Market Consequences of Sovereign Accounting Errors

Abstract

This paper investigates the market consequences of sovereign accounting errors, opening a new area of research on sovereign accounting quality in the accounting literature. Eurostat, a division of the European Commission, provides semiannual assessments of financial reports produced by the member states of the European Union (EU) and issues reservations that detail financial reporting errors. Using a sample of Eurostat reservation issuances across 28 EU countries from 2004 to 2018, we find that sovereign bond yields abnormally increase during a reservation announcement window, especially when a reservation explicitly mentions deficit or debt, when it quantifies the extent of the errors’ financial impact, or when the errors relate to recent fiscal data. Consistent with a home bias after the release of negative news, we find that domestic holdings of sovereign debt increase after the issuance of a reservation. Overall, our evidence suggests that sovereign accounting errors have significant market consequences and raises further questions for future research in sovereign accounting quality. This paper was accepted by Ranjani Krishnan, accounting. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2023.00724 .