Opaque financial reports, R2, and crash risk

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.