Accounting Conservatism, the Sarbanes‐Oxley Act, and Crash Risk

Posted: 7 Jan 2010

See all articles by Xiaohua Fang

Xiaohua Fang

Florida Atlantic University

Yanju Liu

University of Toronto - Rotman School of Management

Baohua Xin

University of Toronto - Rotman School of Management

Date Written: November 28, 2009

Abstract

We examine how accounting conservatism at the firm level and the Sarbanes-Oxley Act (SOX) influence idiosyncratic stock crash risk. We document that firms that are more conservative in reporting their earnings are less prone to stock price crash, consistent with the finding of Jin and Myers (2006) that firms disclosing bad news in a timelier manner are less likely to deliver large negative stock returns. We also find strong evidence that idiosyncratic crash risk has decreased significantly in the post-SOX period, supporting the argument that SOX has led to less withholding of bad news and has improved disclosure and transparency. Moreover, the impact of SOX on crash risk varies systematically with the extent that firms withheld bad news in the pre-SOX period, showing an inverted U-shaped pattern. However, the impact of accounting conservatism on stock crash propensity has been mitigated since SOX was enacted, suggesting that firms are pressured to reveal bad news more through a variety of channels (e.g., management earnings forecasts and press conferences). This is probably due to the high litigation risk and severe penalties imposed by SOX.

Keywords: Crash Risk, Accounting Conservatism, Sarbanes-Oxley Act

JEL Classification: G10, K22, M41

Suggested Citation

Fang, Xiaohua and Liu, Yanju and Xin, Baohua, Accounting Conservatism, the Sarbanes‐Oxley Act, and Crash Risk (November 28, 2009). CAAA Annual Conference 2010, Available at SSRN: https://ssrn.com/abstract=1532601

Xiaohua Fang

Florida Atlantic University ( email )

United States

Yanju Liu

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Baohua Xin (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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