Audit committee equity incentives and stock price crash risk

Abstract

This paper theoretically and empirically investigates whether and how audit committee (AC) equity incentives affect future stock price crash risk. Consistent with our model prediction that equity incentives for ACs contribute to reducing the skewness of return distributions, we document evidence of a negative relationship between AC equity incentives and expected crash risk for a merged sample of 6550 US-listed firms over the 2001–2018 period, even after controlling for a wide range of other firm characteristics, using alternative variable specifications, and addressing potential endogeneity concerns. On average, a one-standard-deviation increase in AC equity incentives is associated with a reduction of 14.09–15.46% in stock price crash risk. Further analysis shows that AC equity incentives affect crash risk through financial reporting quality, the negative relationship between AC equity incentives and future stock price crash risk is more pronounced for firms with weaker external governance and for firms with more financial expertise in the AC, and this negative relationship is mainly driven by option-based equity incentives. Taken together, these findings are consistent with the view that equity-based compensation is critical for inducing greater monitoring efforts from AC members and mitigating managerial incentives to withhold bad news.