The Contagion Effect of Accounting Restatements for Foreign Firms Listed in the United States

• In Event: DSFI no. 1

Abstract

Abstract: U.S. investors consider the strength of home market institutions when evaluating foreign
firms (e.g., Ahearne, Griever, and Warnock 2004). We hypothesize and find that accounting restatements issued by foreign firms traded in the U.S. induce a negative market reaction to nonrestating foreign firms that are from the same home country as the restating firms (contagion effect). Moreover, the magnitude of the contagion effect varies with the strength of the home market
institutions of the restating firms. Over a 3-day announcement window, non-restating firms from
countries with weak laws undergo an average stock price decline of -1.08%, compared to -0.43% for
peer firms from countries with strong laws. Our results suggest that restatements filed by weak-law country-firms are perceived to be more “contagious” than those issued by strong-law country-firms. We also find firms that exhibit inferior financial reporting quality, that share an auditor with the restating firm, or that do not have Big Four auditors suffer more from contagion effects, suggesting that the contagion effect is driven by investors’ concern over the credibility of financial reporting for non-restating home-country peers.

Authors

• Weishi Jia, Emory University

• Jingran Zhao, Hong Kong Polytechnic University