MATERIALITY AND THE LENGTH OF MISSTATEMENT DETECTION PERIODS

Abstract

 In this paper, I examine if misstatement materiality motivates managers to shorten misstatement detection periods. Following the literature, I find that management shortens the gross detection period by about 116 days for material misstatements than for the immaterial misstatements. The impact of materiality is even more evident for the disclosure of serious (fraud/SEC investigated) than non-serious (error-related) misstatements. In order to reduce the confounding factor – SEC 2004 mandates disclosure of material misstatement within four business days – I estimate net detection periods and find consistently that they are negatively associated with materiality. Additional tests using misstatement severity and cumulative income effect in non-BigR firms as alternative measures of materiality yield consistent results. All three tests alleviate the concern that my finding is mechanical due to the regulatory requirement on disclosure. Further test shows that non-earnings related components of materiality contribute to shorter detection periods as well. Finally, I provide evidence that among material-misstating firms the litigation risk is lower for earlier disclosers than for the later. This finding explains why management would like to shorten the detection period of material misstatement.