Does the Balance Sheet Prevent Managers from Hiding Bad News? Evidence from Firm-Specific Crash Risk

53 Pages Posted: 4 Oct 2014

See all articles by Erqiu Wang

Erqiu Wang

affiliation not provided to SSRN

Date Written: April 30, 2012

Abstract

I examine whether the balance sheet serves as a binding control mechanism that prevents managers from withholding bad news from outside investors. I predict that firms with bloated balance sheets are more likely to suffer stock price crashes. I use net operating assets scaled by total assets (NOA) as my proxy for balance sheet bloat; I use three measures of residual returns distribution to capture firm-specific crash risk: extreme negative outliers below the mean weekly returns (CRASH), negative skewness (NCSKEW), and down-to-up asymmetric volatility (DUVOL). While beginning NOA is negatively associated with next period CRASH, I find a positive relation between beginning NOA and NCSKEW as well as DUVOL before the Sarbanes-Oxley Act (SOX). NOA’s predicative power has largely dissipated since the passage of SOX. This finding is consistent with that in Cohen et al. [2008] that managers substitute away from accounting manipulation in response to the heightened outside monitoring in the post-SOX world.

Keywords: stock price crash, SOX, net operating assets, bad news, earnings management

JEL Classification: M41

Suggested Citation

Wang, Erqiu, Does the Balance Sheet Prevent Managers from Hiding Bad News? Evidence from Firm-Specific Crash Risk (April 30, 2012). Available at SSRN: https://ssrn.com/abstract=2503745 or http://dx.doi.org/10.2139/ssrn.2503745

Erqiu Wang (Contact Author)

affiliation not provided to SSRN

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