Machine Learning for Financial Risk Management with Python

Chapter 9. A Corporate Governance Risk Measure: Stock Price Crash

Understanding corporate governance not only enlightens the discussion of perhaps marginal improvements in rich economies, but can also stimulate major institutional changes in places where they need to be made.

Shleifer and Vishny (1997)

Do you think that the quality of corporate governance can be assessed using a risk measure? According to recent studies, the answer is yes. The link between corporate governance and risk measure has been established via stock price crash risk, which is referred to as the risk of a large negative individual stock return. This association triggered a lot of research in this field.

The importance of detecting the determinants of stock price crash lies in identifying the root causes of low (or high) quality corporate governance. Identifying these root causes help a company to concentrate on problematic managerial areas, enhancing the functioning performance of the company as well as improving its reputation. This, in turn, lowers the risk of stock price crash and increases the company’s total revenue.

Stock price crash provides a signal for investors and risk managers about the weakness and strength of a company’s corporate governance. Corporate governance is defined as the way corporations are directed and controlled, as well as the ways they are or are not “promoting corporate fairness, transparency, and accountability” (Wolfensohn 1999).

Following this definition, corporate governance ...