A critique of the agency theory viewpoint of stock price crash risk

Abstract

This study documents a puzzling historical trend in crash risk for US-listed firms: Between 1950 and 2018, firm-specific stock price crashes rose from 5.5% to an astonishing 27%. The vastness of the existing literature notoriously attributes such crashes to agency reasons fueled by managerial opportunism, i.e., self-interested executives who strategically camouflaging bad news via financial reporting opacity and overinvestment. Our findings provide empirical support that these two agency channels cannot effectively explain the increasing frequency of stock price crashes, especially in the period following the enforcement of the Sarbanes–Oxley Act. Overall, this study criticizes the efficacy of the agency paradigm and highlights the stock price crash risk puzzle, for which a plausible explanation remains elusive. Our conclusions offer avenues for future research to pursue in rationalizing this puzzle.