Accounting Restatements: Are They Always Bad News for Investors?

27 Pages Posted: 8 Oct 2008

See all articles by Jeffrey L. Callen

Jeffrey L. Callen

University of Toronto - Rotman School of Management

Joshua Livnat

New York University; Prudential Financial - Quantitative Management Associates

Dan Segal

Interdisciplinary Center (IDC) Herzliyah

Date Written: November 2005

Abstract

This study investigates a large sample of financial statement restatements over theperiod 1986-2001, and compares restatements caused by changes in accounting principlesto those caused by errors. Typically, investors perceive restatements as negative signals due to three potential reasons: (i) the restatement indicates problems with the accounting system that may be manifestations of broader operational (and managerial) problems, (ii) the restatement causes downward revisions in future cash flows expectations, and (iii) the restatement indicates managerial attempts to cover up income decline through â¬Scookingthe booksâ¬?. We provide evidence that market reactions to restatements due to errors aregenerally negative. We show that these restatements come in periods of declining profits and lower profits than industry peers for the restating firms, consistent with bothopportunistic managerial behavior and operational problems. However, investorsâ¬"reactions to income-increasing restatements due to errors are not different from zero,suggesting that the perceived failure of the accounting system is just offset by the upward revisions in future cash flow expectations in these cases of income-increasing errors. Thus, our combined results show that not all restatements are alike; users of theinformation need to carefully assess the existence and potential effects of the three factors that typically cause the downward revisions in stock prices on a case by case basis.

Suggested Citation

Callen, Jeffrey L. and Livnat, Joshua and Segal, Dan, Accounting Restatements: Are They Always Bad News for Investors? (November 2005). NYU Working Paper No. JOSHUA LIVNAT-04. Available at SSRN: https://ssrn.com/abstract=1280738

Jeffrey L. Callen (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-946-5641 (Phone)
416-971-3048 (Fax)

Joshua Livnat

New York University ( email )

44 West 4th Street, Suite 10-76
Stern School of Business
New York, NY 10012-1118
United States
212-998-0022 (Phone)
212-995-4004 (Fax)

Prudential Financial - Quantitative Management Associates ( email )

2 Gateway Center
6th Fl.
Newark, NJ 07102
United States

Dan Segal

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

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