Review of Accounting Studies, 9, 357–367, 2004
# 2004 Kluwer Academic Publishers. Manufactured in The Netherlands.
Discussion of ‘‘The Effect of Accounting Restatements
on Earnings Revisions and the Estimated
Cost of Capital’’
RON KASZNIK email@example.com
Graduate School of Business, Stanford University, Stanford, CA 94305–5015, USA
Abstract. The Hribar and Jenkins study (2004, this issue) investigates the effect of accounting restatements
on ﬁrms’ cost of equity capital. The authors document that the loss of market value associated with
restatement announcements is attributable not only to a downward revision in expected future earnings
but also to an increase in implied cost of capital. This ﬁnding is consistent with the conjecture that
restatements lead to increased investors’ uncertainty about management credibility and competence, as
well as to concerns about overall earnings quality. My discussion evaluates the motivation for the research
question, addresses a number of key research design issues, particularly the estimation of implied cost of
capital, and offers some suggestions for future research.
Keywords: implied cost of capital, earnings restatements
JEL Classiﬁcation: M41
The Hribar and Jenkins (2004) study (hereafter, HJ) investigates the extent to which
accounting restatements affect investors’ expectations of future cash ﬂows and ﬁrms’
cost of equity capital. This investigation is motivated by the well-documented loss of
equity market value associated with accounting restatements. The authors conjecture
that this loss of market value is attributable not only to downward revisions in future
earnings expectations, but also to increases in cost of capital. Following recent
research, HJ estimates several cost of capital measures implied by a valuation
equation derived from the residual income model (Ohlson, 1995). HJ ﬁnds that
accounting restatements are associated with a downward revision of analyst
forecasts for next periods’ earnings, and with an increase in implied cost of capital.
The authors interpret their ﬁndings as evidence that accounting restatements result
in increased uncertainty about management credibility and concerns about overall
earnings quality, leading to increased required rates of return to compensate
investors for the perceived additional risk.
This discussion evaluates the motivation for the primary research question and
addresses several key research design issues, particularly the estimation of implied
cost of capital. Overall, despite the relevance of the topic and the interesting ﬁndings,
I raise a number of concerns about whether the ﬁndings can be interpreted as
evidence that earnings restatements lead to increases in ﬁrms’ cost of equity capital.