Slack and Crash Risk
Journal of Applied Business Research
33 Pages Posted: 29 Jun 2020 Last revised: 16 Jul 2020
Date Written: January 1, 2020
We examine how a firm’s operational slack is associated with current income and future stock price crash risk. By doing so, we test the validity of a firm’s alternative motivations for holding operational slack. We show that Supply Chain Slack, which is based on excess working capital, is associated with higher current profits and higher future crash risk. This evidence is consistent with the firm hoarding bad news. In contrast, SG&A Slack, which is based on excess selling, general, and administrative expenses, is associated with lower current income and lower future crash risk. This evidence is consistent with the firm insuring against rare and adverse events. Furthermore, a firm’s stock price crash risk is lower when a slack type is more costly, consistent with both motivations. Overall, our findings suggest a stronger profit-crash risk tradeoff when firms hold more operational slack.
Keywords: Crash risk, slack, return on equity
JEL Classification: G31, G32
Suggested Citation: Suggested Citation