Cash Flow Restatements: Stock Market Reaction to Overstated versus Understated Restatements

• In Event: Financial Reporting--Cash flow

Abstract

The Securities Exchange Commission has become increasingly concerned with the overall increasing number of restatements to the statement of cash flows (SCF). However, regulators and practitioners seem to be more focused on the overstatement of operating cash flows, while the understatement of operating cash flows is often overlooked but may have the same (or more) negative economic consequences. Specifically, this study examines market reactions to cash flow restatements (CFR) where firms over/understated cash flows from 2000 to 2013. This study finds that 41% of firms overstate operating cash flows, while a surprising 48% understate operating cash flows. While, we find that the market does not significantly react to overstated operating cash flows or overstated total cash flows (TCF), there is a significantly negative response to understated operating cash flows and TCFs. The market penalizes these firms more for understating cash flows. The market as reacts negatively to CFRs with changes to TCF. There is no significant market reaction to CFRs with no changes to total cash flows, which suggests that the market does not reacts significantly to cases where firms appear to be classification shifting within the SCFs. Interestingly, there is a CFR post-announcement drift in abnormal returns that occurs for both understated operating and understated total cash flows beyond the CFR announcement date. This study provides evidence that the often overlooked understatements may have ‘real’ economic consequences and should be evaluated further and given the same consideration as overstatements by auditors, regulators, and investors, alike.

Authors

• Dana Hollie, Louisiana State University

• Shaokun (Carol) Yu, Northern Illinois University

• Elio Alfonso, Florida International University