Local corruption and stock price crash risk: Evidence from China

Using a large sample of Chinese firms over the period of 2004-2017, this study investigates whether and how local corruption affects stock price crash risk. We find that firms headquartered in regions with higher levels of corruption tend to have higher future stock price crash risk. This relation is more pronounced for local state-owned enterprises (SOEs), and local corruption induces crash risk by pushing firms to engage in inefficient over-investment. Our results suggest that corruption induces managers to undertake value-destroying projects and withhold bad news, which will lead to an accumulation of bad news. As the bad news or bad performance accumulates and reaches a tipping point, a large amount of negative firm-specific information comes out, resulting in a crash. The findings enrich the understanding of local corruptions' microeconomic impact on firm's investment decisions and also contribute to the study of external factors that do influence crash risk.