What are the Costs of Admitting Mistakes for U.S. Listed Foreign Firms?

Abstract

We examine the stock market consequences of accounting restatements for U.S. listed foreign firms. After controlling for the severity of restatement and other firm characteristics, we find that, among firms that engage in irregularities, foreign firms experience significantly more negative two-day stock market reactions following restatement announcements than do U.S. firms. Moreover, we find evidence that the stock market reactions are more negative for foreign firms from countries with greater differences in accounting standards from the U.S., countries with weaker auditing and accounting enforcement environments, and countries with weaker rule of law traditions. Finally, we provide evidence of a geographic contagion effect as non-restating firms from the same country also experience significant stock price declines following restatements. Within a country-year, this contagion effect is concentrated among firms with lower accrual quality, suggesting that foreign firms’ restatements cause investors to alter their assessment of the earnings quality of non-restating firms from the same country. Collectively, our results suggest that restatements cause U.S. investors to reassess the information risk associated with country-level factors.