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Investor reactions to restatements conditional on disclosure of internal control weaknesses

Yiwen Li (Department of Accounting, Finance and Business Law, Radford University, Radford, Virginia, USA)
You-il Park (Division of Accounting, Nanyang Technological University, Singapore)
Jinyoung Wynn (School of Accountancy, Louisiana Tech University, Ruston, Louisiana, USA)

Journal of Applied Accounting Research

ISSN: 0967-5426

Article publication date: 10 September 2018

695

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

Copyright © 2018, Emerald Publishing Limited

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