The Importance of Separating the Probability of Committing and Detecting Misstatements in the Restatement Setting

Forthcoming at Management Science

104 Pages Posted: 6 Apr 2022

See all articles by Jane Barton

Jane Barton

City University of New York (CUNY) - Stan Ross Department of Accountancy

Brian Burnett

The University of North Carolina at Charlotte

Katherine Gunny

University of Colorado at Denver

Brian P. Miller

Indiana University - Kelley School of Business - Department of Accounting

Date Written: March 22, 2022

Abstract

This study demonstrates the importance of separating the probabilities of misstatement occurrence and detection when examining financial statement restatements. Despite the many benefits of examining the probability of restatements using traditional logistic models, interpretations of these models are clouded by partial observability – only subsequently detected misstatements are observable. We propose addressing this often overlooked issue by implementing a bivariate probit model with partial observability. We demonstrate the importance of separating these latent probabilities by re-examining three prior restatement studies and show the importance of separating the occurrence and detection probabilities. Our evidence suggests that future studies interested in restatements as measure of accounting quality should consider implementing bivariate probit models as one way to address the partial observability inherent in this setting.

Keywords: Misstatements; Restatements, Occurrence and Detection, Bivariate Probit

JEL Classification: M41, M42, M49

Suggested Citation

Barton, Jane and Burnett, Brian and Gunny, Katherine and Miller, Brian P., The Importance of Separating the Probability of Committing and Detecting Misstatements in the Restatement Setting (March 22, 2022). Forthcoming at Management Science, Available at SSRN: https://ssrn.com/abstract=4064226

Jane Barton

City University of New York (CUNY) - Stan Ross Department of Accountancy ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States

Brian Burnett

The University of North Carolina at Charlotte ( email )

9201 University City Blvd
Charlotte, NC 28223
United States
704-687-7594 (Phone)

Katherine Gunny (Contact Author)

University of Colorado at Denver ( email )

Box 173364
1250 14th Street
Denver, CO 80217
United States

Brian P. Miller

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812-855-2606 (Phone)

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