DO MANAGERS CHANGE THEIR FINANCIAL REPORTING STRATEGIES IN RESPONSE TO AN ACCOUNTING RESTATEMENT?

Abstract

This paper examines firms’ financial reporting strategies in the periods surrounding an accounting restatement. Given that managers continually face a number of contractual and capital market related pressures to meet specified earnings targets and produce a smooth earnings stream, we maintain that firms engage in a regular earnings management strategy. When the earnings management becomes particularly aggressive and outside the boundaries of GAAP, it is detected and the firm is required to restate. The question of interest is whether the firm returns to its regular level of earnings management in the periods following the restatement.

We identify a sample of financial statement restatements during 1997-2000 and compare various empirical measures of financial reporting strategy before and after the restatement. The results indicate that firms do not appear to alter their financial reporting strategies (i.e., do not make more conservative accounting choices) in response to an accounting restatement. The findings are consistent with the interpretation that managers feel that their pre-restatement accounting policy choices were sufficiently

conservative, and do not deem it necessary to change their accounting regime in the post restatement period.