Abstract
We study the frequency of restatements by foreign firms listed on US exchanges. We find that the restatement rate of US listed foreign firms is significantly lower than that of comparable US firms and that the difference depends on the firm’s home country characteristics. Foreign firms from countries with a weak rule of law are less likely to restate than are firms from strong rule of law countries. While the lower rate of restatements can represent an absence of errors, it can also indicate a lack of detection and disclosure of errors and irregularities. We infer the effect of detection and disclosure by associating the frequency of restatements with the quality of the firm’s internal control system. We find that only US firms and foreign firms from strong rule of law countries show a positive association between restatement frequency and internal control weaknesses. Firms from weak rule of law countries show no significant association. We interpret these findings as home country enforcement affecting firms’ likelihood of detecting and reporting existing accounting misstatements. This suggests that for US listed foreign firms, less frequent restatements can be a signal of opportunistic reporting rather than a lack of accounting errors and irregularities.
Highlights
We examine the reporting of accounting restatements by foreign firms listed in the United States
To infer the magnitude of detection and disclosure of misstatements, we examine the sensitivity of restatements to the predictors of accounting restatements, i.e., internal control material weaknesses (ICMW) and earnings management (EM)
We control for the likelihood of accounting errors and irregularities using a measure of the quality of internal control systems (ICMW) and the earnings management measure (EM Index)
Summary
We examine the reporting of accounting restatements by foreign firms listed in the United States. Detection and reporting of accounting errors and irregularities ensures that a firm’s reported financials are free of any misstatements. While more frequent restatements implies more errors or irregularities, it suggests the presence of internal controls that led to timely detection and disclosure of the misstatement. This is because reporting a restatement involves two steps. Observing a restatement is a joint outcome of (i) committing an accounting error or irregularity and (ii) detecting and reporting the misstatement This two step process implies that a lower rate of restatements indicates fewer accounting mistakes only if there is timely detection and reporting of misstatements
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