Corporate Governance and Firm-Specific Stock Price Crashes

We investigate whether four dimensions of corporate governance mechanisms, namely ownership structure, accounting opacity, board structure and process and managerial incentives, relate to 1-year-ahead stock price crash risk. Employing principal component analysis on the 21 attributes that comprise these four categories, we find that corporate governance explains overall between 13.1% and 23.0% of a one standard deviation in future crash risk. Further analysis reveals that transient institutional ownership, CEO stock option incentives and the percentage of directors that hold equity in the firm increase a firm’s future stock price crash, whilst insiders’ ownership, conditional accounting conservatism, board size and the presence of a corporate governance policy have the ability to mitigate crashes. The relations between these governance attributes and future crash risk are more pronounced in environments that accentuate agency risk. Our findings support the notion that sound corporate governance systems curb opportunistic behavior of managers to hide and accumulate bad news from outsiders.