Studies have shown that, following announcement of a restatement, stock prices are abnormally negative for the period 20 to 30 trading days after the announcement. But what happens after the restatement is actually filed? In a study from Audit Analytics, the authors found that, following the date of the restated financials, there were no significant abnormal returns in either the first 30-day window or after a 90-day window, but, in the second 30-day window, the authors found long-term abnormal positive returns “of up to 3.28% following the resolution of the restatement process and filing of the restated financial statements.”
The study involved only companies that had “non-reliance” restatements, that is, companies that filed Forms 8-K, Item 4.02, indicating that their financial statements could no longer be relied on, for the years 2005 to 2016. The authors eliminated from the study companies that announced the restatement and filed their restated financial statements on the same date, as well as instances where the data was not available to the authors. They then calculated the cumulative average abnormal returns for the sample for 25 window periods of 30-day increments, for a period of up to 750 days following the date of restated financial statements. The authors considered the Russell 3000 index to be “representative of the market.”
In the first 30-day window after the date of the restated financials, the authors found no statistically significant abnormal returns. But that result changed in the second 30-day window, when they identified abnormal positive returns of 1.07%, and, thereafter, even higher positive returns in two subsequent windows within the 750 days examined. Even when a restatement was considered more significant—such as a restatement involving net income—the results were quite similar. But where the restatement process was especially lengthy (over 30 days), which characterized slightly less than half of the sample, the authors found, similar to the results above, abnormal positive returns of 1.74% in the second 30-day window, However, in contrast to the results above, the data showed abnormal negative returns of 2.67% in the third 30-day window—the only window that produced abnormal negative returns. Abnormal positive returns were identified in a window almost a year out. Results were similar for lengthy restatements with a net income effect.
As the authors observe, a financial restatement represents “an accounting failure. Inability to provide reliable financial statements may shake investor confidence and raise concerns about the overall health of the company. Moreover, a material restatement caused by an accounting irregularity may cast doubt on management integrity and expose the company to regulatory scrutiny or litigation.” Those concerns, together with the uncertainty associated with the ultimate results, probably explain the negative results that typically follow the announcement of the restatement.
But after the restatement has been filed and the issue resolved and remediated, the market does not appear to reflect a delayed reaction or expect more negative events, except perhaps where the restatement involved a lengthy process. How to explain these results? While a company is undergoing a restatement that is not immediately resolved, it may become delinquent in its SEC filings and even “go dark” by limiting the amount of information and guidance it makes available to the market. Where possible, some companies may even choose to delay positive news until after the restatement is filed. The dearth of information, the authors observe, could lead “the market to initially misprice bad news for companies undergoing a long restatement process,” but that effect could ultimately “create a window of opportunity for abnormal positive returns after the market corrects from the exaggerated reaction to the news.” In addition, the authors suggest, some institutional investors “may avoid investing or increasing their position in the stock while the restatement process is ongoing,” perhaps because of governance concerns, but may be willing to jump in after those concerns have been resolved. But where the restatement process was especially lengthy, the authors suggest that the results may reflect continued volatility or underperformance “long after the restated financials are filed. Yet, the negative abnormal returns are short-lived.”
Although the data reflect averages and there are certainly exceptions, the study suggests that, while the market tends to react negatively on announcements of restatements, once the restatements are filed, unless the process was especially lengthy, companies have an opportunity to recover in the market fairly quickly, even where the restatement was significant and had an effect on net income.