Editor’s Note: The following post comes to us from Kim Jeong-Bon, Professor of Accountancy at City University of Hong Kong; Yinghua Li of the Accounting Department at Purdue University; and Liandong Zhang of the Department of Accountancy at City University of Hong Kong.
In the study, CFOs versus CEOs: Equity Incentives and Crashes, forthcoming in the Journal of Financial Economics, we examine the impact of executive equity incentives on a firm’s stock price crash risk. Based on a recent theoretical study by Benmelech, Kandel, and Veronesi (2010), we argue that equity incentives motivate managers to conceal bad news about growth opportunities and to choose sub-optimal investment policies to support the pretense. The accumulation of bad news within a firm leads to a severe overvaluation and a subsequent crash in the stock price.