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We examine how accounting conservatism at the firm level and the Sarbanes-Oxley Act (SOX) influence idiosyncratic stock crash risk. We document that firms that are more conservative in reporting their earnings are less prone to stock price crash, consistent with the finding of Jin and Myers (2006) that firms disclosing bad news in a timelier manner are less likely to deliver large negative stock returns. We also find strong evidence that idiosyncratic crash risk has decreased significantly in the post-SOX period, supporting the argument that SOX has led to less withholding of bad news and has improved disclosure and transparency. Moreover, the impact of SOX on crash risk varies systematically with the extent that firms withheld bad news in the pre-SOX period, showing an inverted U-shaped pattern. However, the impact of accounting conservatism on stock crash propensity has been mitigated since SOX was enacted, suggesting that firms are pressured to reveal bad news more through a variety of channels (e.g., management earnings forecasts and press conferences). This is probably due to the high litigation risk and severe penalties imposed by SOX.
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