Financial Distress Risk and Stock Price Crashes

56 Pages Posted: 17 Sep 2019 Last revised: 2 Feb 2021

See all articles by Christoforos Andreou

Christoforos Andreou

Cyprus University of Technology

Panayiotis C. Andreou

Cyprus University of Technology

Neophytos Lambertides

Cyprus University of Technology

Date Written: September 8, 2019

Abstract

This study uses 462,678 monthly observations of US-listed firms for the period 1990-2018 to document a strong positive relationship between short-term changes in financial distress risk and future stock price crashes. This result is economically significant as a one interquartile increase of the main explanatory variable in any month increases the probability of a stock price crash by 8.33 percent relative to its mean value. The findings withstand controls for a large array of variables, firm-fixed effect estimations, and alternative definitions of distress and crash risk measures; they are also robust to a range of tests conducted to buttress against endogeneity concerns. The study conducts analyses demonstrating that the positive distress-crash risk relationship is driven by managerial opportunism that seeks to camouflage bad news that has an adverse effect on firms’ economic fundamentals. Accordingly, the findings corroborate an agency theory explanation for the impact of distress risk on stock price crashes. This study offers practical insights to investors, who should be vigilant of a firm’s distress risk, as sudden short-term increases underscore withheld negative information pertinent to crash risk problems.

Keywords: firm-specific stock price crashes; distress risk; bad news hoarding; agency problems; managerial opportunism; financial analysts

JEL Classification: G12, G19, G32, G33, M40, D89

Suggested Citation

Andreou, Christoforos and Andreou, Panayiotis C. and Lambertides, Neophytos, Financial Distress Risk and Stock Price Crashes (September 8, 2019). Journal of Corporate Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3450075 or http://dx.doi.org/10.2139/ssrn.3450075

Christoforos Andreou

Cyprus University of Technology ( email )

Limassol, 3603
Cyprus

Panayiotis C. Andreou (Contact Author)

Cyprus University of Technology ( email )

School Of Management and Economics
P.O. Box 50329
Lemesos, 3036
Cyprus

HOME PAGE: http://www.pandreou.com

Neophytos Lambertides

Cyprus University of Technology ( email )

Limassol, 3603
Cyprus

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