Consequences of Error Announcements on Industry Peers: Capital Market Reaction and Financial Reporting Decisions

Abstract

This paper analyzes the reactions of investors and management to an error announcement within an industry. We investigate capital market reactions as well as changes in the financial reporting decisions for a sample of CDAX®-listed industry peers to error firms in Germany. We find that peers suffer on average negative cumulative abnormal returns of -0.92% within the five day event window. More precisely, we show the contagion effect for the German setting by analyzing industry peers to error firms with negative abnormal returns. This finding can be interpreted as a loss of investors’ confidence in the reliability of financial reporting within the respective industry. As a consequence of the error announcement, all industry peers might have incentives to regain reputation. Therefore, we also examine whether industry peers change the transparency of financial reporting after the event. Our results reveal that industry peers present more informative financial reporting as measured by more timely loss recognition after the error announcements. Nevertheless, we find no evidence for an increase in the preciseness of forecast reporting caused by the event. Supplemental tests reveal no significant increase in auditor turnover after an industry peer’s error announcement, suggesting that industry peers do not penalize their auditors after the stock price decline.