Audited financial statements can make stock market crashes more severe by giving investors a false sense of security.
Clean audit reports often mask underlying systemic risks by making companies appear safer than they really are. Investors rely on these documents for transparency, but the oversight can actually encourage the formation of massive price bubbles. When the bubble finally bursts, the shock is greater because the market was lulled into complacency. The very mechanism designed to protect the public may be amplifying the volatility of the financial system. Trusting the stamp of approval on a balance sheet can lead to catastrophic losses during a downturn.
Do Audited Financial Reports Mitigate (or Exacerbate) Stock Market Crashes?
SSRN · 5812662
Does audit assurance mitigate stock market crashes? We find this is not the case, contrary to conventional wisdom. Building on confirmation bias theory, we predict that audited financial statements may give investors a false sense of security regarding the firm’s fundamental value, potentially amplifying bubbles and crashes. To test this prediction, we compare stock price changes of firms with and without external audits around the Wall Street Crash of 1929––an important event that motivated the