Reportgreen2005

Accounting Restatements: Are They Always Bad News for Investors?

Jeffrey Lawrence Callen · Joshua Livnat · Dan Segal

29 citations0/0 files storedFaculty Digital Archive (New York University Florence)

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Auditing, Earnings Management, Governance Accounting Theory and Financial Reporting Corporate Governance and Financial Management

Abstract

This study investigates a large sample of financial statement restatements over the period 1986-2001, and compares restatements caused by changes in accounting principles to those caused by errors. Typically, investors perceive restatements as negative signals due to three potential reasons: (a) the restatement indicates problems with the accounting system that may be manifestations of broader operational (and managerial) problems, (b) the restatement causes downward revisions in future cash flows expectations, and (c) the restatement indicates managerial attempts to cover up income decline through “cooking the books.” We provide evidence that market reactions to restatements due to errors are generally negative. We show that these restatements come in periods of declining profits and lower profits than industry peers for the restating firms, consistent with both opportunistic managerial behavior and operational problems. However, investors' reactions to income-increasing restatements due to errors are not different from zero, suggesting that the perceived failure of the accounting system is just offset by the upward revisions in future cash flow expectations in these cases of income-increasing errors. Thus, our combined results show that not all restatements are alike; users of the information need to carefully assess the existence and potential effects of the three factors that typically cause the downward revisions in stock prices on a case by case basis.

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References

1996Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC*2000Earnings Management: Reconciling the Views of Accounting Academics, Practitioners, and Regulators 2003Determinants of market reactions to restatement announcements 1997Detecting GAAP violation: implications for assessing earnings management among firms with extreme financial performance 1991The Financial and Market Effects of the SEC's Accounting and Auditing Enforcement Releases 1999Incentives and Penalties Related to Earnings Overstatements that Violate GAAP 1989Characteristics of firms correcting previously reported quarterly earnings 2003Predicting Earnings Management: The Case of Earnings Restatements

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