The Impact of Reporting Quality on Crash Risks in the Korean Stock Market

This paper examines the determinants of a stock crash and aims to find whether reporting transparency has any effect on an extreme stock crash. More specifically, it delves into the quest of whether reporting transparency, as one of the determinants, has any effect on a stock crash in the Korean stock market. To analyze this possible relation, we employ companies with a stock crash record from 2006 to 2011 and use accruals quality, innate accruals quality and discretionary accruals quality as proxies for transparency. Furthermore, we adopt the proportional hazard model (Cox 1972) and PWP model (Prentice et al. 1981) for our analysis. The result conveys that accruals quality, innate accruals quality and discretionary accruals quality have a significant negative relation with stock crash risk. This indicates that the lower the accruals quality, the more likelihood of stock crash risk and that these variables can be used as indicators that can predict the possibility of crash risk. We also study whether the monitoring effect, estimated by institutional investors' trading ratio, affects transparency and crash risk. The result reveals the differences in innate accruals quality and discretionary quality under the monitoring of institutional investors. Moreover, greater involvement of institutional investors in transactions leads to a weak influence of innate accruals quality as well as a strong influence of discretionary accruals quality on a stock crash. In contrast, less involvement of institutional investors in market transactions reveals a weak relation between innate accruals quality and stock crash risk and no significant relation between discretionary accruals quality and stock crash. We conclude that the monitoring by institutional investors enhances discretionary accruals quality. However, when investors misinterpret the managers’ opportunistic behavior, the possibility of stock crash risk can increase. In addition, firms that receive relatively less interest from institutional investors are more likely to not make use of their accounting information effectively.