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Restatement of Earnings, Accruals Quality, and Cost of Capital
Pervaiz Alam,
Kent State University
ABSTRACT. This study investigates the effect of accounting restatements on accruals quality (AQ) and cost of equity capital for a sample of firms announcing restatements over the period 1997-2003. Francis et al. (2005) demonstrate that investors price AQ, which serves as a proxy for information risk associated with earnings. Results indicate that before firms announce accounting restatements there is a positive relation between the cost of equity capital and poorer AQ. However, after the restatement the AQ is no longer associated with the cost of equity. Further analysis of AQ into innate and discretionary components provides similar results as that found for AQ before and after accounting restatements. Overall, the evidence indicates that restatements improves earnings quality, reduces the information risk and implied cost of capital, and increase the stock returns of firms restating earnings.
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