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The Effect of Accounting Restatements on Earnings Revisions and the Estimated Cost of Capital

The Effect of Accounting Restatements on Earnings Revisions and the Estimated Cost of Capital 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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Accounting Studies Springer Journals

The Effect of Accounting Restatements on Earnings Revisions and the Estimated Cost of Capital

Hribar, Paul; Jenkins, Nicole
Review of Accounting Studies , Volume 9 (3) – Sep 30, 2004
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References (11)

Publisher
Springer Journals
Copyright
Copyright © 2004 by Kluwer Academic Publishers
Subject
Business and Management; Accounting/Auditing; Corporate Finance; Public Finance
ISSN
1380-6653
eISSN
1573-7136
DOI
10.1023/B:RAST.0000028194.11371.42
Publisher site
See Article on Publisher Site

Abstract

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.

Journal

Review of Accounting Studies – Springer Journals

Published: Sep 30, 2004

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