An Analysis of the Sources of Value Loss Following Financial Restatements

• In Event: Tax, Loss, and Uncertainty

Abstract

We decompose the total value loss around firms’ announcements of financial restatements into components arising from investors’ revisions in cash flows and discount rates (or cost of equity). While we find significant contributions from both sources, the impact of revisions in the discount rate is more significant, explaining over 66% of the variation in stock returns surrounding restatement announcements. Further analysis shows that for the subsample of firms whose restatements are caused by financial fraud, the discount rate impact is much more important than the cash flow impact, explaining about 84% of return variation. Examination of returns in the post-announcement period shows that firms with a higher relative discount rate impact experience a significant downward stock price drift after the initial announcement-related price decline. For firms with a higher relative cash flow impact, the impact of the restatement announcement is long-lasting. Our findings close gaps in the evidence on financial restatements, extend the literature on the drivers of stock price movements and inform the research on the value relevance of earnings.

Authors

• Sang Hyun Park, Augusta University

• Keejae P Hong, University of North Carolina-Charlotte

• Sukesh Patro, Nothern Illinois University

• Jaywon Lee, Korea Advanced Institute of Science and Technology