Do Restatements Break Bad Habits? Evidence of Earnings Quality Following Restatements

This paper investigates if firms consider restatements so severe that they change their financial reporting strategies and subsequently improve their accounting quality. We compare the accruals quality of restating firms during the period 2000-2010 with a matched control group and hypothesize that the costly consequences of restatements documented in prior researchincentivize firms to improve their accounting quality. We use a multivariate difference-in-difference research design and contrary to our expectations we find that firms do not improve the quality of their financial statements more than the control group following a restatement, even when we isolate the types of restatements considered to be the most severe. Hence, we cannot replicate the univariate results of Wiedman and Hendricks (2013). However, we find that restatements followed by severe, negative stock market reactions to the restatement announcements lead to significant improvement in accruals quality. Thus, while the restatement itself does not lead to improvements in accounting quality, the punishment by the capital markets does. Our findings thus suggest that capital market forces play a larger disciplining role than the restatement itself, which adds to our knowledge of the behavior of firms post restatements.