Hoarding Bad News: When Non-financial Firms Hold Financial Assets

This paper theoretically illustrates and empirically examines how listed non-financial firms use financial assets as an earnings manipulation tool with bad-news-hoarding motives. China created its first accounting standards for financial instruments in 2007, which classify financial assets based on the highly subjective “managerial holding intention” criterion, and financial assets accounted by fair value methods can affect current profits and losses. We find that during the years 2007 through 2016, financial asset holding is positively associated with the likelihood of stock price crashes for Chinese listed firms. The effect is more pronounced for firms with a CEO from a finance background, high information asymmetries, and weak governance. In addition, we identify accrual earnings management as a channel through which financial asset holding increases stock price crash risk. Our evidence indicates that in typical emerging markets such as China, fair value accounting may have unintended consequences, inducing non-financial firms to employ financial assets as a tool to hoard bad news.