Divergence of Cash Flow and Voting Rights, Opacity, and Stock Price Crash Risk: International Evidence

Abstract

This study investigates whether and how the deviation of cash flow rights (ownership) from voting rights (control), or simply the ownership‐control wedge, influences the likelihood that extreme negative outliers occur in stock return distributions, which we refer to as stock price crash risk. We do so using a comprehensive panel data set of firms with a dual‐class share structure from 20 countries around the world for the period of 1995–2007. We predict and find that opaque firms with a large wedge are more crash prone than opaque firms with a small wedge. In addition, we predict and find that the positive relation between the wedge and crash risk is less pronounced for firms with more effective external monitoring and for firms with greater growth opportunities. The results of this study are broadly consistent with Jin and Myers’s theory that agency costs, combined with opacity, exacerbate stock price crash risk.

Do bankers on the board reduce crash risk?

“…In addition, the credibility to convince other board members to disclose negative information to stockholders is higher for CBDs due to their extensive experience in banking careers. Second, through CBDs’ effective monitoring, hoarding bad news becomes increasingly costly, while the relevant benefits of hiding bad news decrease (Hong, Kim, & Welker, ). Since managers’ incentives and capabilities to hide bad news decrease with CBDs’ presence, there will be a lower likelihood of sudden bad news releases that result in a price crash.…”

Can Shareholders Be at Rest after Adopting Clawback Provisions? Evidence from Stock Price Crash Risk

“…Empirical findings in the literature generally support the preceding agency explanations for concealing bad news and stock price crashes. Studies find that such crashes are induced by equity-based compensation (Kim, Li, and Zhang 2011a) and separation of voting (control) from cash flow rights (ownership) (Hong, Kim, and Welker 2013) but mitigated by effective internal control systems (Zhou, Kim, and Yeung 2015), independent audit committees (Andreou, Antoniou, Horton, and Louca 2016), large audit offices (Callen, Fang, Xin, and Zhang 2014), longer auditor tenure (Callen and Fang 2017), religious business environments (Callen and Fang 2015a), better corporate social responsibility performance (Kim, Li, and Li 2014), institutional investor monitoring (Callen and Fang 2013), conditional conservatism in financial statements (Kim and Zhang 2016), and mandatory IFRS adoption (DeFond et al 2015). Studies further provide evidence that bad news may be concealed through a number of channels including accrual-and real activities-based earnings management, earnings guidance, complex tax shelters, and readability of financial reporting (Francis, Hasan, and Li 2016;Hamm, Li, and Ng 2016;Hutton et al 2009;Kim, Li, and Zhang 2011b;Kim, Wang, and Zhang 2015).…”

Individualistic cultures and crash risk

“…Second, we contribute to a growing body of research that examines the factors linked to stock price crash risk. Existing research shows that earnings management (Hutton et al, ); equity incentives to CEOs (Kim et al, ); complex tax shelters (Kim, Li, & Zhang, ); institutional ownership (An & Zhang, ); the adoption of the international financial reporting system (DeFond et al, ); audit quality (Robin & Hao, ); accounting conservatism (Kim & Zhang, ); overconfident managers (Kim, Wang, & Zhang, ), corporate governance (Andreou, Antoniou, Horton, & Louca, ); corporate debt maturity (Dang, Lee, Liu, & Zeng, ); CEO age (Andreou et al, ); divergence of cash flow and voting rights (Hong, Kim, & Welker, ); employee welfare (Ben‐Nasr & Ghouma, ); and real earnings management (Khurana, Pereira, & Zhang, ) all affect crash risk. Extending this line of the literature, we identify one key dimension of national culture, namely, individualism, that helps fuel crash risk.…”