The effect of restatements on analyst behavior

Abstract

This paper examines how changes in the credibility of financial reporting affect analyst behavior. Using a sample of restatement firms experiencing a substantial change in credibility over 1997–2006, we document that restatements have a long‐lived effect on analyst behavior and that analysts differentiate between restatements caused by irregularities and those caused by errors. We find that while irregularity restatement firms exhibit a reduction in analyst coverage and forecast accuracy and an increase in forecast dispersion in the post‐restatement period, other restatement firms exhibit only an increase in forecast error. Finally, we find evidence to suggest that remedial actions reduce the effect of irregularity restatements on analyst behavior. Overall, these results are consistent with the notion that restatements affect analyst behavior in forming judgements regarding subsequent earnings announcements.

Financial restatements and sell-side analysts' stock recommendations: evidence from Malaysia

“…These results reveal that sell-side analysts tend to issue less favorable stock recommendations for the companies with restated financial statements. Our findings based on observations from an emerging economy complement the results of the US studies by Griffin (2003), , Young and Peng (2013) and Ye and Yu (2017) that analysts revise their earnings forecasts or recommendations downwards or drop coverage following financial restatements. Kryzanowski and Zhang (2013) also find a significant downward revision in financial analysts' earnings forecasts after financial restatements in Canada.…”

“…Another stream of research examines the governance role of financial analysts in identifying corporate fraud and in limiting earnings management (Yu, 2008;Chen et al, 2015;Irani and Oesch, 2016), and analysts' reactions to restatements (Griffin, 2003;Ye and Yu, 2017) and corporate social responsibility engagements (Hinze and Sump, 2019). Based on all reported fraud cases in large US companies, Dyck et al (2010) document the role of financial analysts as whistle blowers, as they are often the first to detect corporate fraud.…”

“…Using detailed data from the US SEC Accounting and Auditing Enforcement Releases (AAER), Young and Peng (2013) conclude that financial analysts are more likely to take severe action and drop coverage than simply revise their stock recommendations downwards for companies with accounting fraud. Using a sample of US restatement companies, Ye and Yu (2017) find that analysts react differently according to the severity of restatements based on Hennes et al's (2008) classification. They document that restatement companies exhibit a reduction in analyst coverage but the reduction in analyst following does not vary with the severity of restatements (irregularities, i.e.…”

“…The study makes the following contributions. While most studies on analyst behavior toward restatements focus on the consequences of restatements in terms of analyst following and forecast accuracy and dispersion (Griffin, 2003;Ye and Yu, 2017;Alfonso et al, 2018), our study contributes to the literature by examining if and how the restatements affect the analysts' final output as reflected in the nature of the recommendation opinion, an area that has so far received little attention. As a matter of fact, most existing studies on the determinants of analysts' buy/hold/sell recommendations have only considered various firm-specific factors, such as strength of corporate governance (Yu, 2011), corporate social responsibility initiatives (Ioannou and Serafeim, 2015), earnings growth and risk (Peasnell et al, 2018), shareholder rights (Autore et al, 2009), equity incentive plans (Liu, 2017) and degree of internationalization (Luo and Zheng, 2018).…”

“…A few studies in the developed economies show that the number of analysts covering these companies declines in the period after restatements, and analysts are more likely to revise their earnings forecast downward following financial restatements (Griffin, 2003;Kryzanowski and Zhang, 2013). Ye and Yu (2017) find a reduction in analyst coverage and forecast accuracy and an increase in forecast dispersion for restated companies in the post-restatement period. However, Jiang et al (2015) assert that studies on the consequences of financial restatements in emerging markets are scarce, even though these emerging markets are more vulnerable to financial reporting manipulation and subsequent financial restatements.…”