Stock price crash risk and firms’ operating leverage

Xin Chang, Louis T.W. Cheng, Wing Chun Kwok and George Wong

Journal of Financial Stability, 2024, vol. 71, issue C

Abstract: We extend Jin and Myers’s (2006) model to derive the relation between stock price crash risk and operating leverage (i.e., the fraction of fixed costs in total costs). The model predicts that (1) firms’ operating leverage decreases as stock price crash risk increases and (2) the negative effect of crash risk on operating leverage is more pronounced when firms are closer to the crash threshold or when managers face higher costs of stock price crashes. We empirically test the model predictions using a large sample of manufacturing firms in the US and find consistent results. Further analysis shows that higher levels of crash risk lead to a less sticky cost behavior. In addition, crash risk–driven operating deleveraging effectively reduces stock return volatility and enhances operating performance in subsequent years. Collectively, our findings reveal that crash-prone firms adopt a more flexible cost structure to delay stock price crashes and mitigate adverse outcomes.

Keywords: Crash risk; Operating leverage; Cost structure; Opacity; Operating deleveraging; Cost stickiness (search for similar items in EconPapers)
JEL-codes: D24 G10 G30 M41 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:71:y:2024:i:c:s1572308924000044

DOI: 10.1016/j.jfs.2024.101219

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