Reoccurrence of Financial Restatements: The Effect of Auditor Change, Management Turnover and Improvement of Internal Control

• In Event: Financial Accounting and Reporting 8

Abstract

Restatements are serious corporate reporting failures which cause investors’ concerns about the credibility of restated firms’ financial reporting environment. As a result, restatements are usually followed by auditor turnovers, manager turnovers and disclosures of internal control problems. This study attempts to provide empirical evidence on the associations between the reoccurrence of financial restatements and auditor turnover/choice (Big 4/non-Big 4), management replacement (CEO/CFO), and improvement of internal controls. We also investigate the associations of restated firms’ stock market performance with the role of auditor choice, management turnover and improvement of internal controls.
Using a sample of 460 earnings restatements reported in the years of 2003 and 2004 with 282 firms with no reoccurrence of financial restatement in the subsequent three years and 178 firms with at least one financial restatement in the subsequent three-year period, our findings show a negative relationship between the probability of reoccurrence of firms’ financial restatements and (1) the change to a Big 4 auditor, (2) replacement of CEO/CFO, and (3) improvement on internal controls. Moreover, we find better stock market performance of non-reoccurrence firms compared with that of reoccurrence firms over a three-year period after the initial restatement. Furthermore, the stock market performance is found to be associated with a decrease in the probability of future restatements, which are affected by the change to a Big 4 auditor, replacement of CEO/CFO and improvement on internal controls.

Authors

• Yu-Ho Chi, The University of North Carolina at Pembroke

• Huey-lian Sun, Morgan State University