Director Networks And Stock Price Crash Risk

Previous literature has shown that corporate executives have incentives to opportunistically withhold adverse information from the market for personal gains such as career concerns,and prestige.The bad news hoarding theory propounded by Jin and Myers(2006)asserts that when firms conceal bad news for an extended period of time,negative information is likely to be stockpiled within the firm.When the motivation for such actions collapses,or reaches a tipping point,all the hitherto undisclosed adverse information come to the public at once leading to stock price crashes.Using a sample of S&P 1500 firms from 1996 to 2013,I examine whether firms with well-connected directors better influence corporate behavior to prevent the occurrences of future extreme negative returns and hence investor welfare.I find strong and reliable evidence that stock price crash risk substantially declines for firms with well-connected directors.This mitigating effect is more pronounced in firms with no equity-based compensation and no joint CEO-Chairman position.I interpret these findings as supportive evidence that directors who are well-connected benefits from group innovation and becomes well informed to constrain managers' incentives to suppress bad news from the public.In specifics,my findings highlight director network as an important antidote to the occurrence of extremely negative stock prices/returns crashes.Furthermore,this study from the perspective of stock price crash risk provides an alternative explanation and addition to the value creation literature of firm networks.