Financial Constraints and Future Stock Price Crash Risk

Guanming He, Helen Ren
  • SSRN Electronic Journal, January 2017, Elsevier
  • DOI: 10.2139/ssrn.3021307

Do financially constrained firms susceptible to stock price crash risk, and why?

What is it about?

This study investigates whether and how financial constraints on firms affect the risk of their stock prices crashing. We argue and find that financial constraints increase future stock price crash risk of firms via both bad-news-hoarding and default-risk channels. Further analyses reveal that the future crash risk of financially constrained firms is more prominent for firms with high abnormal accruals or with weak corporate governance and less pronounced for firms that commit tax avoidance or have a high credit rating.

Why is it important?

Our study has some important practical implications. The occasional stock price crashes in the equity markets have material impacts on investor welfare; hence, our findings should be of interest to investors making portfolio investment decisions. By understanding the factors that determine the cross-sectional variations in crash risk, investors can better predict and avoid future stock price crashes; this is also relevant to creditors, suppliers, customers, and other stakeholders concerned about a firm’s creditworthiness and viability. On the other hand, to mitigate crash risk, it is important for a financially constrained firm to build up strong corporate governance and increase creditworthiness as well as information transparency to the public.

Perspectives

Guanming He (Author)
Durham University

Our results shed light on the stock price crash risk of financially constrained firms and should have important implications for not only companies per se but also their stakeholders, including investors, creditors, suppliers, and customers concerned about the companies’ creditworthiness, viability, and prospects.

The following have contributed to this page: Guanming He