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Hutton Marcus
ARTICLE IN PRESS
Journal of Financial Economics 94 (2009) 67–86

Contents lists available at ScienceDirect

Journal of Financial Economics journal homepage: www.elsevier.com/locate/jfec

Opaque financial reports, R2, and crash risk$
Amy P. Hutton Ã, Alan J. Marcus, Hassan Tehranian
Boston College, Fulton Hall 520, 140 Commonwealth Ave., Chestnut Hill, MA 02467-3808, USA

a r t i c l e in fo
Article history: Received 2 April 2008 Received in revised form 16 July 2008 Accepted 1 October 2008 Available online 29 May 2009 JEL classification: G19 D89 M40 Keywords: Earnings management R2 Crashes Transparency

abstract
We investigate the relation between the transparency of financial statements and the distribution of stock returns. Using earnings management as a measure of opacity, we find that opacity is associated with higher R2s, indicating less revelation of firm-specific information. Moreover, opaque firms are more prone to stock price crashes, consistent with the prediction of the Jin and Myers [2006. R2 around the world: new theory and new tests. Journal of Financial Economics 79, 257–292] model. However, these relations seem to have dissipated since the passage of the Sarbanes-Oxley Act, suggesting that earnings management has decreased or that firms can hide less information in the new regulatory environment. & 2009 Published by Elsevier B.V.

1. Introduction Financial economists and accountants have long viewed stock price changes as tied to new information about firms’ prospects. However, Roll (1988) finds that only a relatively small portion of price movements can be explained by contemporaneous public news and speculates that traders acting on nonpublic firm-specific information could drive returns. These results have stimulated considerable interest in the relation between information and stock price dynamics and, in particular, between the R2 from a modified index-model regression and the revelation of firm-specific news. For example, Morck, Yeung, and


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