Does the presence of executives with a legal background affect stock price crash risk?

Abstract Research Question/Issue Executives with a legal background have superior knowledge of the law compared with executives who do not have such a background. This study investigates how executives who are well informed of the law can reduce stock price crash risk and how this is significant from a corporate governance perspective. Research Findings/Insights We collected and evaluated 23,031 firm‐year observations from 2008 to 2018, which resulted in the following findings: (1) Executives with a legal background can effectively reduce stock price crash risk. (2) When the company's external or internal supervision is weak, the effect of executives with a legal background in reducing stock price crash risk is particularly prominent. (3) The executives' ability to reduce stock price crash risk is particularly conspicuous when the company's intention to hide bad news is low or when there is a high risk of the bad news being leaked. Theoretical/Academic Implications Stock price crash risk is a critical problem to address in the Chinese capital market. The prevailing explanation for crash risk emphasizes executives' concealment of bad news as a primary factor. Since the suppression of bad news by company executives is the main reason for stock price crash risk, observing the influence of executives on this risk is a viable direct approach. Executives with a legal background, in particular, have a critical influence on companies. They possess a superior understanding of the law compared with those who do not have such a background and are more willing to respect and abide by the law. As a result, they have a lower tolerance for inappropriate acts by the executive team, namely, concealing bad news, which reduces the risk of stock price crash. Practitioner/Policy Implications In China, the world's largest transitional economy, investor protection and information environments are still developing. Countries with less developed regulations can adopt substitutive mechanisms, such as making the employment of executives with a legal background mandatory, to facilitate the healthy development of their capitalist markets. Given the capacity of these executives to reduce stock price crash risk, thereby supporting continuous and stable development of the capital market, regulatory authorities should encourage listed companies to hire executives with a legal background. Furthermore, they should also start in‐depth promotion of and education on the rule of law among employees to improve their legal competence.