Firms’ Real Earnings Management and Subsequent Stock Price Crash Risk

43 Pages Posted: 16 Jan 2011 Last revised: 25 Aug 2011

Lingxiang Li

Rensselaer Polytechnic Institute (RPI) - Lally School of Management

Bill B. Francis

Rensselaer Polytechnic Institute (RPI) - Lally School of Management

Iftekhar Hasan

Gabelli School of Business, Fordham University; Bank of Finland

Date Written: January 13, 2011

Abstract

Using a large sample of U.S. firms for the period from 1994 to 2009, we find that firms’ prior real earnings management (RM) is positively associated with their stock price crash. These results are robust to firm-fixed effects analysis, different crash likelihood measurements, and suspect-firm analysis. On the other hand, RM does not show any predicting power on positive jumps, which supports the argument that insiders use real activities to hide bad but not good information. We find that the predicting power of RM on crash risks after SOX 2002 is much stronger, with the marginal impact being nearly three times as it is in pre-SOX period. By contrast, and consistent with the finding by Hutton et al. (2009), the marginal impact of accrual-based earnings management on crash risks drops by about half after SOX.

Suggested Citation

Li, Lingxiang and Francis, Bill B. and Hasan, Iftekhar, Firms’ Real Earnings Management and Subsequent Stock Price Crash Risk (January 13, 2011). CAAA Annual Conference 2011. Available at SSRN: https://ssrn.com/abstract=1740044 or http://dx.doi.org/10.2139/ssrn.1740044

Lingxiang Li (Contact Author)

Rensselaer Polytechnic Institute (RPI) - Lally School of Management ( email )

Troy, NY 12180
United States

Bill B. Francis

Rensselaer Polytechnic Institute (RPI) - Lally School of Management ( email )

Troy, NY 12180
United States

Iftekhar Hasan

Gabelli School of Business, Fordham University ( email )

Rose Hill Campus Bronx
New York, NY 10458
United States

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

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