The Consequences of Aggressive Financial Reporting: The Case of External Financing*

Abstract

In this paper, we investigate how aggressive financial reporting affects a firm’s ability to obtain external funds and its choices of external financing. First, we find that after earnings restatements, firms become significantly more financially constrained compared to a group of control firms with similar size and operating performance. Second, consistent with the increase in financial constraints, we find that restatement firms are less likely to obtain external financing after restatements. Third, for restatement firms that do obtain external financing after restatements, we find that they rely more on private debt financing and less on equity financing, consistent with increased information asymmetry after earnings restatements. Our investigation is important because it sheds light on the impact of aggressive financial reporting on firms’ financing options and on what causes, at least partially, the dramatic decrease in firm value upon the detection of aggressive financial reporting.