1. Research Problem:
Financial markets have witnessed numerous crises resulting from the collapse of major companies' stock prices across various countries. It has been proven that the boards of directors of these companies played a fundamental role in fraud and manipulation when preparing financial reports, negatively impacting the quality of financial information disclosed in these reports.
Stock markets serve as a reflection of a country's economic condition and act as a primary driver of economic growth and development. Therefore, understanding stock price behavior and the risks associated with it, such as crashes, is crucial. The stock price crash risk is a significant concern for both investors and companies, as it influences investors' decision-making and affects how companies manage their risks.
Many studies have examined the determinants affecting stock price crash risk, including corporate governance. Governance mechanisms play a crucial role in enhancing financial disclosure and the quality of financial reports, thereby reducing the stock price crash risk. The existence of a risk management committee is considered one of the internal corporate governance mechanisms.
In Egypt, the Corporate Governance Rules and Standards Guide (Second Edition) was issued in 2011, which highlighted the possibility of forming a board committee dedicated to risk management. These rules were further developed with the issuance of the Egyptian Corporate Governance Guide (Third Edition) in 2016, which provided a detailed explanation of the responsibilities of the risk management committee.
The Third Edition of Corporate Governance in Egypt is considered the beginning of widespread attention to the Risk Management Committee, considering it one of the key pillars of good governance. Effective governance implementation enables companies to mitigate various risks they face while enhancing their sustainability and competitiveness.
On the other hand, investors’ demand for risk-related information has increased in recent years. Investors continuously require the disclosure of both quantitative and qualitative risk information regarding current or future risks faced by a company. This helps them assess the company's value, evaluate the present and future risk environment surrounding their investments, and ultimately determine the company’s ability to survive and sustain its operations. Consequently, this contributes to reducing the likelihood of corporate financial failure.
The existence of risk management without proper disclosure can lead to several issues, the most significant of which is information asymmetry between company management and external investors. Risk disclosure refers to informing stakeholders about any opportunity, probability, risk, harm, or threat that currently affects the company or may impact it in the future, as well as how these risks or opportunities are managed.
Risk disclosure offers several benefits, the most important of which is helping stakeholders access the necessary information to understand the risks the company faces or may encounter and how these risks are managed. Additionally, risk disclosure is essential for risk monitoring, identifying potential problems, and taking preventive measures to mitigate issues before they arise.
Risk-related information is particularly valuable to investors, as it enables them to assess company-specific risks, reducing the problem of information asymmetry. This, in turn, facilitates a more accurate valuation of the company’s market share price, ultimately influencing the risk of stock price crashes.
Risk disclosure must be of high quality. Disclosure quality refers to a company’s ability to provide all necessary accounting information in detail and in an appropriate manner to benefit its users, ensuring that the information is free from bias and personal interest. Additionally, it should present information in a way that investors can read, understand, and interpret easily.
Risk disclosure must be of high quality, highlights the importance of providing both detailed quantitative and qualitative information, along with tables and figures that help users especially investors comprehend the disclosed information. This concept is referred to as the financial report readability.
Since risk disclosure in a clear and readable manner provides information that helps users better predict a company’s exposure to risks, it enables them to form a comprehensive understanding of the nature and scope of risks the company faces.
The financial reports readability by their users, including stakeholders associated with the company, is one of the key determinants of financial report quality. Although management plays a crucial role in enhancing the company’s competitive position, maximizing its market value, improving financial performance, and ensuring business continuity, it may sometimes engage in practices that conceal or withhold negative news about the company’s actual financial performance. This could be driven by rewards contracts or professional concerns, ultimately negatively impacting the transparency and readability of accounting information.
Risk disclosure in a clear and accessible manner enhances the financial reports readability, considering the varying levels of expertise among users of such information. Risk disclosure is typically provided through financial statement footnotes and supplementary disclosures. This highlights the relationship between a company’s risk disclosure and the readability of its financial reports.
However, when a company has a risk management committee, there is a greater emphasis on risk disclosure, as an independent committee is dedicated solely to this function. Moreover, having the necessary characteristics for this committee—such as independent members, financial and accounting expertise, and regular meetings—can influence the financial reports’ readability.
Regarding the impact of risk management committee characteristics on stock price crash risk, most studies have explored the relationship between risk management and firm value, while others have examined the effect of risk management on company performance. Some research has also focused on the relationship between corporate governance and stock price crash risk.
As for the relationship between financial report readability and stock price crash risk, contemporary accounting literature has extensively examined this topic and has found a negative impact, indicating that greater financial report readability reduces stock price crash risk.
Based on the above, the researcher can highlight several points that illustrate the research gap as follows:
• Most previous studies have focused on developed financial markets, while only a few have examined emerging financial markets, such as the Egyptian Stock Exchange. There is a general consensus on the existence of a correlation between risk management committee characteristics and stock price crash risk, as well as a correlation between financial report readability and stock price crash risk.
• The impact of both risk management committee characteristics and financial report readability on stock price crash risk has not received sufficient attention in prior research. This study aims to address this gap through an applied study on Egyptian listed companies, building on the findings of most previous studies, which indicate that:
- The presence of strong risk management committee characteristics enhances financial report quality by improving report readability.
- It helps reduce information asymmetry between management and investors.
- It contributes to lowering stock price volatility, ultimately influencing stock price crash risk.
Therefore, the current study seeks to answer the following main research question:
What is the impact of risk management committee characteristics and financial reports readability on stock price crash risk?
To address this question, the study aims to answer several sub-questions:
• What is the impact of risk management committee characteristics on stock price crash risk?
• What is the impact of financial report readability on stock price crash risk?
• What is the interactive effect of the relationship between Risk management committee characteristics and financial report readability on the stock price crash risk of companies listed on the Egyptian Stock Exchange?
2. Research Objectives:
The main objective of this research is to examine the impact of Risk management committee characteristics and financial report readability on stock price crash risk for a sample of Egyptian companies listed in the EGX100 index during the period 2019–2022. This primary objective is broken down into the following sub-objectives:
• Studying and analyzing the characteristics of the Risk Management Committee and evaluating their impact on stock price crash risk.
• Exploring the conceptual framework of financial report readability and analyzing its effect on stock price crash risk.
• Providing empirical evidence from the Egyptian business environment on the impact of Risk Management Committee characteristics and financial report readability on stock price crash risk.
3. Research importance:
The importance of this research lies in its practical contribution to the Egyptian business environment by providing empirical evidence on the impact of risk management committee characteristics and financial report readability on stock price crash risk.
Additionally, the research’s findings may be of interest to boards of directors, stakeholders, accounting standard setters, and regulatory bodies. The research can help Egyptian companies and stakeholders better understand the factors influencing stock price crash risk. By having a risk management committee, companies can mitigate the risk of sudden stock price crashes, as such committees enhance transparency, reduce information asymmetry, and enable more accurate valuation of the company’s market share price—ultimately affecting stock price crash risk.
4. Scope of the research:
This study is limited to examine the impact of Risk Management Committee characteristics and financial report readability on stock price crash risk, focusing on companies listed in the EGX100 index on the Egyptian Stock Exchange during the period 2019–2022.
The study excludes financial companies and banks due to their unique nature, as they are subject to specific legal, regulatory, and corporate governance frameworks that differ from other sectors. Additionally, the generalizability of the study’s findings is subject to the limitations of the applied research approach.
5. Research Hypotheses
Based on the study’s objectives and research questions, the following hypotheses have been formulated:
H1: There is a significant impact of Risk Management Committee characteristics on stock price crash risk.
H2: There is a significant impact of financial report readability on stock price crash risk.
H3: There is a significant impact of risk management committee characteristics and financial report readability on stock price crash risk.
6. Research Plan:
Given the significance of this study and in pursuit of its objectives and research questions, the remaining sections of the study are structured as follows:Section Two: Presents the theoretical framework of the study, Section Three: Analyzes previous studies and derives the research hypotheses Section Four: Describes the design of the applied study and develops the research models, Section Five: Discusses the analysis and interpretation of the applied study results and tests the research hypotheses, Section Six: Concludes with findings, recommendations, and future research directions.
7.Results:
The key findings derived from the theoretical and applied study, as well as the analysis of relevant previous studies, are as follows:
• There is a significant impact of the risk management committee's characteristics on the risk of stock price crashes. This occurs through its influence on the quality of financial reports and corporate financial performance. Additionally, corporate governance, of which the risk management committee is an internal mechanism, plays a role in mitigating stock price crash risk.
• There is a significant impact of financial report readability on stock price crashe risk. Increased readability of financial reports reduces the risk of stock price crashes by enhancing transparency, increasing investor confidence, and facilitating early detection of financial issues. Readable financial reports contribute to accurate analysis, improved investor communication, and better risk management, all of which help stabilize and maintain stock prices.
• There is a significant and negative interactive effect between the characteristics of the risk management committee and financial report readability on stock price crash risk. When an effective risk management committee operates alongside highly readable financial reports, a company is better ability to manage risks and provide clear, accurate financial information to investors. This combination reduces information gaps that traders might exploit to trigger stock price fluctuations. Moreover, it enhances communication between the company and investors, minimizing rumors and misinformation that could lead to stock price crashes.
8. Recommendations:
Based on the study findings, the researcher recommends the following:
• Boards of directors should ensure that risk management committees include independent members with financial and accounting expertise. This would enhance the independence of the committee members, improve financial report readability, and reduce the company’s exposure to stock price crash risk.
• The Financial Regulatory Authority should issue guidelines to improve the readability of annual financial reports and impose penalties on companies that intentionally use overly complex language in their financial disclosures.
• Professional accounting and auditing organizations in the Egyptian business environment should raise awareness among publicly listed companies about the importance of avoiding unnecessary disclosures that reduce the readability of annual financial reports.
• Investors and stakeholders should be adequately informed on how to read financial reports to better assess potential risks that may impact their decision-making.
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