang Business School Research Paper No. 22-22, Available at SSRN: https://ssrn.com/abstract=4217241 or http://dx.doi.org/10.2139/ssrn.4217241

Xin Chang

Nanyang Business School, Nanyang Technological University ( email )

Singapore, 639798
Singapore

HOME PAGE: https://personal.ntu.edu.sg/changxin/

Louis T. W. Cheng

The Hang Seng University of Hong Kong - Department of Economics and Finance ( email )

Hang Shin Link
Siu Lek Yuen
Shatin
United States

Kaz Kwok (Contact Author)

The Hang Seng University of Hong Kong ( email )

Hang Shin Link
Siu Lek Yuen
Shatin, Hong Kong
China

George Wong

The Hong Kong Polytechnic University ( email )

School of Accounting and Finance
Hung Hom, Kowloon, 0
Hong Kong
852 3400 3459 (Phone)
852 2330 9845 (Fax)

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