Stealth Disclosure of Accounting Restatements

Abstract

Managers exercise considerable discretion over how they announce an accounting restatement in a press release. Some firms issue a press release that discloses the restatement in the headline (high prominence). Others provide a press release with a headline on a different subject (for example, earnings news) but describe the restatement in the body of the release (medium prominence). The remaining firms discuss the restatement at the end of the press release in a footnote to operating results (low prominence). Mean three-day returns differ considerably across these three categories of prominence (−8.3, −4.0, and −1.5 percent, respectively). We find that disclosure prominence is significantly negatively associated with returns in a model that controls for the seriousness of the GAAP violation, restatement magnitude, other restatement characteristics, and potential endogeneity. Similarly, we find the likelihood of class action lawsuits is significantly reduced with less prominent disclosure.

Troublesome Tidings? Investors’ Response to a Wells Notice

“…While we predict and find that investors' response to a Wells notice varies negatively in litigation risk, another explanation could relate to the prominence of the disclosure (Files, Swanson, & Tse, 2009), whereby the more prominent first-time 8-K disclosures elicit a more negative price response. To implement this test, we split the first-time 8-K sample into high and low prominence groups, where high prominence refers to a first-time 8-K with a press release that mentions the Wells notice or a first-time 8-K without a press release but where the Wells disclosure is the sole item of the 8-K (N=59).…”

Evidence on the Association between Financial Restatements and Auditor Resignations

“…PRESSRELEASE captures the relative transparency of the restatement disclosure. We expect that higher visibility restatements are of greater concern to auditors, as prominent disclosures are more likely to trigger litigation (Files et al 2009). In addition, prior research indicates that more severe restatements tend to be disclosed transparently in Form 8-Ks and press releases rather than in regularly scheduled or amended SEC filings (Myers et al 2011;Plumlee and Yohn 2008).…”

Admitting Mistakes: Home Country Effect on the Reliability of Restatement Reporting

“…Cheng, Srinivasan, and Yu (2013) show that foreign listers are less likely to be sued in securities lawsuits compared to US firms, in part due to fewer restatement triggers. Firms that do not correct misstatements face lower risk of SEC action since restatements prompt SEC investigations and investor scrutiny (Karpoff et al, 2008;Files, Swanson, and Tse 2009). Therefore, our results imply that US listed foreign firms may be underscrutinized by US public and private enforcement mechanisms.…”

“…Prior studies show that, conditional on reporting a restatement, firms make disclosure choices regarding the announcement medium to minimize the cost of restating (Files et al 2009;Myers, Scholz, and Sharp 2010;Badertscher and Burks 2011). While our main focus is on the likelihood of restatement, we also examine whether foreign firms differ in the disclosure method.…”

“…(5) The dependent variable, Visible restatement i,t , equals 1 if the restatement is reported with a separate filing (e.g., 8-K or a press release), in addition to the regularly scheduled financials, and zero otherwise (Files et al 2009). Materiality is an indicator variable that equals one if the restatement is material, zero otherwise.…”