Financial Restatements in a Time of Turbulence, Leverage, and Rational Expectations

Abstract

Using agency theory and transaction cost economics as a conceptual foundation, this study uses backward- and forward-looking measures, sales instability and market leverage, to examine likelihood of financial restatement. We test hypotheses using a sample of 43,876 firm-year observations from 2005-2018, involving 5,397 firms and 3,991 restatements. As hypothesized, higher levels of sales turbulence as well as higher levels of market leverage increase likelihood of restatement. Although firms evidencing sales increases over prior years have lower likelihood of restatement, examination of interaction reveals this effect is reduced when such increases occur in the context of increased sales turbulence or increased levels of leverage.