Do Investors See Through Mistakes in Reported Earnings?
Abstract (Salavei, Golec, Harding)
This study investigates whether investors see through materially misstated earnings, and whether they anticipate earnings restatements. For firms that restate at least one annual report, we find that investors are misled by mistakes in reported earnings at the time of initial earnings announcements. Investors react positively to the component of the favorable earnings surprise that will subsequently be restated, and attach the same valuation to it as to the true earnings surprise. We also find that investors anticipate the subsequent downward restatements and start marking stock prices down several months before a restatement announcement, so that the full impact of a restatement is about three times as large as the initial announcement effect. Overall our findings indicate that although investors anticipate restatements several months before its announcement, they are misled by misstated earnings for several years and therefore would benefit from better quality of financial information.