This study aims to provide empirical evidence on the relationship between formal institutions and stock price crash risk from a global perspective.
This paper uses data of 35,468 firms globally over the years 1987–2019 and address the endogeneity issue by employing the Mundlak random effects estimator.
The authors find a significant negative impact of institution quality on stock price crash risk (i.e. better institutions reduce crash risk), after controlling for common determinants of crash risk such as leverage, return on asset, firm size, investment, etc. as well as macro factors such as GDP growth. This effect is robust to different measures of crash risk and sub-indicators of institutions quality. In addition, the authors also find this effect to be universally present in economies characterized by different levels of income.
To the best of the authors' knowledge, there's no known study that explores the potential causal relationship between institution quality and stock price crash risk. Therefore, the research topic in this study is original and can contribute significantly to the existing literature.
