Management Earnings Forecasts Bias, Internal Control, and Stock Price Crash Risk: New Evidence from China

ABSTRACT

Using a sample of Chinese listed firms over 2012–2018, we find robust evidence that management earnings forecasts bias is positively associated with crash risk, and this effect mainly exists in optimistic bias. Furthermore, higher levels of internal control can reduce management earnings forecasts bias and then reduce crash risk. Specifically, among the five components of internal control, risk assessment and communication are the main channels. In addition, the effect of internal control in weakening management earnings forecasts bias on stock price crash risk is more pronounced in firms with mandatory disclosure, timely disclosure and bad news. Our research shows that internal control plays an important role in mitigating stock price crash risk caused by management earnings forecasts bias.

KEYWORDS:

• Management earnings forecasts
• optimistic bias
• internal control
• crash risk

JEL:

• G19
• D89
• M40

Notes

1. In the literature, price crash risk defined as the probability of extreme negative returns over a specific period, normally one year (Jin and Myers 2006; Kim, Li, and Zhang 2011a, 2011b).

Additional information

Funding

We appreciate the support of the fund project from (SWU2008019), the Industry-university cooperation funds (202002322001), the Coupling Mechanism and Support Policies of Multiplex Agricultural Investors under China Rural Vitalization Strategy (18BJY157),and the Philosophy and Social Sciences Research Funds for Universities in Jiangsu Province (2020SJA0287). Major Project of National Social Science Foundation of China: A Survey on Deep Poverty in Ethnic Areas and Strategies for Crossing Poverty Trap (18ZDA121).