Advances in information technology have revolutionized the dissemination and acquisition of firm-specific information, allowing investors and other stakeholders to quickly assess firm performance and value and monitor management effectively. Our research examines the impact of information technology on the ability of managers to hide and hoard bad news that, when ultimately released, results in a stock price crash. We use the staggered implementation of the Securities and Exchange Commission’s Electronic Data Gathering Analysis and Retrieval System (EDGAR) from 1993 through 1996 as a proxy for advances in information technology. The EDGAR implementation significantly changed public access to required corporate filings, moving from a paper-based system with limited access to an electronic system available to anyone with a computer and internet access. The EDGAR implementation is an ideal setting to investigate our research question because it represents an information technology shock that affected all public firms.
Jin and Myers (2006) suggest that stock price crashes occur when managers withhold bad news about the firm (e.g., missed market expectations, investigations by a governmental agency, and product failures) to protect their salary, wealth, jobs, or reputation. Withholding bad news for an extended period of time leads to a stockpile of negative information unknown to market participants. When the bad news reaches a certain threshold, managers give up and release the bad news at once, resulting in a stock price crash (e.g., Jin and Myers 2006; Hutton, Marcus, and Tehranian 2009). Stock price crashes are extreme outcomes with significant economic consequences to investors. Prior empirical and theoretical research suggests that average investors are averse to investing in firms that have greater stock price crash risk (e.g., Ibragimov and Walden 2007; Chang, Christoffersen, and Jacob 2013; Conrad, Dittmar, and Ghysels 2013; and Robin and Zhang 2015). Information technology has the potential to strengthen the ability of investors to monitor management. To the extent that improved monitoring resulting from information technology reduces the ability of managers to hide and hoard bad news, we would expect a negative association between advances in information technology and stock price crash risk.
The EDGAR implementation, our proxy for advances in information technology, occurred on a staggered basis between 1993 and 1996. All pubic firms were assigned to one of 10 implementation groups, and each group was required to begin filing electronically on EDGAR by a specified date. The first group was required to begin on April 26, 1993, and subsequent group implementation dates occurred periodically over the following three years. We exploit the staggered EDGAR implementation to test our hypothesis. As suggested by Gao and Huang (2019), the staggered implementation of EDGAR allows us to control for general market changes and other potentially confounding events that occurred over the sample period, which increases our confidence in the causal inferences drawn from the results.
Using a sample of 3,755 firms that implemented EDGAR over the staggered adoption period of 1993-1996, we find that firms’ stock price crash risk significantly decreased after the EDGAR implementation (compared with the pre-adoption period and with firms that had not yet adopted EDGAR). We also find that the EDGAR implementation reduced stock price crash risk to a greater extent for firms with greater information asymmetry. These results suggest that information technologies such as EDGAR, which strengthen the monitoring ability of investors and make it more difficult for managers to hoard bad news, ultimately reduce stock price crash risk. In additional analyses, we directly test whether firms respond to the increased monitoring ability of investors by accelerating the reporting of bad news following the EDGAR implementation. Using Basu’s (1997) differential timeliness coefficient, we find that the EDGAR implementation is associated with greater accounting conservatism, suggesting that bad news is recognized in earnings in a more timely manner following the EDGAR implementation. Thus, increased conservatism is a channel through which stock price crash risk decreased following the EDGAR implementation.
Although information technology has the potential to significantly affect and revolutionize capital markets, there is limited research on the consequences of information technology advances. Gao and Huang (2019) use the staggered EDGAR implementation to investigate how information technology affects information production and stock pricing efficiency. They find that, after the adoption of EDGAR, trades become more informative, analyst forecasts are more frequent and accurate, and stock pricing efficiency increases. Our research adds to the literature by focusing on the economic consequences of information technology. Our results suggest that, by strengthening the monitoring ability of investors, information technology advances attenuate managers’ ability to withhold bad news and therefore results in a decrease in stock price crash risk. This reduction in extreme stock market outcomes directly benefits investor welfare.
REFERENCES
Basu, S. 1997. The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting and Economics 24 (1): 3-37.
Chang, B. Y., P. Christoffersen, and K. Jacob. 2013. Market skewness risk and the cross section of stock returns. Journal of Financial Economics 107 (1): 46-68.
Conrad, J., R. F. Dittmar, and E. Ghysels. 2013. Ex ante skewness and expected stock returns. The Journal of Finance. 68 (1): 85-124.
Gao, M., and J. Huang. 2019. Informing the market: The effect of modern information technologies on information production. Review of Financial Studies Forthcoming.
Hutton, A. P., A. J. Marcus, and H. Tehranian. 2009. Opaque financial reports, R2, and crash risk. Journal of Financial Economics 94: 67-86.
Ibragimov, R., and J. Walden. 2007. The limits of diversification when losses may be large. Journal of Banking & Finance. 31 (8): 2551-2569.
Jin, L., and S. C. Myers. 2006. R2 around the world: New theory and new tests. Journal of Financial Economics 79: 257-292.
Robin, A. J., and H. Zhang. 2015. Do industry-specialist auditors influence stock price crash risk? Auditing: A Journal of Practice & Theory 34 (3): 47-79.
This post comes to us from professors Feng Guo at Iowa State University, Ling Lei Lisic at Virginia Tech, Michael D. Stuart at Vanderbilt University, and Chong Wang at Hong Kong Polytechnic University. It is based on their recent paper, “The Impact of Information Technology on Stock Price Crash Risk: Evidence from the EDGAR Implementation,” available here.