The Relationship between Equity Overvaluation and Company's Financial Crisis

Companies that are valued more than their real value, do not have the ability to achieve the expected level of performance, proportionate with the stock market price and managers due to the many benefits of very high stock prices, such as easy access to capital market funds, higher job security and more rewards, instead of correcting equity overvaluation, they use various techniques such as earnings management to support incorrect stock values. Certainly, in the years when the company's financial situation is unfavorable and there are signs of moving towards a financial crisis for the managers, the incentive to earning management increases in order to hide the poor performance of the company and take measures to justify the stock incorrect prices. Given the importance of the subject of equity overvaluation and its consequences, the main purpose of this study was to investigate the relationship between equity overvaluation and company's financial crisis and the role of earnings management on this relationship.

According to the purpose of the study, this research is applied research. To investigate the subject, data of 104 companies listed in the Tehran Stock Exchange for the period from 2011 to 2020 was selected. Data analysis and hypotheses testing was performed using Panel Generalized Linear Models and logistic regression model by R software. Equity overvaluation based on the Rhodes-Kropff et al. (2005) method are measured and companies in financial crisis based on the existence of each of the three conditions: 3 consecutive years of loss, a 40% reduction in dividends over the previous year and subject to Article 141 of the Commercial low, was selected. 

The results show that there is a positive and significant relationship between equity overvaluation and financial crisis. In other words, equity overvaluation (increasing evaluation errors) increases the risk of corporate financial crisis. Other findings suggest that earnings management does not moderate the relationship between equity overvaluation and financial crisis. 

Given that the equity overvaluation is not permanent and the stock market value will move towards the real value, in the end, the equity overvaluation will lead to operating loss, net loss and consecutive retained loss for the company and will cause the company will not be able to have the necessary cash resources for dividends and will face a reduction in dividends and eventually, based on the losses, more than half of the company's capital will be lost. So, when the stock market value is above its real value and the company is not able to provide the performance needed to justify its stock market value, Can reduce the company's profitability and increase likelihood of inability to repay interest and debt, lower corporate cash inflow from total interest expense for long-term debt, losing or being negative Special value of the company which in fact each of these, indicates the company's entry into the financial crisis that in the last and most acute phase of the financial crisis, it can lead to bankruptcy of companies.