Stock price crash risk and the market for corporate control

Abstract

Recent studies suggest that greater exposure to the market for corporate control matters for managers and shareholders since it affects firms’ ex-post risk of experiencing a stock price crash. The findings though question the direction of the effect. In contrast, in this study, we are the first to examine the effects of firms’ ex-ante risk of experiencing a stock price crash, a likely antecedent of which is managers’ concealment of news on aspects of the market for corporate control. We find that higher crash risk leads to greater takeover target likelihood. This relationship, which is robust to duly circumventing reverse causality, depends to a significant extent on inferior managerial quality and greater managerial discretion around financial accruals, affording richer insight into the notion that correction of managerial behaviour is a stimulus for the market for corporate control, but one that depends on the likely extent of managers’ concealment of news. We also concurrently find that actual takeover targets with higher crash risk generate a lower bid premium and receive more payment with stock. Overall, our findings strongly suggest that decision-making in the market for corporate control is at least partially explained by incentives linked to opportunistic prices and takeovers of lemons.