1. Introduction
This paper aims to analyze the relationship between managerial ability and subsequent stock price crash risk. In addition, this study aims to investigate how such relationships between managerial ability and future stock price crash risk is affected by whether the managers’ firm belongs to a large business group.
Managers play a fundamental role in corporate decision-making, and their characteristics are known to affect a wide range of firm strategies from financing, investing, tax reporting [
1,
2,
3]. Manager-specific factors also impact final decision-making of corporate disclosures, as managers are generally the final decision-makers both on mandatory and voluntary corporate disclosures [
4,
5,
6]. Moreover, the influence of managers is particularly more powerful in Korea, as ownership and management are not separate in most Korean firms unlike some financially advanced countries where ownership and control are effectively separated.
If the accumulated negative information crosses a certain tipping point, such excessive negative information is flooded into the capital market in the form of bad news, resulting in a stock price crash [
7]. The determinants of stock price crash risk have been identified at several levels; Manager-specific, firm-specific, environment-specific levels and so on. Most of the previous studies focused on specific factors at the firm or industry level. Several studies suggest that firm-level evidence such as tax avoidance, discretionary accruals and biased earnings forecast could affect the level of disclosure of bad news, which is positively related with subsequent stock price crash risk [
8,
9,
10]. A firm-specific stock price crash is caused by the accumulation of bad news about the firms. Managers withhold and accumulate bad news mainly because a conflict of interest arises between shareholders and managers, i.e., agency problems, which leads to information asymmetry [
11]. In fact, some studies find that one of the causes of stock price crash is agency problems [
7,
8,
12]. That is, managers have incentives to delay disclosing negative information about the firms due to an agency problem which exists between shareholders and managers, and thus engage in opportunistic behaviors [
11]. Information asymmetry, which is caused by the separation of ownership and control, allows managers to access more inside information [
13]. Under such circumstance, if they find negative information, managers withhold and postpone the release of bad news due to their career concerns and reputational risk.
However, these prior studies do not consider manager-specific factors as an independent determinant influencing the release of bad news and subsequent stock price crash risk. Some have overlooked and underestimated how managers’ characteristics could have significant implications on the capital market such as stock price crash risk. Before Reference [
14] introduced a noble approach called data envelopment analysis (DEA) to measure managerial ability, managerial ability had been difficult to quantify.
To enhance the firm’s sustainable management, it is important to identify the determinants of stock price crash risk which would result in a doubt on going concern. Hence, in this study we focus on managerial ability as one of the main factors of stock price crash risks. We view that manager-specific factors would have direct influence on a subsequent stock price crash risk. As such, we focused our attention on managerial ability and conducted an empirical analysis on the relationship between managerial ability and future stock price crash risks; we examined whether higher managerial ability would allow timely disclosure of corporate information, leading to a lower future stock price crash risk, or it would rather motivate managers to hoard bad news out of reputational and career concerns, resulting in a higher future stock price crash risk.
Reference [
3] showed that managers’ personal background, such as education, work experience and military experience, could affect financial disclosure styles. They explained that individual managers’ idiosyncratic characteristics and cognitive biases influence their financial disclosure choices, and corporate outcomes depend on managers’ individual attributes. Considering this logic, managerial ability, one of such manager-specific characteristics, could have the following implications on firm’s future stock price crash risk.
On the one hand, managerial ability and future stock price crash risk would be negatively related. This is supported by the findings from prior studies, i.e., managers issue voluntary earnings forecasts to signal their ability [
15] and managers with higher ability release more voluntary disclosures [
16]. On the other hand, CEOs with high ability may be reluctant to disclose management earnings forecasts due to opportunistic reasons [
17,
18]. In this case, managerial ability and future stock price crash risk would be positively related. Given these conflicting views, we can expect that managerial ability would have either positive or negative consequences on firm’s future stock price crash risk.
Another important aspect to consider is that the Korean economy has been hugely affected by large business groups called Chaebol, i.e., family-run conglomerates with unique corporate governance systems. People have expressed mixed views on Chaebol. Some say Chaebol have played a leading role in the economic development of Korea in the past years; others argue that itsr closed corporate governance structure where only the majority shareholders have controlling power results in inefficient business management, and minority shareholders suffer loss because the owners selfishly seek personal gains, and its market monopoly hinders balanced growth of the Korean economy. For this reason, it is essential to consider Chaebol’s functions, its management behaviors as well as its influence on the Korean economy in an academic research. Despite such importance, not many studies have reached a clear conclusion on this subject. In this respect, this study will also explore whether the managers’ firm belongs to a large business group or not has impacts on the relationship between managerial ability and future stock price crash risk.
In this study, we employed the DEA method suggested by [
14] to measure managerial ability, and a market-based measure for stock price crash risk of [
7]. We measured managerial ability by estimating firm efficiency by industry group (i.e., firm efficiency of a specific firm is compared to that of its industry peers) and then obtaining residual of the estimated firm efficiency after removal of firm-specific characteristics using the Tobit regression [
14]. This assumes managers with a higher level of ability produce higher revenue from a given level of resources and thus provides more precise and direct measures of managerial ability, compared to prior methods in which work experience, education or management performance was used as a proxy for managerial ability.
We conducted our empirical analysis by using 3944 listed firm observations for the period from 2002 to 2014 in Korea and discovered the following results. First, there is a significantly negative association between managerial ability and subsequent stock price crash risk. This negative relationship is in line with the view that managers with a higher level of ability provide more voluntary disclosures, which are useful channel to signal their ability; hence, they exhibit a significantly lower level of future stock price crash risk. Second, the negative relationship between managerial ability and stock price crash risk is weakened when the managers’ firm belongs to a large business group. It indicates that the large business group firms have lower demand for corporate information to monitor managers, due to their high access to information and direct involvement in management, hence they play a role of reducing the positive effect of managerial ability on decreased stock price crash risk.
This study contributes to earlier literature in many ways. First, to our knowledge, there is no previous study that assessed the association between managerial ability and subsequent stock price crash risk in Korea. We believe that our empirical results would shed light on how managers’ ability influences stock price crash risk. Second, we extended the research on the determinants of stock price crash risk by empirically proving that managers with higher ability leads to lower stock price crash risk. This implies that managerial characteristics, especially manager’s ability, affect the entire capital market. Third, our study acknowledges the importance of corporate governance by examining the effect of large business group on the association between managerial ability and subsequent stock price crash risk. Fourth, what makes our empirical analysis differentiated from previous research is that managerial ability is measured using a more sophisticated method to discover additional determinants of future stock price crash risk other than managers’ demographic traits or firm-specific effects.
The rest of this paper is organized as follows.
Section 2 reviews the prior researches and develops our hypotheses.
Section 3 provides the sample and research models, and
Section 4 explains the empirical results from the model. Finally,
Section 5 presents discussions and conclusion.
5. Discussion and Conclusions
This study explored how managerial ability influences future stock price risk using Korean listed firms’ observations. Using the DEA method suggested by [
14] to measure managerial ability and market-based measure for subsequent stock price crash risk which was also used by [
7], we examined the relationship between managerial ability and stock price crash risk by conducting empirical analysis. Compared to some financially advanced countries, managers tend to exert more powerful influence on the firm in Korea, as ownership and management are not effectively separated in most Korean firms. In addition, we considered the effect of large business groups called Chaebol, which is family-run conglomerates with unique corporate governance system and hugely affect the Korean economy. If managers with higher ability release more voluntary disclosures to signal their ability, we would expect managerial ability to be associated with lower stock price crash risk. On the other hand, if managers with higher ability are less likely to issue disclosures for opportunistic reasons and thus hoard bad news, managerial ability could be correlated with higher future crash risk. Furthermore, the relationship between managerial ability and subsequent stock price crash risk would be affected by the role of large business group firms.
Utilizing 3944 observations of KOSPI listed firms over the period from 2002 to 2014, we found that there is a significantly negative relation between managerial ability and subsequent stock price crash risk. We interpret this result as meaning that managers with higher ability have more incentives to disclose information to signal their ability, resulting in lower future stock price crash risk. Furthermore, we find that firms in large business group significantly weakens the negative relationship between managerial ability and subsequent stock price crash risk. This may imply that the demand for corporate information in large business group firms may be reduced because they already have high access to such information thanks to owner’s direct involvement in management, and bad news hoarding would increase as a result. Hence, firms belong to large business group play a role of weakening the positive effect of managerial ability on the subsequent stock price crash risk.
Our study contributes to the growing literature on the subject of stock rice crash risk and managerial ability and their implications on firms and investors. In this study, we pay attention to the unique role of managerial ability as one of the factors of stock price crash risk and provide the evidence of the effect of large business group, i.e., Chaebol, on the association between managerial ability and stock price crash risk. We also use more sophisticated methods to measure managerial ability in identifying a new factor of subsequent stock price crash risk.