Re‐stating financial statements and its reaction in financial market

Abstract

PurposeThe purpose of this paper is to examine the short‐term reactions of stock prices to the announcement of earnings restatement by the public companies listed in the Toronto stock exchange in Canada.Design/methodology/approachThe paper conducts an empirical study. For the purpose conducting the empirical study, a standard event study methodology has been utilized to examine the effect of restatement announcements on the stock returns. The dates of the announcement of restatement by each company have been collected and the effect of the announcement has been studied surrounding the announcement dates.FindingsThe results of empirical works indicate that, in general, the financial market reacts negatively to any restatement of earnings. This is evident from the fact that irrespective of the reasons for restatement, all restatements show a negative effect on the stock price. The impact of the restatement announcements is significant for all the prediction intervals. However, the long‐term reaction is more pronounced compared to short‐term reaction. In addition, the negative reaction is much higher for those reasons that are directly related to the earnings management than those that do not involve any active earnings management.Research limitations/implicationsSince the paper investigates only one stock exchange, it may have a limited application in other financial markets. Similar researches can be undertaken for other financial markets different in size, scope or geographical location.Practical implicationsThe findings of the paper may have broad implications both for individual investors and corporate executives. The decisions made by executives on restatements affect stock price and hence the investors' rate of return. Since the general effect of such restatement is negative on the stock returns, it may portray a negative perception about the company. Therefore, the paper has implications on the decisions made by both the investors and the corporate executives.Originality/valueThe paper studied the Canadian stock market which was not studied in the past to examine the reactions of restatement.