The Contagion Effects of Accounting Restatements

Abstract

We predict and find that accounting restatements that adversely affect shareholder wealth at the restating firm also induce share price declines among non-restating firms in the same industry. These share price declines are unrelated to changes in analysts' earnings forecasts, but instead seem to reflect investors' accounting quality concerns. Peer firms with high industry-adjusted accruals experience a more pronounced share price decline than do low-accrual firms. This accounting contagion effect is concentrated among revenue restatements by relatively large firms in the industry. We also find that investors impose a larger penalty on the stock prices of peer firms with high earnings and high accruals when peer and restating firms use the same external auditor. Our results are consistent with the notion that some accounting restatements cause investors to reassess the financial statement information previously released by non-restating firms.

Contagion of accounting methods: evidence from stock option expensing

“…2 Once managers become aware of the new accounting method, they will estimate the net benefits of the method and develop a preference concerning adoption of the method (Rogers 2003, p. 176), which I label the intrinsic propensity to adopt. This 1 There are some recent papers examining the role of other firms in other accounting settings (e.g., Kedia and Rajgopal 2007;Tse and Tucker forthcoming;Gleason et al 2008). In addition, this paper is related to information transfer studies, but generally those studies focus on how investors' views of company A are impacted by actions of company B.…”

The effect of stock price on discretionary disclosure

“…In that context, financial restatements by industry peers, although not ideal, provide several important advantages. First, previous research (Gleason et al 2008;Xu et al 2006) finds significantly negative cumulative abnormal returns for industry peers of the restating firm on the 3 days surrounding a restatement announcement (hereafter ''contagion effect''). Thus, restatements are events during which investors revise firm valuations based on the probability that the peer firms will also restate.…”

“…This setting offers several advantages. As documented by recent literature (Gleason et al 2008;Xu et al 2006), peers of restating firms experience on average negative cumulative abnormal returns at the time of the restatement announcement (henceforth contagion effect). 4 This provides a public event generating a shock to stock prices.…”

“…The most obvious effect of a restatement is that investors believe that other firms in the industry are more likely to restate their earnings as well. Poorer expected earnings for these peer firms lead to stock price declines (Gleason et al 2008;Xu et al 2006). As a result, managers of nonrestating peer firms who withheld bad news are likely to find that the new stock price is lower than their own private information indicates.…”

Business Strategy and Intra-Industry Information Transfers

“…Lang and Stulz (1992) find that bankruptcy announcements by one firm negatively affect the stock prices of other firms in the same industry. Gleason, Jenkins, and Johnson (2008) find that accounting restatements result in negative stock price reactions by industry peers. Relatedly, Kedia, Koh, and Rajgopal (2015) find that firms are more likely to begin managing earnings when there is an accounting restatement announcement by an industry peer firm.…”