Policy uncertainty, bad news disclosure, and stock price crash risk

Abstract

This paper documents that economic policy uncertainty reduces future stock price crash risk by increasing firms’ disclosure of bad news. Our tests show that firms release more bad news during periods of high policy uncertainty – they use more conservatism accounting, exhibit stronger future earnings response coefficients, use more negative tones in their financial reports, and have managers that express more negative sentiment in earnings conference calls than during periods of low policy uncertainty. Additional analyses show that the negative relation between EPU and future stock price crash risk is more pronounced among firms with more short-sale constraints, with no actively traded credit default swap contracts, with lower options-implied negative skewness, or with higher firm-level political risks. The results from regressions adopting the instrumental variable approach and from a quasi-natural experiment suggest that the negative relation observed between policy uncertainty and stock price crash risk is unlikely to be driven by potential endogeneity.