The Impact of Financial Restatements on Debt Markets

Abstract

This paper examines the effect of financial restatements on the firm's source of debt financing, contractual debt covenants and cost of debt, both in the public and the private debt markets. Using a sample of public debt issued, we find evidence of higher treasury-spreads post restatement, which suggests that restatements increase the cost-of-debt. Also, using a sample of private debt issues, we find evidence of higher incidence of financial covenants post restatement, which is consistent with financial theory that firms seek to rebuild their reputation by issuing private debt. We also find support for the idea that the proportion of private debt versus public debt increases post restatements, which is consistent with finance theory that reputation and monitoring benefits are offered in the private debt markets. Overall our results make a unique contribution to the literature concerning financial restatements because we examine the topic in the context of debt markets.