Financial Reporting Opacity and Expected Crash Risk: Evidence from Implied Volatility Smirks

By Jeong‐Bon Kim, Liandong Zhang. 2014

392 citations recorded by the source corpus.

The recent financial crisis has stimulated a renewed interest in understanding the determinants of stock price crash risk (i.e., left tail risk). Recent research shows that opaque financial reports enable managers to hide and accumulate bad news for extended periods. When the accumulated bad news reaches a certain tipping point, it will be suddenly released to the market at once, resulting in an abrupt decline in stock price (i.e., a crash). This study extends this line of research by examining the impact of financial reporting opacity on perceived or expected crash risk. Prominent economists, such as Olivier Blanchard, argue that removing the perception of tail risks (in addition to realized tail risks) is crucial in restoring investor confidence and stabilizing the stock market. Using the steepness of option implied volatility skew as a proxy for perceived crash risk, we find that accrual management, the presence of financial statement restatements, and auditor-attested internal control weakness are all positively and significantly associated with the level of perceived crash risk. Our results suggest that improving financial reporting transparency is an important mechanism for firms and policymakers to reduce the perception of tail risks and stabilize the stock market.

Subfields: Accounting, Finance

View Paper: https://www.semanticscholar.org/paper/bf8d501cd50c626c6769e418b9369d84f3707d7e

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Citations in the corpus

The role of internet-related technologies in shaping the work of accountants: New directions for accounting research (2019, background): “Those involved in financial reporting(6) (Kim and Zhang, 2014), corporate social responsibility (Gallhofer, Haslam, and van der Walt, 2011) and supply chain management (Agndal and Nilsson, 2010) have argued for increased transparency in transactions.”
Accounting Conservatism and Stock Price Crash Risk: Firm-level Evidence. (2012, positive): “Finally, this study contributes to the literature on the relation between accounting properties and stock price crashes (e.g., Hutton et al. 2009; Kim and Zhang 2014).”
Stock price crash risk: review of the empirical literature (2018, positive): “Kim and Zhang (2014) introduce a new measure, implied volatility smirks, as a proxy for perceived crash risk and validate this measure by documenting a positive association with financial reporting quality, and accounting restatements.”
CEO Overconfidence and Stock Price Crash Risk (2016, methodology): “Kim and Zhang (2015) find evidence that conditional conservatism in financial reporting lowers the likelihood of a firm’s future stock price crashes. In this section, we examine whether conditional conservatism can limit overconfident CEOs’ tendency to withhold bad news and mitigate the impact of CE”
Corporate Governance and Firm-Specific Stock Price Crashes (2016, positive): “1 Kim and Zhang (2014) also examine the relation between financial reporting opacity and ex ante (or perceived) crash risk, as reflected in the steepness of implied volatility smirks.”
The Linear and Non-Linear Effects of Internal Control and Its Five Components on Corporate Innovation: Evidence from Chinese Firms Using the COSO Framework (2020, result): “First, as suggested in Chen et al. (2017), previous studies (e.g. Kim & Zhang, 2014; Zhou et al., 2014) primarily consider internal control as a single summary measure of all internal control components because the individual component scores are not available.”
Internal Control and Stock Price Crash Risk: Evidence from China (2017, methodology): “3 We conjecture that there at least three reasons that could lead to different findings from Kim and Zhang (2014). First, the proxy of internal control quality in the two US studies is a dummy variable, while ours is a continuous variable which could lead to more powerful tests.”
Firm crash risk, information environment, and speed of leverage adjustment (2015, positive): “Prior studies (Jin and Myers, 2006; Hutton et al., 2009; Kim et al., 2011a; Kim et al., 2011b; An and Zhang, 2013; Kim et al., 2014; Kim and Zhang, 2014; Kim and Zhang, forthcoming) focus on the determinants of crash risk but do not analyze the consequences of crash-risk exposure on corporate…”