Financial Misstatements and Contracting in the Equity Market: Evidence from Seasoned Equity Offerings

Abstract:     
We examine whether a firm’s previous financial misrepresentation affects the costs of raising equity capital. We find that firms that restated earnings due to accounting irregularities subsequently pay higher underwriting fees when they raise seasoned equity financing. The effect of restatements on underwriting fees is more pronounced for larger offerings and offerings in the first few years after restatements, and lessens as restatement firms make corporate governance improvements. We also find that restatement firms employ more lead underwriters and are less likely to use the faster and cheaper accelerated underwriting method than the traditional book building process. We further examine the costs borne by firms that are not able to access the equity capital market because of their misreporting and find that these firms are less likely to make investments to take advantage of growth opportunities and are more likely to go bankrupt or be acquired by other companies. Overall, our results suggest that financial misrepresentation undermines a firm’s financial reporting integrity and increases the difficulties and costs of accessing the equity market, which carry serious implications for firms. As such, we contribute to the broad literature on disclosure quality and costs of capital.

Number of Pages in PDF File: 60

Keywords: Financial Misstatements, Disclosure Quality, Cost of Capital, Financial Contracting, Seasoned Equity Offering, Corporate Governance, Underwriting Contract

JEL Classification: G24, G32, G34, M41, M43

working papers series