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The Effect of Accounting Restatements on Earnings Revisions and the Estimated Cost of Capital

33 Pages Posted: 21 Jan 2004  

Paul Hribar

University of Iowa - Henry B. Tippie College of Business

Nicole Thorne Jenkins

University of Kentucky - Von Allmen School of Accountancy, Gatton College of Business and Economics

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Date Written: November 2003

Abstract

This paper examines the effect of accounting restatements on a firm's cost of equity capital. We show that, on average, accounting restatements lead to both decreases in expected future earnings and increases in the firm's cost of equity capital. Depending on the model used, relative percentage increases in the cost of equity capital average between 7 and 19 percent in the month immediately following a restatement. The increase in the cost of capital dissipates as time passes and after controlling for analyst forecast biases, but continues to average between 6 and 15 percent in the most conservative setting. We also show that restatements initiated by auditors are associated with the largest increase in the cost of capital, and that firms with greater leverage experience greater increases in their cost of capital. Overall, our evidence is consistent with accounting restatements lowering the perceived earnings quality of the firm and increasing investors' required rates of return.

Keywords: Accounting restatements, cost of capital, earnings quality

JEL Classification: M41, G12

Suggested Citation

Hribar, Paul and Jenkins, Nicole Thorne, The Effect of Accounting Restatements on Earnings Revisions and the Estimated Cost of Capital (November 2003). Available at SSRN: https://ssrn.com/abstract=488003 or http://dx.doi.org/10.2139/ssrn.488003

Paul Hribar (Contact Author)

University of Iowa - Henry B. Tippie College of Business ( email )

Dept. of Accounting
Iowa City, IA 52242-1000
United States
319-335-1008 (Phone)

Nicole Thorne Jenkins

University of Kentucky - Von Allmen School of Accountancy, Gatton College of Business and Economics ( email )

Lexington, KY 40506
United States

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