Studying the effect of quality of financial reporting on risk of future stock price crash in firms listed in Tehran stock exchange

Author Name(s): Farhad Rezazadeh, Javad Ghadimpour*
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Abstract

A lot of economic decisions are taken based on information arising from accounting information systems. Attention to quality of provided information for users is of special necessity and increasing quality of information can give rise to higher efficiency of firms’ investors and maintenance and development of their resources. Meanwhile, financial reporting and its quality are of high importance for all users. Stock price crash is an event that the price of stock sustains sudden negative and severe moderation. This sudden decline of price is definitely harmful for shareholders and even for the firm; therefore this paper aims to study the effect of quality of financial reporting on risk of future crash of stock prices in firms listed in Tehran stock exchange. Along this, one seeks to examine 131 firms member of Tehran stock exchange within 2008-2013 period that includes 786 observations. Quality of earnings indicator is used for calculating the quality of financial reporting based on Francis’s (2005) model which is developed based on Dichef and Dicho (2002). Skewness negative coefficient model of Chen (2001) is used for calculating the stock price crash. Results have shown that financial reporting quality has significant impact of future stock price crash risk, thus higher the quality of financial reporting, lower the risk of future stock price crash.

KeyWords

quality of financial reporting, risk of future stock price crash

Introduction

Today, successful economic firms for rapid response to commercial alteration should meet the need of users and supply information required for management in an appropriate manner so that by a suitable definition of organization relative advantages, they would be able to have a rapid accountability to needs of customers and users of financial statement and to put the reduction of costs in their agenda. Thus, there are considerable alterations in the manner in which financial reporting is presented in evaluating the performance and financial and non-financial reporting. In fact, today, reporting should keep the pace with change of users’ needs;otherwise it loses its efficiency and effectiveness. This can be of high

importance when we consider the survival of accounting job dependent on accepting fundamental changes in line with changed made in economic firms and world commercial milieu. Many studies have been done over recent three decade about quality of reporting and its desirable limit (Verdy, 2006).

Risk of crash of stock price in the market is one of greatest concerns of investors and many studies addressed the importance of this in different stock exchanges markets around the world, because stock price crash can be important for capital market as its intensification gives rise to pessimism of investors about investing within stock exchange, finally it leads to bringing the capital out of the stock exchange and it deteriorates the stock exchange market. Theoretic basics show that high quality of reporting can reduce this risk (Ferughi et al, 2012).

Conclusion

Quality of financial information and reporting serves always as most effective variables in determining the investment strategy in financial markets. However, managers as responsible of providing financial statement tend to distort financial information in favor of their interests. Among measures of managers resulting in low quality of financial information is manipulation of earnings. Within earning manipulation, managers attempt to accumulate the negative news in the firm so as not to reveal it. When this mass of negative accumulated news reaches to its peak it flows to the market suddenly and leads to stock price crash. Therefore, one can say that low quality of financial reporting increases the risk of stock price crash. The main objective in this study is examining the effect of quality of financial reporting on future risk of stock price crash in firms listed in Tehran stock exchange over 6-year period. A hypothesis is set forth based on study objectives and it is analyzed in section 4 by collecting information of 131 firms over study period. In the following, hypothesis results are studied.

Hypothesis: quality offinancial reporting has direct influence on future risk of stock price crash.

Considering the findings from section 4, it is specified that level of significance of quality of earning variable as indictor of quality of financial reporting is less than error level 0.05 ( value of coefficient is -0.0000152 with level of significance 0.000). therefore it can be concluded that this variable has significant effect on stock price future crash risk. Similarly, as minus sign implies, as quality of earning is higher, risk of stock price future crash would be lower. Therefore, based on earlier discussion, one can say that hypothesis “ quality of financial reporting has significant effect on risk of stock price future crash” is confirmed with 95 % confidence. By studying literature review it can be concluded that current paper results are similar to that of Raj Gupal & Venakata Chalam’s (2011) and Hutton et al (2009) studies.

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