Enterprise Risk Management and Restatement Contagion

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Abstract

The announcement of a financial restatement reduces shareholder wealth at both the restating firm and its non-restating industry peers (i.e., restatement contagion). We examine whether industry peers’ use of an Enterprise Risk Management (ERM) program reduces this restatement contagion risk. ERM is an integrated approach to managing a portfolio of interconnected risks faced by a firm. We hand-collect firms’ ERM status and measure restatement contagion risk using the change in peers’ stock option implied volatility skewness around restatement filing dates. Using S&P 500 firms and a generalized difference-in-differences specification, we find that ERM mitigates restatement contagion risk. In cross-sectional tests, we find that the ERM effect is more pronounced among peers with lower quality information environments, less institutional ownership, or larger positive discretionary accruals. This suggests that investors respond more to the presence of an ERM program among peers with fewer alternative sources of information and peers that may appear risky. Overall, our results are consistent with ERM firms exhibiting lower restatement contagion risk.

Authors

• Michael Neel, University of North Texas

• Jianren Xu, University of North Texas