We examine the relation between earnings smoothing and stock price crash risk to evaluate the role of earnings smoothing on the downside risk of equity values. We find that, within firm, a higher degree of earnings smoothing is associated with greater crash risk; and this association, in the cross-section, is more pronounced for firms with fewer analysts following, smaller institutional holdings, and positive cumulative discretionary accruals. We also use stock returns to assess the economic significance of our results. We find that, controlling for firm fixed effects, earnings smoothing is associated with sizable negative returns in the quarter following the earnings announcement. Our findings caution investors about the downside risk of firms reporting smooth earnings, in contrast to the conventional belief that these firms are low in equity risk.

This study investigates whether and how the deviation of cash flow rights (ownership) from voting rights (control), or simply the ownership‐control wedge, influences the likelihood that extreme negative outliers occur in stock return distributions, which we refer to as stock price crash risk. We do so using a comprehensive panel data set of firms with a dual‐class share structure from 20 countries around the world for the period of 1995–2007. We predict and find that opaque firms with a large wedge are more crash prone than opaque firms with a small wedge. In addition, we predict and find that the positive relation between the wedge and crash risk is less pronounced for firms with more effective external monitoring and for firms with greater growth opportunities. The results of this study are broadly consistent with Jin and Myers’s theory that agency costs, combined with opacity, exacerbate stock price crash risk.

In this study, we show that a firm's use of special purpose entities (SPEs) is associated with unfavorable loan contract terms, including higher loan rates, collateral requirements, and restrictive covenants. Further analyses suggest that the association between the use of SPEs and unfavorable loan contract terms is primarily due to the increase in the information risk faced by lenders, as firm managers can easily use SPEs to manipulate earnings and hide losses. Specifically, we find that the use of SPEs has a more pronounced effect on increasing the cost of loans and causing more stringent non-price loan terms when managers have a stronger incentive to manipulate earnings and when banks have less knowledge about the SPE sponsor firms due to the lack of prior lending relationship. In addition, we find that the use of SPEs is associated with a greater likelihood of accounting restatements and greater information asymmetry between inside managers and outside capital suppliers.