Do Firm-Specific Stock Price Crashes Lead to a Stimulation or Distortion of Market Information Efficiency?

We study the consequences of firm-specific stock price crashes (SPCs) by examining whether, and if so, how SPCs affect market information efficiency. This contrasts with prior research that focuses on firm-specific causes or determinants of SPCs. The tension underlying our research question stems from two competing explanations. As an unanticipated shock, a SPC could stimulate (distort) information efficiency by triggering investor rational attention (opinion divergence). As an identification strategy, we adopt a difference-in-differences analysis in which SPC firms in the treatment sample are propensity-score matched to non-SPC firms in the industry-peer control sample, and implement placebo tests for falsification purposes. Consistent with the view that SPCs stimulate information efficiency, we find that the magnitude of the earnings response coefficient (ERC) increases, and the extent of post-earnings announcement drift (PEAD) decreases, from the pre- to post-SPC period, and that these changes in ERC and PEAD are greater for SPC firms than for non-SPC control firms. Further analyses reveal that SPC firms attract increased investor attention in the post-SPC period, as reflected in greater analyst following and revision responsiveness after the SPC and more investor access of the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system following such an event. We also observe a stronger SPC impact on ERC and PEAD when investors focus more on firm-specific rather than market-wide information. In contrast, stock price jumps do not invoke the above effects. Collectively, our evidence suggests that SPCs can bring about positive externalities of stimulating market information efficiency by attracting increased investor attention