Stock price crash risk and internal control weakness : presence vs. disclosure effect

Research output: Journal Publications and Reviews (RGC: 21, 22, 62)21_Publication in refereed journalpeer-review

18 Scopus Citations
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Author(s)

Detail(s)

Original languageEnglish
Pages (from-to)1197–1233
Journal / PublicationAccounting and Finance
Volume59
Issue number2
Online published31 May 2017
Publication statusPublished - Jun 2019
Externally publishedYes

Abstract

This study examines the stock price crash risk for a sample of firms that disclosed internal control weaknesses (ICW) under Section 404 of the Sarbanes‐Oxley Act (SOX). We find that in the year prior to the initial disclosures, ICW firms are more crash‐prone than firms with effective internal controls. This positive relation is more pronounced when weakness problems are associated with a firm's financial reporting process. More importantly, we find that stock price crash risk reduces significantly after the disclosures of ICWs, despite the disclosure itself signalling bad news. The above results hold after controlling for various firm‐specific determinants of crash risk and ICWs. Using an ICW disclosure as a natural experiment, our study attempts to isolate the presence effect of undisclosed ICWs from the initial disclosure effect of internal control weakness on stock price crash risk. In so doing, we provide more direct evidence on the causal relation between the quality of financial reporting and stock price crash risk.

Research Area(s)

  • Crash risk, Internal control weakness, Sarbanes-Oxley Act