Publication Type

Journal Article

Publication Date

2006

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.

Discipline

Accounting | Corporate Finance

Research Areas

Financial Performance Analysis

Publication

Journal of Investing

Volume

15

Issue

3

First Page

57

Last Page

68

ISSN

1068-0896

Identifier

10.3905/joi.2006.650145

Publisher

Institutional Investor

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