Academic research has been closing in on why stock prices go up in small increments over a long period but ‘crash’ more violently over much shorter periods.
The reason seems to be a combination of asymmetric management reporting and the fact that all investors can buy good news but few can sell short. Company managers share good news but hoard bad leading to bad-news-avalanches. Poorly informed investors get reliable signalling from the stock price on the way up from buying by the better informed; but, there’s little signalling in the other direction when problems are uncovered by the diligent because they can’t employ the information.
The hunt is on then for anything that can signal when companies are becoming risky and a crash is more likely. Ahsan Habib and Hedy Huang of the Massey University in Auckland New Zealand wondered if a slow audit report might have some predictive power?
You’d think the answer was obvious; slower audit, poorer company therefore more crash risk, right? Not quite. Research from America shows that a delayed audit, provided it’s not too delayed, can often be a sign of extra diligence and a good company going the extra mile to make sure a report is thorough.
For their study the researchers looked at domestically listed Chinese companies from 2002~2013 and asked the question does a company with a poor score-card for governance and an excessively late audit have an increased crash risk? They do and, more usefully for investors, the relationship is reliable.
My advice, to self and others, for many years is have nothing to do with shabby operators. The paper highlighted this week (and another on the same topic coming next week) adds rigor to the notion and a useful additional check for future diligence.
You can access the paper in full via the following link Audit Lag and Stock Price Crash Risk
Happy Sunday.