Short- and long-term share price reaction to announcements of financial restatements

Purpose - This study examines both the short- and long-term share price reaction to announcements of financial restatements cited in the U.S. General Accounting Office (2006) database. Methodology - It uses the augmented four-factor Fama-French model for assessing share price reaction. Findings - The study finds that the average cumulative abnormal return (CAR) for a sample of 553 restatements (by 437 companies) is significantly negative (-1.58) for the three-day window surrounding the day of announcement. The average CAR for the one-year period prior to the announcement (-9.6%) and for each of the four years after the announcement is negative as well, with the average CAR for the four years adding up to -22%. The study also documents differences in CARs based on the entity prompting the restatement (company, auditor, and Securities and Exchange Commission), the reason behind the restatement (revenue, cost, reclassification of item, etc.), and for one-time versus repeat offenders. Social implications - Taken together, the findings indicate that financial restatements impose significant short-term as well as long-term costs on shareholders. Originality/Value - The evidence about long-term share price reaction to financial restatements is missing in prior research. The relationship between long-term and short-term share price reaction to financial restatements fails to suggest systematic over/underreaction by the market.