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Boardroom backscratching and stock price crash risk

Version 2 2024-06-03, 00:56
Version 1 2023-09-27, 00:16
journal contribution
posted on 2024-06-03, 00:56 authored by D Hanlon, M Khedmati, Edwin LimEdwin Lim, C Truong
AbstractWe empirically capture boardroom backscratching, or cronyism, as when a firm's Chief Executive Officer (CEO) and directors concurrently receive excessive remuneration. We argue that boardroom backscratching can inhibit a board's constructive criticism and monitoring, resulting in a greater likelihood of bad news hoarding. Using 14,104 US firm‐year observations spanning 1999–2020, we document a significant positive relationship between boardroom backscratching and stock price crash risk. In additional analyses, we show that boardroom backscratching firms produce less readable annual reports and engage in greater upward real earnings management as channels for concealing bad news. We also find that external monitoring mechanisms weaken the positive association between boardroom backscratching and stock price crash risk. Our main findings withstand several endogeneity tests including propensity score matching, entropy balancing, difference‐in‐differences analysis using firms’ commencement of boardroom backscratching and CEO turnover event analysis. Our study offers insights to securities regulators and policymakers to revisit the notion of board independence, develop relevant market oversight and revise director and executive remuneration disclosure requirements so as to mitigate adverse stock market performance associated with boardroom backscratching.

History

Journal

Journal of Business Finance and Accounting

Pagination

1-41

Location

London, Eng.

ISSN

0306-686X

eISSN

1468-5957

Language

eng

Publication classification

C1 Refereed article in a scholarly journal

Publisher

Wiley

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