Earnings Restatements: A Capital Market Perspective

Abstract

I investigate the stock-return behavior around earnings restatement announcements, the quantitative information and qualitative characteristics of restatements contributing to the short-term abnormal returns, and the change in the investors’ confidence in the restating firms. Using hand-collected data from between 1977 and 2001, my work demonstrates that there is a sharp increase in the number of restatements from 1998 on. I find a strongly negative short-term market reaction to restatement announcements, a significant downward pattern in the six-month period leading up to the restatement announcements, and a negative post-announcement drift for up to four months. The study shows that both quantitative information (e.g., the amount of the earnings restatement) and qualitative characteristics of restatements carry significant explanatory power for the short-term market response. Finally, the research shows that the investor-perceived earnings quality deteriorates after the restatement announcement in terms of a decrease in earnings response coefficients from those before the restatement announcements, which implies that investors lose confidence in restating firms. At least before Enron, however, this negative confidence effect did not spill over to companies with similar characteristics.