Opaque Financial Reports , R - square , and Crash Risk

We investigate the relation between the transparency of financial statements and the distribution of stock returns. Using earnings management as a measure of opacity, we find that opacity is associated with higher R-squares, indicating less revelation of firm-specific information. Moreover, opaque firms are more prone to stock price crashes, consistent with the prediction of the Jin-Myers (2006) model. However, these relations seem to have dissipated since the passage of the Sarbanes-Oxley Act, suggesting that earnings management has decreased or that firms can hide less information in the new regulatory environment. JEL Descriptors G19, D89, M40 * Corresponding Author: [email protected]; 617 552-1951 phone; 617 552-6345 fax; Fulton Hall 520, 140 Commonwealth Ave. Chestnut Hill, MA 02467-3808 We thank workshop participants at Boston College, Harvard Business School, and the University of Wisconsin, Madison for helpful comments. We also thank Ying Duan and Shan He for excellent research assistance. We thank Qiang Cheng and David Farber for their restatement dataset.