Investor reactions to restatements conditional on disclosure of internal control weaknesses
Abstract
Purpose
The purpose of this paper is to investigate investor reactions to financial restatements conditional on disclosures of internal control weaknesses under Section 404 of the Sarbanes-Oxley Act.
Design/methodology/approach
The research uses cumulative abnormal stock returns (CARs) as a proxy for investor reactions. Restatements and internal control reports are available on audit analytics. Multivariate regression analyses were used for testing.
Findings
Using a sample of restating firms whose original misstatements are linked to underlying internal control weaknesses, the research finds that cumulative abnormal returns for firms disclosing internal control weaknesses in a timely manner is negative in a three-day window around the restatement announcements. The finding indicates that restatements with early disclosure of internal control weaknesses provide more persuasive evidence of the ineffectiveness of a firm’s internal control over financial reporting, rather than early disclosure lowering the information asymmetry between a firm and investors.
Research limitations/implications
This study employs CARs to examine the market reaction to restatements conditional on disclosure of internal control weaknesses.
Practical implications
Further study on reactions by creditors who have access to private information on firms could extend the implications of the finding.
Originality/value
The study contributes to the existing research by documenting that early disclosure of material weaknesses in internal control affects investors’ reactions to financial restatements.
Keywords
Citation
Li, Y., Park, Y.-i. and Wynn, J. (2018), "Investor reactions to restatements conditional on disclosure of internal control weaknesses", Journal of Applied Accounting Research, Vol. 19 No. 3, pp. 423-439. https://doi.org/10.1108/JAAR-10-2017-0107
Publisher
:Emerald Publishing Limited
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