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Stock price crash risk and firms’ operating leverage

Author

Listed:
  • Chang, Xin
  • Cheng, Louis T.W.
  • Kwok, Wing Chun
  • Wong, George

Abstract

We extend Jin and Myers’s (2006) model to derive the relation between stock price crash risk and operating leverage (i.e., the fraction of fixed costs in total costs). The model predicts that (1) firms’ operating leverage decreases as stock price crash risk increases and (2) the negative effect of crash risk on operating leverage is more pronounced when firms are closer to the crash threshold or when managers face higher costs of stock price crashes. We empirically test the model predictions using a large sample of manufacturing firms in the US and find consistent results. Further analysis shows that higher levels of crash risk lead to a less sticky cost behavior. In addition, crash risk–driven operating deleveraging effectively reduces stock return volatility and enhances operating performance in subsequent years. Collectively, our findings reveal that crash-prone firms adopt a more flexible cost structure to delay stock price crashes and mitigate adverse outcomes.

Suggested Citation

  • Chang, Xin & Cheng, Louis T.W. & Kwok, Wing Chun & Wong, George, 2024. "Stock price crash risk and firms’ operating leverage," Journal of Financial Stability, Elsevier, vol. 71(C).
  • Handle: RePEc:eee:finsta:v:71:y:2024:i:c:s1572308924000044
    DOI: 10.1016/j.jfs.2024.101219
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    More about this item

    Keywords

    Crash risk; Operating leverage; Cost structure; Opacity; Operating deleveraging; Cost stickiness;
    All these keywords.

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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