Do Firm‐Specific Stock Price Crashes Lead to a Stimulation or Distortion of Market Information Efficiency?*

Abstract

Unlike prior research that focuses on determinants of firm‐specific stock price crashes (SPCs), we study the consequences of SPCs on market information efficiency. The tension underlying our research question stems from two competing explanations. As an unanticipated shock, an SPC could stimulate (distort) information efficiency by triggering investor rational attention (opinion divergence). Our identification strategy involves a difference‐in‐differences analysis in which SPC firms in the treatment sample are propensity score matched with non‐SPC firms in the industry‐peer control sample, as well as placebo tests for falsification. Consistent with the stimulation effect, we find an increase of the earnings response coefficient and a decrease in post‐earnings announcement drift, from the pre‐ to post‐SPC period, for SPC firms, but not for non‐SPC firms. Further analyses reveal that SPC firms attract increased investor attention, as reflected in greater analyst coverage and more investor access to firms' online financial filings following such an event. Using mutual fund flow redemption pressure based on hypothetical sales as an exogenous shock to SPCs, we provide evidence corroborating our causal interpretation of the main findings. Collectively, the evidence suggests that SPCs can attract increased investor attention, bringing about positive externalities by stimulating market information efficiency.

How does management respond to stock price crashes?

“…In addition, we apply year-fixed effects and firm-fixed effects to our model to control for any unobservable time- and firm-specific variations (e.g. Kim et al ., 2022). Our robust standard errors are clustered by the firm (e.g.…”

The moderating effect of financial constraints on the relationship between stock price crash risk and managerial ability

“…Literature review and hypotheses development 2.1 Literature review 2.1.1 Stock price crash risk. Given the hugely damaged investor confidence and shareholder wealth caused by market crashes (Kim et al, 2022), a burgeoning body of empirical research investigates stock price collapse determinants. Prior studies on crash risk can be classified into three streams.…”

“…Stock crash risk is considered as one of the major concerns in capital markets (Kim et al , 2022). Stock price crashes, referred to as an unanticipated but sharp fall in stock prices (Zhang et al , 2022), often impose devastating outcomes on investors’ wealth and leading many firms to declare bankruptcy (Kim et al , 2022). Pursuant to Jin and Myers (2006), the risk of stock collapse is partially due to managerial self-interest to deliberately hide negative information from outsiders, thus, increasing information asymmetry.…”

“…Stock crash risk is considered as one of the major concerns in capital markets (Kim et al, 2022). Stock price crashes, referred to as an unanticipated but sharp fall in stock prices…”

“…Stock crash risk is considered as one of the major concerns in capital markets (Kim et al , 2022). Stock price crashes, referred to as an unanticipated but sharp fall in stock prices (Zhang et al , 2022), often impose devastating outcomes on investors’ wealth and leading many firms to declare bankruptcy (Kim et al , 2022).…”