Financial Statement Analysis and Predicting Stock Price Crash Risk : Evidence from Korea Stock Market

This study investigates whether the aggregate fundamental score (hereafter, AFS) developed through financial statement analysis has an ability to predict the stock price crash risk. Prior studies documented that the higher AFS can explain the higher future earnings. Given that bad news in firm performance are primarily followed by stock price crash, this study examines if financial statement information on future earnings (i.e., AFS) has the ability to signal future stock price crash. Using Korean Stock Exchange-listed firms from 2005 to 2015, a series of multivariate regression analyses and path analysis are conducted to test the hypothesis. The results show that the AFS is negatively related to the future stock crash risk. This is ensured by path analysis results showing the negative relationship between AFS and stock crash risk which is mediated by future earnings change. By showing that AFS based on financial statement analysis incorporates ex-ante information on stock price crash risk, this study underlines not only the significance of financial statement analysis as a fundamental analysis but also the usefulness of accounting information in firm valuation on which investment strategy is developed based.