Stock Price Crash Risk and Firms’ Operating Leverage

Abstract

We extend Jin and Myers’ (2006) model to derive the relation between stock price crash risk and operating leverage (i.e., the fraction of fixed costs in total costs). The model predicts that (i) firms’ operating leverage decreases as stock price crash risk increases, and (ii) the negative effect of crash risk on operating leverage is more pronounced when firms are closer to the crash threshold or when managers face higher costs of stock price crashes. We empirically test the model predictions using a large sample of manufacturing firms in the United States and find consistent results. Further analysis shows that higher crash risk leads to a less sticky cost behavior. In addition, crash-risk-driven operating deleveraging effectively reduces stock return volatility and enhances operating performance in subsequent years. Collectively, our findings reveal that crash-prone firms adopt a more flexible cost structure and technology to delay stock price crashes and mitigate adverse outcomes.

Keywords: Crash risk, Operating leverage, Cost structure, Opacity, Operating deleveraging, Cost Stickiness

JEL Classification: D24, G10, G30, M41