The 'Big' Question on Accounting Restatements: When and How Do Earnings Restatement News Affect Investor Trading and Investing Trust?

Abstract

In this paper, I examine when and how accounting restatement information about a firm manifests in its price and volume of shares traded and empirically contrast price and trading volume responses with the endogenous firm size factor. The stock price analyses indicate that investors’ increased announcement-period response is systematic (i.e. has a market-wide effect). I find evidence of price adjustments in the non-announcement and extended announcement days, suggesting that the market is adjusting slowly to restatement information as investors weigh disclosures according to the credibility of the information. I find evidence of significant pre-and post-disclosure periods trading responses, consistent with Holthausen and Verrecchia (1990) two round trading by investors. In comparing price response between large versus small firms, I find evidence of price response and the response appears to be concentrated among large firms. No evidence of significant trading response is found for large firms, except for the multi-day period examined. Extending the analysis on partition sample — large versus small firms, I find that small firms’ trade on a relatively small portion of earnings restatement information that tend to cluster around pre-announcement period. Overall, the results indicate that investors do not appear to be confused about accounting restatements, and in fact use information about earnings restatement in their valuation of the affected firms’ equity.