Corporate Accessibility, Private Communications And Stock Price Crash Risk
Lingnan University – Department of Finance and Insurance
Zhongshan University – Department of Finance and Insurance
The Chinese University of Hong Kong (CUHK) – Department of Finance
December 22, 2015
Abstract:
We construct a corporate accessibility measure for publicly listed firms in China based on their responses to outsiders’ attempted communications with them (telephone, email, and on-line discussion forum). We find robust evidence that stock price crash risk of accessible firms is lower than that of non-accessible firms, with the results being more pronounced when public information environment is opaque. Furthermore, accessible firms’ crash risk declines less when short-selling constraints are removed, have lower market synchronicity, and have more corporate site visits made by market participants. Our results suggest that corporate accessibility is a good measure of private communication that complements public information sources in reducing stock price crash risk.
Corporate Accessibility, Private Communications And Stock Price Crash Risk – Introduction
Following the work of Jin and Myers (2006), several scholars have turned their attention to examining the determinants of stock price crash risk1. This body of research has built on the premise that a lack of corporate transparency enables corporate insiders to hoard and accumulate bad news, which subsequently increases future stock price crash risk once the bad news is forced out. Consistent with this notion, prior studies show that stock price crash risk is reduced when firms adopt more conservative accounting standards, file more voluntary disclosures, increase disclosures following the adoption of IFRS, and have better earnings quality (Hutton, Marcus, and Tehranian, 2009; Kim, Li, and Zhang, 2011; DeFond, Hung, Li, and Li, 2014; Kim, Li, and Li, 2014; Kim and Zhang, 2015).
Studies on corporate transparency and crash risk typically focus on the accounting and disclosure practices adopted by firms. However, recent studies have shown that corporate transparency is determined not only by publicly available firm-specific information (which is generated from corporate accounting and financial disclosures made by firms as well as recommendations and reports produced by financial intermediaries) but also by information from private communications between corporate insiders and outsiders (such as verbal and written communications and/or conducting corporate site visits and interviews) (Bowen, Davis, and Matsumoto, 2002; Agarwal, Liao, Taffler, and Nash, 2008; Green, Jame, Markov, and Subasi, 2012; Cheng, Du, Wang, and Wang, 2013). In this paper, we turn our attention from accounting and disclosure practices to the private communications between insiders and outsiders and examine whether they can reduce stock price crash risks in China, a market operating under weak public information environment and that has hitherto been ignored in the stock price crash risk literature.
China is an ideal setting for our research because crash risks in emerging markets such as China tend to be more profound and vary a lot across the publicly listed firms. For example, Piotroski, Wong, and Zhang (2011) show that the negative skewness in daily excess returns in China is significantly greater than the global average documented in Jin and Myers (2006). More importantly, while China has many laws and regulations on corporate governance, the enforcement of accounting rules and disclosure standards is weak and the level of expertise and sophistication of financial intermediaries are less developed. As a result of this, the quality of publicly available firm-specific information is relatively low (Aharony, Lee, and Wong, 2000; Chen and Yuan, 2004; Liu and Lu, 2007; Kao, Wu, and Yang, 2009; Jian and Wong, 2010; Piotroski and Wong, 2011). Thus, the market participants (individual investors, fund managers, analysts, journalists) face great difficulties in obtaining accurate information from publicly available sources. Participants operating in such a weak public information environment will have incentives to seek additional information directly from companies by initiating private communications with corporate management. During private communications, market participants can ask corporate management to clarify ambiguities in the publicly available information, which can help them to make sense of the otherwise confusing public information (Green, Jame, Markov, and Subasi, 2012). In addition, market participants can also obtain new firm-specific information through directly observing the operation of the firms and/or the responses/tones of the managers (Cheng, Du, Wang, and Wang, 2013).
Realizing the importance of private communications in enhancing corporate transparency, the CSRC (China Securities Regulatory Commission) issued a regulation-“The Provisions on Strengthening the Protection of the Rights and Interests of the General Public Shareholders” (No. 118 [2004] of the CSRC) in 2004 to facilitate direct communications between investors and firms2. The provision requires listed firms in China to offer a variety of communication channels to outside investors. However, as it is voluntary for listed firms to comply with the regulation, we expect to see substantial variations among firms in terms of actual accessibility and this makes China a good testing venue for our investigation.
Unlike corporate accounting reports and disclosure practices, private communications initiated by outsiders are difficult to observe by third parties. Furthermore, the information generated depends on the quality of the communications, which is hard to measure. In this study, we construct a novel measure to capture the amount and the quality of private communications by looking at the ease with which outsiders can effectively contact corporate insiders through publicly available communication channels (via telephone, email, and on-line discussion forum) (hereafter referred to as corporate accessibility). We believe that corporate accessibility is a good proxy for private communication because corporate outsiders have to contact the insiders in some way or other before any communication can occur. Thus, corporate accessibility is expected to be related with the frequency of private communication, especially those initiated by outsiders who have no personal contacts with the firms. Furthermore, the willingness of insiders to set up public communication channels for unconnected outsiders could signal the hard-to-observe keenness of the insiders to engage in meaningful communications with outsiders. Thus, corporate accessibility should be positively related to the quality of the private communications.
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