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The effect of accounting fraud on future stock price crash risk

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  • Richardson, Grant
  • Obaydin, Ivan
  • Liu, Chelsea

Abstract

Accounting fraud constitutes serious misconduct that damages investor confidence in capital markets. While accounting fraud revelations trigger declines in stock prices, it remains unclear whether firms’ past accounting fraud revelations (ex-post) or predicted future likelihood of fraud (ex-ante) affect their future risk of stock price crashes. Hence, we examine the effect of accounting fraud on future stock price crash risk. Using a sample of 51,492 U.S. firm-year observations over the 2000–2014 period, we find that both ex-post and ex-ante accounting fraud are significantly and positively related to future stock price crashes. Channel analysis shows that the relationship is magnified for firms with opaque information environments. This supports our theoretical mechanism that accounting fraud affects stock price crash risk through information opacity. Cross-sectional analysis is also conducted to explore potential heterogeneity across firms. We find that the relationship is magnified in firms with managerial entrenchment, CEO power, and CEO-board cooption.

Suggested Citation

  • Richardson, Grant & Obaydin, Ivan & Liu, Chelsea, 2022. "The effect of accounting fraud on future stock price crash risk," Economic Modelling, Elsevier, vol. 117(C).
    • Handle: RePEc:eee:ecmode:v:117:y:2022:i:c:s0264999322003091
    DOI: 10.1016/j.econmod.2022.106072
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    Keywords

    Accounting fraud; Stock price crash risk; Information environment; Agency theory;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law
    • K41 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Litigation Process

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