The Effect of Accounting Restatements on Earnings Revisions and the Estimated Cost of Capital
Rent the article at a discountRent now
* Final gross prices may vary according to local VAT.Get Access
This paper examines the effect of accounting restatements on a firm's cost of equity capital. We show that, on average, accounting restatements lead to both decreases in expected future earnings and increases in the firm's cost of equity capital. Depending on the model used, relative percentage increases in the cost of equity capital average between 7 and 19% in the month immediately following a restatement. The relative increase in the cost of capital dissipates as time passes and after controlling for analyst forecast biases, but continues to average between 6 and 15% in the most conservative setting. We also show that restatements initiated by auditors are associated with the largest increase in the cost of capital, and that firms with greater leverage experience greater increases in their cost of capital. Overall, our evidence is consistent with accounting restatements lowering the perceived earnings quality of the firm and increasing investors' required rates of return.
- Anderson, K. and T. Yohn. (2002). “The Effect of 10-K Restatements on Firm Value, Information Asymmetries, and Investors' Reliance on Earnings.” Working paper, Georgetown University.
- Botosan, C. A. (1997). “Disclosure Level and the Cost of Equity Capital.” The Accounting Review 72, 323–349.
- Botosan, C. and M. Plumlee. (2002). “A Re-examination of Disclosure Level and the Expected Cost of Equity Capital.” Journal of Accounting Research 40, 21–40.
- Callahan, C., C. Lee and T. Yohn. (1997). “Accounting Information and Bid-Ask Spreads.” Accounting Horizons 11, 50–61.
- Dechow, P. M., A. P. Hutton and R. G. Sloan. (1996). “Economic Consequences of Accounting for Stock-Based Compensation.” Journal of Accounting Research 34, 1–20.
- Easley, D. and M. O'Hara. (2004). “Information and the Cost of Capital.” The Journal of Finance 59.
- Easton, P. and S. Monahan. (2003). “An Evaluation of the Reliability of Accounting Based Measures of Expected Returns: A Measurement Error Perspective.” Working paper, Insead.
- Easton, P., G. Taylor, P. Shroff and T. Sougiannis. (2002). “Using Forecasts of Earnings to Simultaneously Estimate Growth and the Rate of Return on Equity Investment.” Journal of Accounting Research 40, 657–676.
- Francis, J., R. Z. LaFond, P. Olsson and K. Schipper. (2003). “Cost of Capital and Earnings Attributes.” Working paper, Duke University.
- Gebhardt, W., C. Lee and B. Swaminathan. (2001). “Toward an Implied Cost of Capital.” Journal of Accounting Research 39, 135–176.
- General Accounting Office. (2002). “Financial Statement Restatements: Trends, Market Impacts, Regulatory Responses, and Remaining Challenges.” Washington D.C. GAO-03-138.
- Gode, D. and P. Mohanram. (2002). “Inferring the Cost of Capital using the Ohlson-Juettner Model.” Review of Accounting Studies 8, 399–432.
- Guay, W., S. P. Kothari and S. Shu. (2003). “An Empirical Assessment of Accounting Based Cost of Capital Measures.” Working paper, University of Pennsylvania.
- Healy, P. M., A. P. Hutton and K. G. Palepu. (1999). “Stock Performance and Intermediation Changes Surrounding Sustained Increasing Disclosure.” Contemporary Accounting Research 16, 485–520.
- Ohlson, J. (1995). “Earnings, Book Value, and Dividends in Security Valuation.” Contemporary Accounting Research 11, 661–687.
- Ohlson, J. and B. Juettner-Nauroth. (2001). “Expected EPS and EPS Growth as Determinants of Value.” Working paper, New York University.
- Palmrose, Z-V., V. J. Richardson and S. Scholz. (2004). “Determinants of Market Reactions to Restatement Announcements.” Journal of Accounting and Economics 37, 59–90.
- Richardson, S., I. Tuna and M. Wu. (2002). “Predicting Earnings Management: The Case of Earnings Restatements.” Working paper, University of Pennsylvania.
- Welker, M. (1995). “Disclosure Policy, Information Asymmetry, and Liquidity in Equity Markets.” Contemporary Accounting Research 11, 801–827.
- The Effect of Accounting Restatements on Earnings Revisions and the Estimated Cost of Capital
Review of Accounting Studies
Volume 9, Issue 2-3 , pp 337-356
- Cover Date
- Print ISSN
- Online ISSN
- Kluwer Academic Publishers
- Additional Links
- accounting restatements
- cost of capital
- earnings quality
- Industry Sectors