Swanson Et Al

Stealth Disclosure of Accounting Irregularities: Is Silence Golden?
Edward P. Swanson*
Professor
Texas A&M University
eswanson@mays.tamu.edu
Senyo Tse
Professor
stse@mays.tamu.edu
Rebecca Wynalda
Ph.D. Student
rwynalda@mays.tamu.edu
*Corresponding Author.
Edward P. Swanson
Mays Business School
4353 TAMU
College Station, TX 77843-4353
Current Draft: August 21, 2007
Keywords: accounting restatements, press release disclosure, voluntary disclosure
Data Availability: The data used in this study are publicly available from the sources indicated in the text.
Acknowledgments: We would like to thank Devin Shanthikumar, Nate Sharp, and workshop participants at
Texas A&M University and at the 2007 AAA Annual Meeting for their comments. We are indebted to Jason
Call, Vikas Hegde, and Natasha Thomas for their research assistance. The authors gratefully acknowledge
financial support from the Mays Business School of Texas A&M. Swanson would also like to acknowledge
funding from the Durst Chair in Accounting.
ABSTRACT: Managers are allowed considerable discretion over how they announce an
accounting restatement. Some firms issue a press release that discloses the restatement in
the headline (high prominence); others provide a press release with a headline on a
different subject (for example, earnings news) but discuss the misstatement in the press
release (medium prominence); and most of the remaining firms simply change the
comparative-period amounts reported in an earnings release, with no direct mention of
the restatement (low prominence). Mean three-day returns are negative and differ
substantially across these categories of disclosure prominence (-8.3%, -4.0%, and -1.5%
for high, medium, and low prominence, respectively). We investigate whether this
pattern is due to differences in the severity of the accounting irregularity or in the relative
transparency of the three press release formats. Our tests support the latter explanation.
We also find that companies providing less prominent press release disclosure of their
restatement are less likely to be sued for securities fraud. In sum, both return and
litigation tests indicate that silence can be golden.
I. INTRODUCTION
Key leaders of the business community argue that new regulations and high litigation
costs are making U.S. capital markets less competitive (Interim Report of the Committee on
Capital Markets Regulation 2006). In a widely covered speech before the Economic Club of
New York, Treasury Secretary Henry Paulson expressed concern that U.S. competitiveness is
being impaired by a broken legal system. He cited tort costs that have reached a record
quarter-trillion dollars (2.2 percent of GDP), which is twice the relative cost in Germany and
Japan, and three times the level in the UK. Paulson suggested these costs could be lowered
by reducing the number of accounting restatements, which he said are often caused by
companies well-intentioned attempts to follow complex and changing accounting rules.1
The Treasury Secretary has since announced plans to commission a rigorous analysis of
factors driving financial restatements, and their impact on investors and the capital markets.
(Financial Times, May 17, 2007).
This legal environment may help explain why many corporate managers provide only
minimal disclosure when announcing an accounting irregularity. We discovered this while
reading companies press releases underlying the GAO report (2002), which was prepared
for the U.S. Senate Committee on Banking, Housing, and Urban Affairs, chaired by Senator
Sarbanes. We observed three levels of disclosure: Some companies disclose their
restatement prominently in the headline of a press release which is usually dedicated to the
accounting irregularity (high prominence). Other firms provide less prominent disclosure,
typically citing an earnings release in the headline, but still discussing the misstatement in the
1
See Solomon 2006 and the text of Paulsons remarks at http://www.treasury.gov/press/releases/hp174.htm).
1
body of the press release (medium prominence). And the remaining firms simply restate
prior-period comparative balances in an earnings release, with no disclosure of the
restatement other than a footnote stating that the financial figures for the prior year have been
changed (low prominence). With the last two practices, an investor who does not read each
press release might not be aware of the accounting irregularity. A report by Glass Lewis
(2006) uses the expression stealth restatements to refer to the practice of disclosing an
accounting irregularity within an earnings release. The poor quality of many restatement
disclosures has recently come to the attention of the SEC and received press coverage (Reilly
2006a, b).2
We use these differences in disclosure prominence to investigate the broader question
of whether firms are rewarded or penalized for openness in disclosing bad news. This
question has been studied previously in the context of earnings warnings. Kasznik and Lev
(1995) find that returns for warning firms are lower than returns for firms with similar risks
and earnings news that do not warn. Their paper led to an article in The Economist, Silence
is golden (1994, 91), which concludes: But so long as openness is penalized, it is unlikely
to become the voluntary norm. 3 Tucker (2007) replicates Kasznik and Levs (1995) result
using a similar window. She then extends the window to five (or more) months and finds
that warning firms have more unfavorable non-earnings news (e.g., product news, alliances,
and management changes), suggesting that their long-window returns would have been lower
2
Glass Lewis suggests that companies hope investors may dismiss a restatement as relatively minor if it is
tucked away quietly in the current periods results. Subsequent to our test period, the SEC clarified that
restatements constitute information that is material to investors and thus needs to be formally disclosed in a
restatement filing clearly labeled as such. (Reilly 2006a). However, a recent working paper by Sharp (2007)
shows that the SEC clarification has not ended the practice. We focus on the press release because we find little
market reaction to the SEC filings.
3
Consistent with The Economist, we use expressions such as penalty for openness or reward for silence
interchangeably.
2
than non-warning firms returns even without the warning. She concludes that firms are not
penalized in the long-run for providing voluntary management forecasts.
The question of whether firms are rewarded or penalized for openness in disclosing
bad news has also been studied in the context of shareholder litigation. Skinner (1994, 1997)
conjectures that litigation concerns could explain why some firms warn investors in advance
of a large negative earnings surprise. Francis, Philbrick and Shipper (1994), however, find
that firms that issue an earnings warning are more likely to be sued than a control sample of
firms that do not warn, which suggests that silence is rewarded. However, Field, Lowry, and
Shu (2005) use a research design that attempts to control for the endogenous relation between
earnings warnings and litigation and conclude that warnings may deter litigation. Most
recently, Rogers and Van Buskirk (2007) find that firms that are sued reduce the frequency of
management forecasts (and conference calls) in the year following the lawsuit filing. This
finding suggests that managers believe reduced disclosure lowers the likelihood of another
lawsuit.
Existing evidence is therefore mixed about whether firms are rewarded or penalized
for openness in disclosing bad news. Our paper provides new evidence, but in the context of
disclosures of accounting irregularities rather than earnings shortfalls. Accounting
irregularities provide an important setting in which to extend this line of research. Since the
passage of the Private Securities Litigation Reform Act of 1995, accounting litigation has
shifted to firms disclosing the need for an accounting restatement and away from class
actions alleging a failure to provide timely warning of an earnings shortfall (Grundfest and
Perino 1997).
3
Our first finding is that the magnitude of the market response to a restatement is
related to press release format. The differences are substantial with average returns for the
three categories of disclosure prominence of -8.3%, -4.0%, and -1.5% for high, medium, and
low prominence, respectively. (The average return for low-prominence disclosures is not
statistically different from zero.) We consider two scenarios in which this return pattern
could occur. In the first scenario, press release prominence conveys the severity of the firms
accounting irregularity, and the return responses simply reflect misstatement severity. This
scenario is consistent with market efficiency. In the second scenario, press release
prominence is not closely related to misstatement severity. This could occur if some
managers provide less prominent press release disclosure in an effort to reduce the stock
price decline and the likelihood of litigation. Specifically, some managers may use medium
(or even low) prominence disclosure for a severe accounting irregularity to avoid attracting
market attention. In this case, the less negative returns associated with less prominent
disclosure would constitute a reward for silence. This scenario is consistent with limited
attention theory (Hirschleifer and Teoh 2003).
We evaluate the scenarios by first examining whether the return differences
associated with disclosure prominence decline over time, as investors presumably learn more
about the accounting irregularity. We observe a negative price drift in the 20 days after the
restatement announcement for firms that do not disclose the restatement in a headline (i.e.,
medium and low prominence), and this drift significantly reduces return differences across
the three categories. This response is consistent with the delayed market reaction to less
transparent disclosure predicted by limited attention theory (Hirshleifer and Teoh 2003).
Importantly, over the longer window (-1, +20), returns for each category differ significantly
4
from zero (-7.9%, -6.4%, and -3.2%). This evidence indicates that market participants are
initially misled by the differences in press release format used to announce restatements.
We next examine whether press release format is associated with announcement date
returns (-1, +1) when we control for misstatement severity. Our prominence variable should
no longer be significant if press release format simply reflects misstatement severity, but we
find that prominence is still highly significant. We then use the same model to explain
returns over the longer window (-1, +20) that allows market participants more time to assess
the accounting irregularity, and find that press release prominence is no longer statistically
significant. In sum, our returns tests indicate that firms providing less prominent press
release disclosure of an accounting irregularity are rewarded with less negative returns at the
announcement date; however, much of the reward is short-term.
Next, we examine the association between disclosure prominence and the incidence
of a class action lawsuit. About twenty percent of the companies in our sample are sued as a
result of their accounting restatement, with the frequency declining monotonically across the
three categories of disclosure prominence (27%, 16%, and 0% for the high, medium, and low
prominence firms, respectively). To determine whether the lower rate of litigation for
restatements disclosed without a headline (i.e., medium and low prominence) is due to a less
severe accounting irregularity or a less transparent press release, we estimate a logistic
regression model of the likelihood of litigation that includes controls for misstatement
severity, determinants of lawsuits identified in prior research, and announcement-date
returns. We find that the coefficient of the prominence index is positive and significant,
despite the inclusion of controls for misstatement severity. This finding suggests that press
release format is a separate determinant of lawsuit likelihood, and that managers not
5
providing headline disclosure are rewarded with a lower likelihood of litigation. We find this
result is robust to the treatment of dismissed lawsuits, so in contrast to the return differences,
the effect is permanent.
The results of this study should be of interest to regulators, corporate executives, and
academics with an interest in corporate disclosure. This paper adds to the (limited) evidence
indicating that press release emphasis affects investor responses to the accounting
information reported (e.g. Bowen, Davis and Matsumoto 2005, Gordon et al. 2007). The
paper also provides evidence about whether firms are rewarded or penalized for openness in
disclosing bad news. Prior studies on earnings warnings provide conflicting evidence about
whether the market and legal system exact a penalty for openness. Our paper provides new
evidence of a penalty. Regulators, especially the SEC, may want to standardize press release
disclosure and thereby reduce the large differences in returns and lawsuit outcomes for
substantively similar economic events. Lastly, our findings should be of interest to the
commission formed by Secretary Paulson, in their effort to understand how restatements
impact investors and the capital markets (see introductory paragraph).
The rest of the paper is organized as follows. In Section II, we present the
hypotheses. In section III, we describe the sample. We summarize the multivariate models
used to explain returns and litigation in section IV. In section V, we present the results based
on market returns, including robustness checks and extensions. In section VI, we report
litigation results. We conclude in section VII.
6
II. HYPOTHESES
Guidelines about how to write an effective press release stress the importance of the
headline. Mahoney (1991, 284) comments, The headlines drive an idea, instead of simply
identifying a subject. And Feid (2005) states Dont Bury the NewsA headline should
convey the entire key message at the top of the press release. Then the lead paragraph should
reiterate it with the basic facts.
To-date, the effect of press release format on market reactions has received little
attention in the accounting literature. A relevant exception is a study by Bowen, Davis and
Matsumoto (2005) which investigates whether investors relative response to GAAP earnings
versus pro forma earnings depends on placement in the firms press release. They find that
the relative strength of the price response to each earnings metric is greater if that metric is
emphasized by its placement in the press release. Using an approach similar to that in
Bowen et al. (2005), we define a three-level index of disclosure prominence. We code as 3
(high prominence) any press release in which the restatement is mentioned in the headline;
we use 2 (medium prominence) for any press release in which the restatement is not
mentioned in the headline but is discussed in some detail within the body of the report;4 and
we assign 1 (low prominence) to those press releases that mention the restatement only in the
footnotes to comparative period results.5
4
Firms in this category typically present other company information in the press release. Fifty-eight percent
present current earnings information, and the remaining firms issue a variety of other announcements, such as a
new credit facility (Sybron Dental 2002), the settlement of past litigation charges (Cognos 2002), and the
adoption of new tax rules (First American Financial Corporation 2000). Kothari, Shu, and Wysocki (2005, 3)
posit that managers often delay disclosing bad news, apparently gambling that subsequent corporate events (i.e.,
future corporate turnaround or restructuring) will allow them to bury the bad news.
5
Bowen et al. (2005) use a 4-point scale for each earnings metric: 1 = discussed in the headline; 2 = discussed
in the 1st or 2nd paragraph; 3 = discussed further down in the body of the release; and 4 = only discussed in the
financial statements provided at the end of the release (i.e., the footnotes). Our index combines scores 2 and 3
into one measure.
7
Concurrent research by Gordon et al. (2007) also examines the effect of press release
characteristics on returns in a three-day window centered on the restatement announcement.
Two of their characteristics are similar to those we consider, and their results are consistent
with our findings. First, they find that firms reporting the restatement in the headline (using a
dummy variable) experience a larger price decline. Second, they find that firms providing
more details about the restatement, including the restatement amount, experience a less
negative market reaction. In other respects, the papers are complementary but quite
different.6
Theory differs about whether the format of a press release would affect investor
response. In an efficient market, security prices respond promptly and fully to all publicly
available information, so it should not matter whether the restatement is in the headline.
However, limited attention theory (Hirshleifer and Teoh 2003) predicts that the speed and
completeness of price reactions are both reduced when information is disclosed in a form that
investors may overlook. Thus, price reactions to restatements that are omitted from the press
release headline (for example, restatement disclosures in an earnings press release) may be
smaller and/or extend over a longer period than headline announcements. We therefore test
the following null hypothesis:
H0 1: The extent of prominence given to an accounting restatement in the press

release does not affect the magnitude of the markets response.
Disclosure prominence may also affect the likelihood of shareholder litigation. This
could occur if potential litigants are themselves subject to limited attention. For example,
6
Gordon et al. (2007) focus on determining whether disclosure credibility is associated with market
reactions to restatement announcements. Disclosure credibility consists of situational incentives at the time
of the disclosure (which they argue is homogenous among restating firms), management credibility
(determined by the amount and tone of prior discretionary disclosures), and the characteristics of the
restatement announcement. Their research therefore complements and extends the capital markets analysis
in our paper. Note that Gordon et al. (2007) do not consider whether restatement disclosure practices
influence the likelihood of litigation.
8
class action law firms typically have staff assigned to clip newspaper articles about corporate
events with lawsuit potential, and a headlined event is less likely to be overlooked. We test
the following null hypothesis:
H0 2: The extent of prominence given to an accounting restatement in the press

release does not affect the likelihood of class action litigation.
Note that lawsuit likelihood may increase with the stock price decline that triggers the
lawsuit, and those returns may in turn be driven by disclosure prominence. We control for
this possibility by including announcement-period returns in testing H0 2.
III. SAMPLE SELECTION AND DATA DESCRIPTION
Our sample is taken from the GAO (2003) database, which lists 919 companies that
announced an accounting restatement between January 1, 1997 and June 30, 2002. The GAO
list is restricted to accounting irregularities and excludes restatements that arise from
normal corporate activity or simple presentation issues.7 The GAO tracks restatements based
on the press release announcement date, not the date on which adjusted financial statements
are filed. In addition to the company name and announcement date, the database reports the
ticker, entity that prompted the restatement (e.g. auditor, company, SEC, unknown), and the
accounting issue(s) underlying the misstatement (selected from nine categories). The GAO
list of restating companies is important because it influenced passage of the Sarbanes-Oxley
Act of 2002 by showing Congress that accounting irregularities were widespread. About
7
The GAO report (2002, 2) states: For the purposes of this report, an accounting irregularity is defined as an
instance in which a company restates its financial statements because they were not fairly presented in
accordance with generally accepted accounting principles (GAAP). This would include material errors and
fraud. The GAO report further states that accounting irregularities include so-called aggressive accounting
practices, intentional and unintentional misuse of facts applied to financial statements, oversight or
misinterpretation of accounting rules, and fraud. An important advantage of the GAO list is that the researcher
does not make the judgment about which restatements constitute aggressive accounting practices. A second
advantage is that the list is publicly available, so other researchers can extend (or replicate) research results.
9
10% of all companies listed on the NYSE, NASDAQ and Amex have a restatement cited in
the database (GAO 2002, 16).
Table 1 reconciles our sample to the GAO list. We require that our sample firms
have short-interest data, and drop 452 firms (from the 919) that do not meet this requirement.
Most of the eliminated firms are small or trade over-the-counter. We use the level of short
interest to control for information available to a sophisticated investor about accounting
problems. Desai et al. (2006) and Efendi et al. (2005) show that the level of short interest
increases before a restatement announcement. Of direct importance to our use of short
interest, Efendi et al. (2005) show that the entire increase occurs for companies with severe
accounting irregularities. 8 Our sample is further reduced by 61 firms for which we could not
locate the press release; 9 17 firms that do not have return information on CRSP; and eight
firms whose returns are in the top or bottom one percent of the cumulative market-adjusted
returns distribution. The final sample consists of 381 restatement firms.
<Insert Table 1 Here>
We obtain information about litigation from the Securities Class Action
Clearinghouse (http://securities.stanford.edu/). This website covers more than 2500 issuers
that have been named in federal class action securities fraud lawsuits since passage of the
Private Securities Litigation Reform Act of 1995. It includes information about complaints,
briefs, filings, and other litigation-related materials. We review this information to determine
8
We would like to acknowledge these authors for allowing us to use their proprietary database, which contains
short interest for firms listed on the NYSE, AMEX, and NASDAQ.
9
To ensure that we are capturing managements disclosure choices, we use press releases sent out over either
PR Newswire or Business Wire, when available. These services distribute the exact press release issued by a
firm, while other media outlets may alter the press release to conform to their format guidelines, space
requirements, etc. Almost all of the press releases in our sample are from one of these two sources.
10
whether any litigation filed against a sample firm is a direct consequence of the accounting
restatement.
Table 2 provides descriptive information about the sample. Panel A shows that
restating firms are widely distributed across 49 two-digit industries. To provide insight into
whether some industries have a higher than normal rate of restatements, we compare the
industry distribution of the sample to the Compustat population. The differences are modest:
Business services provides 15.49% of the restatement sample (59 of the 381 companies),
which is higher than the industrys 11.01% representation in Compustat. Only five other
industries provide more than 12 sample firms, and only two of them have at least a three
percent difference from Compustat: 1) Industrial and commercial machinery and computer
equipment (8.66% vs. 4.89%); and 2) electronic and other electrical components, except
computer equipment (8.66% vs. 5.58%). Table 2, Panel B reports the distribution of the
sample announcements over time. Restatement frequency increases over the sample period,
peaking at 117 restatements in 2001.10 Table 2, Panel C provides a cross-tabulation of
accounting issue with the three categories of disclosure prominence. Because some firms
restate for more than one accounting issue, the 442 accounting issues exceed the 381
companies in the restatement sample. Revenue recognition is the most common type of
accounting misstatement for each of the three prominence categories. Of particular note, a
large portion of the companies providing footnote-only disclosure restate revenue (25 of the
37). This is the primary reason that the 2.17 prominence score for revenue restatements is
low compared to the full sample average of 2.33. (Later in the paper, we report robustness
tests to determine the effect of revenue restatements on our findings.)

10
Recall that the GAO dataset ends June 30, 2002 so our sample does not include all restatements for 2002.
11
IV. MULTIVARIATE MODELS
For H0 1, we use an OLS regression model to investigate whether disclosure
prominence is associated with the magnitude of returns around the restatement
announcement. For H0 2, we use a logistic regression to examine whether disclosure
prominence influences the likelihood of class action litigation. For each hypothesis, we
control for factors other than press release format that could influence the response to the
accounting irregularity.
Abnormal Returns Surrounding Restatement Announcements
We estimate the following OLS regression model to test our first hypothesis:
CAR 1 PROMINENCE INDEX 2 RESTATEMEN T AMT 3 SEC

4 FRAUD 5 REVENUE 6 RULE CHANGE 7 COUNT (1)
8 SHORT INTEREST 9 MKTCAP 10TECH 11FINANCIAL ,
where CAR is the cumulative abnormal return calculated as the raw stock return minus the
CRSP equally-weighted market return. CAR is measured over a three-day window centered
on the restatement announcement date (-1, +1). Additional analyses extend the window to 20
days after the announcement date (-1, +20).
We read each press release to code the primary variable of interest, PROMINENCE
INDEX, which takes on the value of 3, 2, or 1. As discussed in developing the hypotheses,
we code headline disclosure of the restatement as 3, discussion of the misstatement but
without a headline citing the restatement as 2, and footnote-only disclosure as 1. Press
releases also vary by whether an estimate of the restatement amount is provided. We code
RESTATEMENT AMT as 1 if the press release reports the magnitude of the restatement and 0
12
otherwise.11 We expect a positive sign because reporting an amount signals that managers
know the extent of the accounting irregularity, while a press release that omits an amount
would indicate that managers do not yet grasp the extent of the accounting problems. Wu
(2003) shows that announcement-day returns are lower for firms that omit the restatement
amount.
We control for misstatement severity using several variables, most of which have
been used in prior studies (Lev, Ryan, and Wu 2007; Palmrose and Scholz 2004; Palmrose,
Richardson, and Scholz 2004; Wu 2003). SEC takes on the value of 1 if the press release
mentions an SEC inquiry and 0 otherwise. Based on prior research, we expect a positive sign
(i.e., a smaller decline at the announcement). A rationale is that the market would usually
know a restatement is forthcoming when it is of sufficient importance to involve the SEC,
and the actual announcement reduces uncertainty by providing information about the nature
of the accounting irregularity FRAUD is coded 1 if the press release mentions an allegation
of fraud and 0 otherwise. We expect a negative sign if fraud is alleged (i.e., greater price
decline). REVENUE is coded 1 if the restatement is at least partly due to revenue recognition
problems and 0 otherwise. We expect a negative sign because prior research finds that
investors react more negatively to revenue restatements than to other accounting
irregularities. RULE CHANGE takes on the value of 1 for firms that cite an accounting
pronouncement as the reason for their restatement and 0 otherwise. We expect the RULE
CHANGE coefficient to be positive because these restatements are caused by a change in
11
We do not use the dollar magnitude of the restatement as a measure of severity. First, many firms do not
report an amount. Second, some firms report only the restated amounts in the press release, and it is difficult to
locate the corresponding amounts originally reported in the financial statements in order to calculate the amount
of the adjustment. Third, revenue growth was emphasized as much as earnings at the top of the late 1990s
market bubble (Ertimur and Livnat 2003), and many of the misstatements that affect revenue have little effect
on earnings (Efendi, Srivastava, and Swanson 2007).
13
rules or a new interpretation of existing accounting rules, rather than by a clear violation of
GAAP. COUNT records the number of distinct accounting issues cited in the GAO database
(2003). We expect the market to react more negatively to restatements stemming from
multiple GAAP violations. The last measure, SHORT INTEREST (calculated as 100 *
(number of shares sold short)/(total shares outstanding) as of the month prior to restatement
announcement), proxies for the information about accounting problems available to
sophisticated investors before the restatement is announced. Efendi et al. (2005) show that
the level of short interest is positively associated with the severity of the accounting
irregularities.
We also include some general control variables. MKTCAP is the natural log of the
firms market capitalization measured at the fiscal year-end prior to the restatement
announcement. Tucker and Zarowin (2006) find that large firms are more likely than small
firms to provide timely disclosure of bad news. We include dummy variables for firms
operating in technology and financial (SIC 6000-6999) industries. Based on prior research,
we anticipate more negative price reactions for TECH firms and less negative price reactions
for FINANCIAL firms.
Disclosure Prominence and the Likelihood of Class Action Lawsuits
We investigate the association between disclosure prominence and the likelihood of
shareholder litigation by estimating the following logistic regression model:
LITIGATION 1 PROMINENCE INDEX 2 RESTATEMEN T AMT

3 SEC 4 FRAUD 5 REVENUE 6 RULE CHANGE
7 COUNT 8 SHORT INTEREST 9 CONCURRENT RETURN
(2)
10 PRIOR STOCK RETURN 11POST STOCK RETURN
12 SHARE TURNOVER 13 MARKET CAP 14TECH
15 FINANCIAL ,
14
where LITIGATION is equal to 1 if a class action lawsuit was filed against a firm in response
to their restatement and 0 otherwise.
Eleven of the fifteen variables in model 2 are also used in model 1 to explain CARs.
The expected signs are the same, but the rationale changes for two variables: SEC is now
expected to have a positive coefficient because a restatement subject to an SEC inquiry is
more likely to elicit litigation. MKTCAP is still expected to have a positive coefficient, but
the rationale differsdue to their deep pockets, large companies have greater litigation risk
(Beaver and Malernee 1990).
We add four variables to the litigation model. Prior research shows that SHARE
TURNOVER is positively associated with the likelihood of litigation. The rationale is that,
when shares trade rapidly, more investors are potentially harmed by any mispricing (Field et
al. 2005; Gande and Lewis 2006). The calculation of this variable is based on Field et al.
(2005): [1-t(1-volume tradedt/total sharest)], accumulated over the 1-year period ending on
the second day prior to the restatement announcement date. The other variables we add
capture changes in stock price. CONCURRENT RETURN is the compounded raw return
over the three-day period centered on the date of the restatement announcement (-1, +1). The
likelihood of litigation is expected to increase with a greater decline in share price around the
announcement (Palmrose and Scholz 2004). PRIOR STOCK RETURN is the compounded
raw return over the one-year period ending two days before the restatement announcement
(-252, -2). Weak stock price performance in the recent past has been shown to increase the
incidence of lawsuits (Jones and Weingram 1996; Gande and Lewis 2006). POST RETURN
is the compounded raw return over the (+2, +20) interval following the restatement
15
announcement. This return window allows for a delayed market reaction as investors assess
the accounting irregularity.
V. RESULTS FOR MARKET RETURNS
Returns over Short and Longer Windows
Table 3 reports mean abnormal returns for a three-day window centered on the
announcement date (-1, +1), the next nineteen days (+2, +20), and the combined window
(-1, +20). The Full sample column reports returns of -5.5%, -1.1%, and -6.7%,
respectively, for those three windows.
The full sample return of -5.5% for the three-day announcement window is an
average of returns that differ substantially depending on the prominence provided to the
restatement in the press release. Abnormal returns for high, medium and low prominence in
the three-day window are -8.3%, -4.0% and -1.5%, respectively. The returns for high and
medium prominence are significantly different from zero, and the high prominence return
(i.e., for headline disclosure) differs significantly from the returns for medium and low
prominence. Therefore, our first finding is that the magnitude of the market response to a
restatement differs by press release format, with smaller declines for firms providing less
prominent disclosure.
We consider two scenarios in which this return pattern could occur (as discussed in
the introduction). In the first scenario, press release prominence conveys the severity of the
firms accounting irregularity, and the return responses simply reflect misstatement severity.
This scenario is consistent with market efficiency. In the second scenario, press release
16
prominence is not closely related to misstatement severity. This could occur if some
managers provide less prominent press release disclosure in an effort to reduce the stock
price decline and the likelihood of litigation. Specifically, some managers may use medium
(or even low) prominence disclosure for a severe accounting irregularity to avoid attracting
market attention. In this case, the less negative returns associated with less prominent
disclosure would constitute a reward for silence. This scenario is consistent with limited
attention theory (Hirschleifer and Teoh 2003). 12
We evaluate the scenarios by first examining whether the return differences
associated with disclosure prominence decline over time as investors presumably learn more
about the accounting irregularity. As reported in Table 3, over the period +2 to +20, returns
change by 0.6%, -2.3%, and -1.6% across the three disclosure categories. As a result, over
the longer (-1, +20) window, the average return for the full restatement sample declines to -
6.7% (from -5.5%), and the spread in returns across the three disclosure categories is smaller
with mean returns of -7.9%, -6.4%, and -3.2%, respectively. Importantly, each return now
differs significantly from zero. This result, which is consistent with the delayed market
reaction to less transparent disclosure predicted by limited attention theory, indicates that
market participants are initially misled by the differences in press release format used to
announce restatements.
12
Research on managers disclosure practices is ambiguous about how managers would disclose a
restatement. Ninety-one percent of the CFOs surveyed by Graham, Harvey and Rajgopal (2005) believe
that developing a reputation for transparent reporting is the key factor motivating voluntary disclosures.
To develop a reputation for transparency, managers may use prominence to signal restatement severity
(scenario 1) or disclose all accounting irregularities prominently (scenario 2). This second set of firms may
expect the long-term benefits of disclosure reputation to offset any short-term adverse effects from using
high prominence (e.g. headline) disclosure when the level of severity justifies medium or low prominence.
On the other hand, Gibbins, Richardson and Waterhouse (1990) find anecdotal evidence that firms manage
the visibility of their disclosure by burying sensitive information in verbiage. This strategy is consistent
with severe restatements being less prominently disclosed in a press release (scenario 2).
17
Correlations among Variables
Table 4 reports correlations for the variables used in the multivariate models. The
short window CAR, which is reported in the second column, is significantly associated with
three explanatory variables used in the return models: PROMINENCE INDEX, REVENUE,
and RULE CHANGE. Coefficient signs indicate that returns are lower for restatements with
greater press release prominence and for revenue restatements. Returns are higher for
restatements arising from an accounting rule change. Each of these associations is consistent
with our expectations. Two of the variables used only in the litigation model are
significantly correlated with CAR. First, LITIGATION is positively associated with CAR,
which is consistent with our rationale for using returns as a variable in the litigation model.
Second, SHARE TURNOVER and CAR are negatively associated. We do not include this
variable in the returns model because we have no a priori reason to expect share turnover to
be associated with returns around the restatement, and because this variable has not been
used to explain returns in prior research.
LITIGATION, which is reported in the third column of Table 4, is significantly
associated with seven explanatory variables: PROMINENCE INDEX, SEC, FRAUD, RULE
CHANGE, SHORT INTEREST, SHARE TURNOVER, and MKTCAP. The coefficient signs
indicate that litigation is positively associated with disclosure prominence, SEC involvement,
an allegation of fraud, the level of short interest, share turnover, and market capitalization.
Litigation is negatively associated with restatements arising from an accounting rule change.
A complete discussion of the litigation results is provided in Section V.
PROMINENCE INDEX, which is the primary explanatory variable of interest in both
the return and litigation models, is reported in the third column. A positive sign on the
18
correlation with RESTATEMENT AMT indicates that firms providing more prominent
disclosure of a restatement are more likely to disclose the dollar magnitude of the
misstatement. Negative correlations indicate that PROMINENCE INDEX tends to be lower
for restatements that arise from recognition of REVENUE or a RULE CHANGE, and for large
firms (MKTCAP). As discussed previously, PROMINENCE INDEX is also associated with a
lower CAR and more LITIGATION.
The indicator variable, RESTATEMENT AMT, is also correlated with several
variables. The associations show that an estimate of the dollar amount is less likely to be
provided for restatements due to REVENUE recognition or a RULE CHANGE, and for firms
with high SHORT INTEREST or SHARE TURNOVER. An amount is more likely to be
provided when the restatement involves a high COUNT of accounting issues.
The correlation coefficient signs for the remaining variables seem logical. And
multicollinearity is not likely to be a serious problem, due to the moderate size of the
correlations. (Note that no VIF in our model is greater than 2.0).
Multivariate Analysis
Abnormal Returns Surrounding Restatement Announcements
Table 5, Panel A reports regression results for a model of cumulative abnormal
returns over a three-day window centered on the restatement announcement. We report three
versions of the model in separate columns of the table. Column 1 provides a baseline result
by omitting the disclosure variables. We find the REVENUE coefficient is significantly
negative, which indicates that returns are more negative when revenue is not recognized in
accord with GAAP. The RULE CHANGE coefficient is significantly positive, so returns are
19
less negative when the restatement arises from a change in rules or a new interpretation of
existing accounting rules (rather than from a clear violation of GAAP). Among the general
control variables, the FINANCIAL coefficient is significantly positive, indicating that returns
are less negative for restatements by firms in the financial industry. The model in column 2
adds one variable, RESTATEMENT AMT, to the model but the coefficient on this variable is
insignificant, indicating that short-window returns are not affected by whether the press
release reports the dollar magnitude of the misstatement.
The model in column 3 adds the other disclosure variable, PROMINENCE INDEX, to
the variables in column 2. The PROMINENCE INDEX coefficient is negative and highly
significant, and the overall explanatory power of the model increases considerably (to 9.45%
from 6.43% in column 2). Press release format is thus a separate factor explaining
announcement date returns. The negative sign shows that after controlling for misstatement
severity and other factors, firms that disclose the restatement more (less) prominently in their
press release are penalized (rewarded) with a more (less) negative return. The coefficient of -
0.04 indicates that announcement day returns are reduced by about 4% for each level of the
prominence index (from high to medium to low prominence). Considering the economic
effect of the severity variables, returns are more negative by 5.9 percent when revenue is not
recognized in accord with GAAP. Returns are less negative by 3.0 percent when the SEC is
involved and less negative by 5.3 percent when the restatement arises from a change in rules
or a new interpretation of existing accounting rules (rather than from a clear violation of
GAAP). Among the general control variables, the FINANCIAL coefficient is significantly
positive, indicating that returns are less negative by 3.2 percent for restatements by firms in
the financial industry.
20
Table 5, Panel B reports results for a model with the same variables as in Panel A
when the return window is extended to 20 days after the restatement announcement. The
purpose is to determine whether the negative returns associated with press release
prominence in the three-day window reverse when investors have additional time to assess
the accounting irregularity. To facilitate comparisons to the short window results, the first
column of Panel B repeats the full regression (column 3) from Table 5, Panel A. The model
in the second column reports abnormal returns over a longer window that includes the
announcement day (-1, +20).13 The primary finding is that PROMINENCE INDEX is no
longer significantly associated with abnormal returns. Interestingly, RESTATEMENT AMT is
now significant, so returns are less negative over the longer window by an average of 3.8
percent when managers report the dollar magnitude of the restatement. The other three
significant variables are the same as in the short (-1, +1) window model.
To summarize, we find that PROMINENCE INDEX is significant in explaining short
(-1, +1) window returns but not returns over a longer (-1, +20) window. This result provides
additional evidence of a reward for silence at the announcement day, but suggests that much
of the reward dissipates within 20 days of the restatement announcement. Based on the
evidence presented, we reject hypothesis 1, which states that the prominence given to an
accounting restatement in the press release does not affect the magnitude of the markets
response.
Extensions and Robustness Tests
Restatement Amount
13
We also ran a similar regression over a window that omits the announcement day (+2, +20). The model
was not significant and therefore is not reported in Table 5.
21
In the analysis just presented, RESTATEMENT AMT is significant in explaining
longer (-1, +20) window returns. This variable appears to replace PROMINENCE INDEX,
which is significant in explaining the short (-1, +1) window returns. To better understand the
relation between these two variables, we provide a breakdown of market-adjusted returns by
whether or not an amount is reported and by the three categories of press release disclosure
(i.e., six cells). The returns in each cell are determined from multivariate models that include
the misstatement severity and control variables presented in Table 5. The models, which are
reported in Table 6, Panel A omit the prominence index and restatement amount variable,
and substitute a set of dummy variables to capture the interaction between the prominence
index and restatement amount. We then add the individual dummy variable coefficients to
the intercept to obtain returns for each of the six cells that are independent of the effect of the
misstatement severity and control variables.
Table 6, Panel B reports adjusted returns for the short window (-1, +1). Note that the
returns increase monotonically from the high prominence to the low prominence group,
consistent with the significantly negative PROMINENCE INDEX coefficient in the short-
window returns model. This is true whether or not the restatement amount is reported,
although the return differences among the three prominence categories are greater when the
restatement amount is not reported. The greatest price decline among the six cells is for
firms that provide high prominence disclosure but omit the amount of the restatement
(-8.9%). The data in Table 6, Panel B therefore provide additional support for the finding in
Table 5 that disclosure prominence is a separate factor in explaining the short window
returns.
22
We report similar information for the longer (-1, +20) window in Table 6, Panel C
and find that increased prominence is monotonically associated with lower returns only for
companies that do not report the restatement amount. Note that returns in Panel C are also
consistently lower for firms that do not report an amount than for firms that report an
amount. In addition, returns are substantially lower in the long window than in the short
window for firms that omit an amount. Specifically, the returns in the second row of Panel C
are lower than the corresponding second row returns in Panel B by 3.6%, -3.9%, and -3.9%
for the high, medium, and low prominence categories, respectively. These returns indicate
that after the initial price declines at the restatement announcement, investors further revise
prices downward for firms that omit the restatement amount from the press release. As a
result, the mean long window return of -12.5% for firms that provide high prominence
disclosure but do not report the amount of the restatement is even lower than the
corresponding short-window return of -8.9%. Most importantly, the data in Table 6, Panel C
show that disclosure prominence remains a separate factor in explaining long window returns
when the restatement amount is not reported.
Revenue Restatements
The descriptive statistics in Table 2, Panel C show that revenue restatements are the
most common type of accounting issue and the average prominence score for revenue
restatements is lower than the sample average. To determine whether the return results are
sensitive to revenue restatements, we rerun the return models omitting firms that restated
revenue. We find similar results to those reported for both the short and longer windows
(untabulated), and only one difference is noteworthy: With revenue restatements omitted,
SHORT INTEREST is negative and significant in explaining returns in both the short and
23
longer windows. Short sellers appear to be more successful in identifying non-revenue
accounting irregularities.
Share Turnover
The correlations reported in Table 4 show that SHARE TURNOVER is significantly
associated with short window CAR. We calculated this correlation because prior studies find
that SHARE TURNOVER is significantly associated with the likelihood of litigation. Recall
that we exclude this variable in the returns model because we do not have an a priori reason
to expect returns around the restatement to be associated with share turnover. As a
sensitivity test, we reran the returns models to include this variable. We find that the SHARE
TURNOVER coefficient is significantly negative and the financial industry coefficient is no
longer significant. The coefficients of the remaining variables are unchanged.
Restatement Initiator
Some prior studies of accounting restatements use the initiator field in the GAO
database (2003) to develop a measure of misstatement severity, and typically view
restatements initiated by an entity other than the company as more severe (Palmrose et al.
2004; Efendi et al. 2007). We rerun our return models with this variable and find that the
coefficient is insignificant.
Earnings Surprise
The announcement of an accounting irregularity often coincides with the release of
current earnings news. To ensure that our results are robust to controlling for earnings
surprise, we rerun our model on a reduced sample of firms that announce current period
earnings in the same three-day window as their restatement announcement. This occurs for
24
173 firms in our sample (45% of the sample), comprised of 11% of the high prominence
firms, 40% of the medium prominence firms, and 74% of the low prominence firms.
We calculate earnings surprise (SURPRISE) as the difference between actual
quarterly earnings per share and the most recent consensus analyst earnings forecast prior to
the earnings announcement (both reported by I/B/E/S) scaled by stock price measured just
before the forecast date. BEAT is a dummy variable used to indicate firms whose earnings
exceed analyst expectations, and is defined as 1 if SURPRISE >0 and 0 otherwise.
Requiring consensus analyst forecasts and stock price availability, plus deleting likely
outliers on the basis of news magnitude, reduces our sub-sample to 120 firms.
Table 7 shows the estimation results including SURPRISE and BEAT .14 In the short
window (-1, +1), earnings surprise is positively and significantly associated with abnormal
returns. The BEAT coefficient is also significant, indicating that firms that exceed analyst
expectations on average experience a 6% higher return than those that do not. As we would
expect, the addition of these variables increases the R2 dramatically: Using the same sub-
sample of firms, the R2 value jumps from 10.98% to almost 27% after controlling for
earnings surprise. More importantly, the PROMINENCE INDEX coefficient remains
negative and highly significant after we control for the earnings surprise and estimate the
model on a sample that is less than one-third of our original sample.
In the longer window (-1, +20), we find that the PROMINENCE INDEX coefficient is
statistically insignificant, consistent with our earlier finding that much of the short window
return penalty dissipates within 20 days after the restatement announcement. The only
notable difference from the full sample model is that RESTATEMENT AMT is insignificant.
14
No firms in this sub-sample mention allegations of fraud in their press releases, so we exclude FRAUD
from the model specification in Table 7.
25
As a further robustness check, we also add the earnings surprise controls to a model
utilizing our full sample of restatement firms (refer to Table 5, column 3), as opposed to the
sub-sample discussed above. Firms not announcing earnings are given a value of zero for
both SURPRISE and BEAT. Our findings do not changePROMINENCE INDEX remains
highly significant and all other variables are of the same sign and significance as Table 5,
with the exception of SEC, which is no longer a statistically significant predictor of abnormal
returns (results untabulated).
In summary, analyses that control for the releases of earnings again demonstrates that
returns around the restatement announcement are negatively associated with disclosure
prominence, but the role of prominence in explaining returns is reduced in the twenty days
after the announcement. Next, we consider if firms announcing restatements more
prominently face an increased likelihood of lawsuits.
VI. LITIGATION RESULTS
Table 8 reports on the frequency of class action lawsuits arising from accounting
restatements. Of the 381 companies in our sample, 73 (19 %) are served with a class action
lawsuit. The litigation rate increases monotonically across the three categories of disclosure
prominence. The rate is 27% (42 of 157) for firms providing high prominence disclosure,
16% (31 of 189) for firms providing medium prominence disclosure, and 0% for the 35 firms
providing low prominence disclosure. A chi-square test of association shows that lawsuit
incidence is significantly associated with disclosure prominence (at the 0.001 level). This
test complements the earlier finding that PROMINENCE INDEX and LITIGATION have a
significant positive correlation of 0.19 (see Table 4).
26
The correlations in Table 4 show that several other factors are significantly associated
with LITIGATION: SEC, FRAUD, SHORT INTEREST, CONCURRENT RETURN (-1, +1),
RULE CHANGE, SHARE TURNOVER, and MKTCAP. We therefore use a logit model to
estimate litigation likelihood with disclosure prominence as an explanatory variable, along
with controls for other potential determinants of litigation likelihood. We report estimation
results in Table 9. The explanatory variables are grouped into three categories: disclosure
variables, misstatement severity variables, and control variables. We find that the
PROMINENCE INDEX coefficient is positive and highly significant (at the 0.009 level). The
odds ratio of 2.3 indicates that a change of one category in the PROMINENCE INDEX more
than doubles the odds of having a lawsuit. This evidence therefore indicates that disclosure
prominence is penalized with an increased likelihood of litigation.
The significance of the misstatement severity variables is also of interest.15 We find
that all five of the severity variables that have significant pair-wise correlations with the
litigation variable (as shown in Table 4) are significant in the logistic regression model on
Table 9 (specifically, SEC, FRAUD, SHORT INTEREST, CONCURRENT RETURN (-1, +1),
and RULE CHANGE). One additional variable, COUNT, is significantly positively
associated with litigation likelihood. Of those variables, the influence of FRAUD is striking.
Its odds ratio of 20.799 indicates that firms that cite fraud as a cause of the restatement are
over 20 times more likely to face litigation than other firms. The likelihood of litigation also
increases with an SEC inquiry, the level of short interest, and the count of accounting issues.
15
To the best of our knowledge, no published study provides this information for the GAO (2003) sample
of restatements. These restatements are particularly important because they influenced passage of the
Sarbanes-Oxley Action of 2002.
27
Litigation likelihood declines for restatements attributed to an accounting rule change and
with greater announcement-period returns. Results for the general control variables indicate
that litigation likelihood increases with share turnover in the prior year and market
capitalization, but declines with greater returns in the prior year.
Dismissed Lawsuits
During the discovery phase of litigation, extensive information about the nature of the
accounting irregularity is revealed. Dismissal rates therefore provide another indicator of
restatement severity. If greater prominence indicates a more severe accounting irregularity,
we would expect fewer dismissals for restatements disclosed with high prominence. To
determine which lawsuits are dismissed, we used the Stanford Securities Class Action
Clearinghouse website at the end of 2006 to review the status of each of the court cases.
Table 10, Panel A reports that almost a quarter of the class action suits are dismissed, but the
rate of dismissal is almost identical for high (24%) and medium prominence (23%)
disclosures. These dismissal rates suggest that some severe accounting irregularities have
been disclosed with medium prominence or some less severe misstatements have been
disclosed with high prominence. (Note that the negative post-announcement drift in returns
for medium prominence disclosure, reported in Table 3, supports the former explanation.)
To provide direct evidence about the effect of dismissals on the likelihood of
litigation, we reran the logistic regression model with a reduced sample that omits dismissed
lawsuits. The results are reported on Table 10, Panel B. We find that PROMINENCE
INDEX remains significant (although the significance level drops from 0.009 to 0.036 and
the odds ratio declines from 2.292 to 2.071). The results for the misstatement severity
28
variables are similar to those reported on Table 9, except that COUNT is no longer
significant. Among the general control variables, MKTCAP loses its significance while the
FINANCIAL industry indicator variable is now significant.
Based on the litigation analyses presented above, we reject hypothesis 2, which states
that the extent of prominence given to an accounting restatement in the press release does not
affect the likelihood of class action litigation. Instead, we conclude that companies that
provide less prominent press release disclosure are rewarded with a lower likelihood of
litigation. We find this result is robust to the treatment of dismissed lawsuits, so in contrast
to the return differences, the reward is permanent.
Robustness Tests
Because the average prominence score for revenue restatements is low compared to
the sample average (see Table 2, Panel C), we rerun the litigation model to determine if the
litigation results are robust to the exclusion of those firms. We find results very similar to
those reported (untabulated).
Some prior studies of accounting restatements use information on the initiating entity
(i.e., the restating firm, the auditor, or the SEC) as a measure of severity (Palmrose et al.
2004; Efendi et al. 2007). To our knowledge, prior literature has not yet examined the
relationship between restatement initiator and the likelihood of litigation. We find that the
coefficient on this variable is negative and significant when we include it in the litigation
regression. Coefficient signs and significance levels are unchanged for the other variables.
Thus our results indicate that restatements initiated by an external party are less likely to
result in litigation than those initiated by the firm.
29
VII. CONCLUSION
We investigate the effect on market prices and litigation of the extent of prominence
given to a restatement in the press release making the announcement. We find that firms
providing less prominent press release disclosure of a restatement are rewarded with a less
negative return at the announcement, but much of this reward dissipates over the next 20
days. We also find that companies providing less prominent disclosure are less likely to be
sued for securities fraud, and the decrease in litigation is a permanent reward. In sum, both
return and litigation tests indicate that silence can be golden.
We contribute to the disclosure literature by extending the notion of a penalty
(reward) for openness (silence) in corporate disclosure into a new arena: press release
prominence. Prior research focuses on managers decision whether to issue a press release
warning of an earnings shortfall. Press release format constitutes a promising avenue for
future research because press releases are the primary disclosure medium used to convey
information to the market on a timely basis -- especially since Reg. FD now restricts selective
communications. The findings in this study are important to investor relations executives
and other corporate managers with responsibility for press release disclosure. Regulators,
especially the SEC, may want to issue guidelines to standardize press release disclosures so
firms will not be rewarded for providing less prominent disclosure of an accounting
restatement.
30
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33
TABLE 1
Sample Selection
Number of
Observations
Restatement firms in General Accounting Office studya 919
Less: firms without short selling informationb (452)
Less: firms without press release information available (61)
Less: firms without CRSP data (17)
Less: possible outliersc (8)
Final Sample 381
a
The General Accounting Office (GAO 2002) prepared a report for the U.S. Senate
Committee on Banking, Housing and Urban Affairs, chaired by Senator Sarbanes.
This report identifies 919 firm restatements from January 1, 1997 to June 30, 2002 that
correct accounting irregularities. (See text for further description.)
b
Short selling information is taken from a proprietary database which contains short
interest for firms listed on the NYSE, AMEX, and Nasdaq. Most of the companies
deleted are small and trade in the over-the-counter (OTC) market.
c
Observations whose abnormal returns around the restatement date fall in the top or
bottom 1% of the distribution are deleted as possible outliers.
34
TABLE 2
Sample Description
Panel A: Distribution of Restatement Firms by Industry

Sample Sample Compustat
SIC Industry Description Firms Percentage Percentagea
10 Metal Mining 1 0.26 1.32%
13 Oil and gas extraction 5 1.31 3.76%
15 General building contractors 2 0.52 0.54%
16 Heavy construction other than building 3 0.79 0.23%
construction contractors
20 Food and kindred products 10 2.62 1.74%
23 Apparel and other textile products 4 1.05 0.74%
24 Lumber and wood products 2 0.52 0.39%
25 Furniture and fixtures 2 0.52 0.42%
26 Paper and allied products 4 1.05 0.74%
27 Printing, publishing and allied industries 4 1.05 1.09%
28 Chemicals and allied products 22 5.77 5.69%
29 Petroleum refining and related industries 2 0.52 0.47%
30 Rubber and misc. plastics products 4 1.05 0.98%
32 Stone, clay, glass and concrete products 2 0.52 0.56%
33 Primary metal industries 2 0.52 1.02%
34 Fabricated metal products; except machinery 3 0.79 1.18%
and transport equip.
35 Industrial and commercial machinery and 33 8.66 4.89%
computer equipment
36 Electronic and other electrical components; 33 8.66 5.58%
except computer equip.
37 Transportation equipment 6 1.57 1.54%
38 Measuring, analyzing and controlling 26 6.82 4.77%
instruments
39 Misc. manufacturing industries 2 0.52 0.99%
42 Motor freight transportation and warehousing 2 0.52 0.58%
44 Water transportation 1 0.26 0.40%
47 Transportation services 1 0.26 0.34%
48 Communications 6 1.57 3.98%
49 Electric, gas and sanitary services 12 3.15 2.99%
50 Wholesale trade-durable goods 8 2.10 2.22%
51 Wholesale trade-non-durable goods 4 1.05 1.37%
52 Building materials, garden supply and mobile 1 0.26 0.20%
53 General merchandise stores 5 1.31 0.48%
54 Food stores 3 0.79 0.60%
55 Automotive dealers and service stations 1 0.26 0.29%
56 Apparel and accessory stores 10 2.62 0.54%
57 Home furniture, furnishings and equipment 7 1.84 0.47%
stores
58 Eating and drinking places 2 0.52 1.35%
59 Misc. retail 5 1.31 1.71%
60 Depository institutions 29 7.61 8.53%
35
61 Non depository credit institutions 1 0.26 1.45%
62 Security, commodity brokers and services 3 0.79 1.03%
63 Insurance carriers 11 2.89 2.12%
65 Real estate 2 0.52 1.19%
67 Holding and other investment offices 10 2.62 6.97%
73 Business services 59 15.49 11.01%
78 Motion pictures 1 0.26 0.93%
79 Amusement and recreation services 3 0.79 1.06%
80 Health services 6 1.57 1.67%
82 Educational services 4 1.05 0.29%
87 Engineering and management services 4 1.05 1.80%
99 Unclassified establishments 8 2.10 1.35%
381 100% 100%
Panel B: Distribution of Announcement Dates

Time Period Number of Firms Percentage of Sample
Calendar 1997 24 6.3%

Calendar 1998 20 5.3%
Calendar 1999 75 19.7%
Calendar 2000 87 22.8%
Calendar 2001 117 30.7%
To June 30, 2002 58 15.2%
Panel C: Cross Tabulation of Accounting Issue by Press Release Prominence

High Medium Low Average
Prominence Prominence Prominence Prominence
Coded as (3) (2) (1) Frequencyb Scorec
Revenue 52 81 25 158 2.17
Cost or expense 28 42 3 73 2.34
Restructuring, assets or
inventory 26 24 3 53 2.43
Other 17 13 2 32 2.47
Acquisitions and
mergers 14 13 1 28 2.46
Securities related 12 12 0 24 2.50
IPR&D 4 15 2 21 2.10
Reclassification 8 10 1 19 2.37
Related-party
transactions 6 7 0 13 2.46
Unspecified 6 3 0 9 2.67
Loan-loss 6 1 0 7 2.86
Tax related 2 3 0 5 2.40
Total Obs. 181 224 37 442 2.33
a
Based on Compustat companies in 2000.
b
Each restatement can be caused by one or more accounting issues. Therefore, the total number of accounting issues
(442) is greater than the number of firms in our sample (381).
c
Disclosure emphasis is coded as 3 (high prominence) for any press release that mentions the earnings restatement
in the headline. Disclosure quality is coded 2 (medium prominence) for press releases that do not mention the
36
restatement in the headline, but that discuss the restatement in some detail within the body of the report. A code of 1
(low prominence) is assigned to press releases that only mention the restatement in the footnotes of the report.
Average Prominence Score = [(# High Prominence)*(3) + (# Medium Prominence)*(2) +
(# Low Prominence)*(1)] / # Total
37
TABLE 3
Mean Abnormal Returns Around the Restatement Announcement for the Full
Sample and by Restatement Disclosure Prominencea
High Medium Low

Event Full Prominence Prominence Prominence Differenceb Difference Difference
Window Sample (3) (2) (1) (2-3) (1-2) (1-3)
(-1, +1) -5.5%*** -8.3%*** -4.0%*** -1.5% 4.3%*** 2.4% 6.8%***
(+2, +20) -1.1% 0.6% -2.3%* -1.6% -2.9% 0.7% -2.2%
Entire Event
Window:
(-1, +20) -6.7%*** -7.9%*** -6.4%*** -3.2%* 1.5% 3.2% 4.7%**
Number of
Obs. 381 157 189 35
*** Significantly greater than zero at the p = 0.01 level or better (two-tailed).
** Significantly greater than zero at the p = 0.05 level or better (two-tailed).
* Significantly greater than zero at the p = 0.10 level or better (two-tailed).
a
CAR = cumulative abnormal return, calculated as the raw stock return minus the CRSP equally-weighted market portfolio
return measured over the windows specified above, with day 0 indicating the restatement announcement. Firms in the High
Prominence, Medium Prominence, and Low Prominence categories are coded as 3, 2, and 1, respectively.
b
t-test of the differences between the two groups noted (for example, High Prominence vs. Medium Prominence), where
*, **, or *** indicates that the two groups had significantly different abnormal returns during the event window at the 0.10,
0.05, 0.01 alpha level, respectively.
38
TABLE 4
Pearson Correlation Table
Prominence Restatement Rule Short Share

Variable CAR Litigation Index Amt SEC Fraud Revenue change Count Interest Turnover
LITIGATION -0.34
PROMINENCE INDEX -0.19 0.19
RESTATEMENT AMT -0.05 0.02 0.32
SEC 0.05 0.12 0.09 0.07
FRAUD 0.00 0.12 0.05 0.00 -0.04
REVENUE -0.16 0.08 -0.20 -0.14 -0.10 -0.05
RULE CHANGE 0.17 -0.20 -0.36 -0.27 -0.14 -0.06 0.31
COUNT -0.05 0.09 0.02 0.10 0.00 0.07 0.07 -0.14
SHORT INTEREST -0.05 0.24 -0.06 -0.10 0.06 -0.05 0.13 -0.00 -0.03
SHARE TURNOVER -0.18 0.30 -0.05 -0.11 0.06 -0.11 0.23 0.00 -0.05 0.44
MKTCAP -0.04 0.12 -0.17 -0.08 0.10 -0.00 0.09 0.04 -0.06 0.19 0.28
39
Bold values are significant at the 0.05 level.
Variable Definitions: CAR = cumulative abnormal return, calculated as the raw stock return minus the CRSP equally-weighted market portfolio return measured over the
three-day window (-1,+1) with day 0 indicating the restatement announcement ; LITIGATION = 1 if a class action lawsuit was filed against the firm as a response to the
restatement of their financial statements and 0 otherwise; PROMINENCE INDEX takes on the value of either 1, 2, or 3. Disclosure emphasis is coded as 3 (high
prominence) for any press release that mentions the earnings restatement in the headline. Disclosure quality is coded 2 (medium prominence) for press releases that do not
mention the restatement in the headline, but that discuss the restatement in some detail within the body of the report. A code of 1 (low prominence) is assigned to press
releases that only mention the restatement in the footnotes of the report. RESTATEMENT AMT = 1 if the press release includes information on the amount of the
restatement and 0 otherwise; SEC = 1 if the press release indicates an SEC inquiry and 0 otherwise; FRAUD = 1 if the press release mentions an allegation of fraud and 0
otherwise; REVENUE = 1 if any part of the restatement is due to revenue recognition problems and 0 otherwise; RULE CHANGE = 1 if a change in accounting rules was
mentioned in the press release as the reason for the restatement and 0 otherwise; COUNT = the number of different accounting issues, as reported in the GAO database;
SHORT INTEREST = the percent of short interest [100 * (number of shares sold short)/(total shares outstanding)] as of the month prior to the restatement announcement;
SHARE TURNOVER = [1-(1-volume tradedt/total sharest)], accumulated over the 1-year period ending on the second day prior to the restatement announcement date;
MKTCAP = market capitalization (closing stock price * common shares outstanding) measured as of the end of the fiscal year prior to t.
40
TABLE 5
Multivariate Analysis of Abnormal Returns around Restatement Announcement
Panel A: Model with Short CAR Window (-1,+1)
CAR = + 1PROMINENCE INDEX+ 2RESTATEMENT AMT + 3SEC + 4FRAUD + 5REVENUE +

6RULE CHANGE + 7COUNT + 8SHORT INTEREST + 9MKTCAP + 10TECH + 11FINANCIAL +
OLS Regression Coefficients (p-value in parentheses)

a
Variable Predictions (1) (2) (3)
Intercept ? -0.043 -0.037 0.065
(0.147) (0.237) (0.122)
Press Release
PROMINENCE INDEX ? -0.040
(<0.001)
RESTATEMENT AMT (+) -0.009 0.004
(0.260) (0.390)
Misstatement Severity
SEC (+) 0.026 0.027 0.030
(0.112) (0.106) (0.075)
FRAUD (-) -0.002 -0.003 0.002
(0.487) (0.481) (0.485)
REVENUE (-) -0.056 -0.056 -0.059
(<0.001) (<0.001) (<0.001)
RULE CHANGE (+) 0.072 0.069 0.053
(<0.001) (<0.001) (0.001)
COUNT (-) -0.002 -0.002 -0.004
(0.440) (0.454) (0.406)
SHORT INTEREST (-) -0.001 -0.001 -0.001
(0.311) (0.583) (0.274)
Controls
MKTCAP ? -0.001 -0.002 -0.003
(0.678) (0.653) (0.331)
TECH (-) -0.004 -0.005 -0.005
(0.397) (0.385) (0.382)
FINANCIAL (+) 0.026 0.026 0.032
(0.084) (0.085) (0.044)
n 358 b 358b 358 b

Adjusted R2 6.58% 6.43% 9.45%
41
Panel B: Model Comparing Short (-1, +1) and Long (-1, +20) Window Returns
CAR = + 1PROMINENCE INDEX+ 2RESTATEMENT AMT + 3SEC + 4FRAUD + 5REVENUE +

6RULE CHANGE + 7COUNT + 8SHORT INTEREST + 9MKTCAP + 10TECH + 11FINANCIAL +

a
Variable Predictions CAR = (-1,+1) CAR = (-1,+20)
Intercept ? 0.065 0.009
(0.122) (0.897)
Press Release
PROMINENCE INDEX ? -0.040 -0.031
(0.000) (0.112)
RESTATEMENT AMT (+) 0.004 0.038
(0.390) (0.057)
SEC (+) 0.030 -0.010
(0.075) (0.389)
FRAUD (-) 0.002 0.055
(0.485) (0.280)
REVENUE (-) -0.059 -0.040
(<0.001) (0.047)
RULE CHANGE (+) 0.053 0.052
(0.001) (0.039)
COUNT (-) -0.004 -0.011
(0.406) (0.349)
SHORT INTEREST (-) -0.001 -0.001
(0.274) (0.346)
Controls
MKTCAP ? -0.003 -0.002
(0.331) (0.737)
TECH (-) -0.005 -0.012
(0.382) (0.327)
FINANCIAL (+) 0.032 0.052
(0.044) (0.056)
n 358 b 353c
Adjusted R2 9.45% 1.15%
42
The p-values are in parentheses under the regression coefficients. Two-tailed tests are shown for variables without a
signed prediction; one-tailed tests are shown for variables with a signed prediction.
a
Variable Definitions: CAR = cumulative abnormal return, calculated as the raw stock return minus the CRSP
equally-weighted market portfolio return measured over various windows [either (-1,+1), (+2, +20), or (-1, +20)] with
day 0 indicating the restatement announcement; PROMINENCE INDEX takes on the value of either 1, 2, or 3.
Disclosure emphasis is coded as 3 (high prominence) for any press release that mentions the earnings restatement in
the headline. Disclosure quality is coded 2 (medium prominence) for press releases that do not mention the
restatement in the headline, but that discuss the restatement in some detail within the body of the report. A code of 1
(low prominence) is assigned to press releases that only mention the restatement in the footnotes of the report;
RESTATEMENT AMT = 1 if the press release includes information on the amount of the restatement and 0 otherwise;
SEC = 1 if the press release indicates an SEC inquiry and 0 otherwise; FRAUD = 1 if the press release mentions an
allegation of fraud and 0 otherwise; REVENUE = 1 if any part of the restatement is due to revenue recognition
problems and 0 otherwise; RULE CHANGE = 1 if a change in accounting rules was mentioned in the press release as
the reason for the restatement and 0 otherwise; COUNT = the number of different accounting issues, as reported in the
GAO database; SHORT INTEREST = the percent of short interest [100*(number of shares sold short)/(total shares
outstanding)] as of the month prior to the restatement announcement; MKTCAP = natural log of market capitalization
(closing stock price * common shares outstanding) of the firm measured as of the end of the fiscal year prior to t;
TECH = 1 if the firm is classified as a technology firm and 0 otherwise; FINANCIAL= 1 if the firm operates in the
financial services sector (SIC codes 6000-6999) and 0 otherwise.
b
23 firms were excluded from the regression due to missing market capitalization information.
c
5 additional firms are excluded from the (-1,+20) regression due to missing abnormal return data. Both regressions
were also run using a common sample of 353 firms for which all data are available. The results are qualitatively
unchanged from those reported in the table.
43
TABLE 6
Extension of Main Analysis to Replace Prominence Index with Indicator Variables
Panel A: Multivariate Model

CAR = + 1HIGH_NOAMT + 2MEDIUM_AMT + 3MEDIUM_NOAMT + 4LOW_AMT +
5LOW_NOAMT + 6-14 [CONTROLS] +
OLS Regression Coefficients
(p-value in parentheses)
a
Variable Predictions CAR = (-1,+1) CAR = (-1,+20)
Intercept ? -0.046 -0.037
(0.124) (0.474)
Disclosure Variable Interactions Compared to
Baseline Group of High Prominence with Amount
High Prominence without Restatement Amount ? -0.043 -0.088
(0.064) (0.026)
Medium Prominence with Amount Reported ? 0.020 -0.001
(0.237) (0.981)
Medium Prominence without Restatement
? 0.041 -0.007
Amount
(0.025) (0.823)
Low Prominence with Amount Reported ? 0.066 0.055
(0.194) (0.533)
Low Prominence without Restatement Amount ? 0.067 0.019
(0.017) (0.690)
Misstatement Severity and Controls
Omitted for spaceSign and significance for all
variables are the same as in Table 5.
n 358 b 353c
Adj. R2 9.88% 1.06%
Panel B: Short-window CAR Multivariate Coefficient Sums

High Prominence Medium Prominence Low Prominence
Obs. CAR (-1,+1) Obs. CAR (-1,+1) Obs. CAR (-1,+1)
Restatement YES 109 -4.6% 92 -2.6% 6 2.0%
Amt
Disclosed? NO 37 -8.9%** 86 -0.5% 28 2.1%
Panel C: Long-window CAR Multivariate Coefficient Sums

High Prominence Medium Prominence Low Prominence
Obs. CAR (-1,+20) Obs. CAR (-1,+20) Obs. CAR (-1,+20)
Restatement YES 107 -3.7% 92 -3.8% 6 1.8%
Amt
Disclosed? NO 37 -12.5%** 83 -4.4% 28 -1.8%
44
The p-values are in parentheses under the regression coefficients. Two-tailed tests are shown for variables without
a signed prediction; one-tailed tests are shown for variables with a signed prediction.
*** Significantly greater than zero at the p = 0.01 level or better (two-tailed).
** Significantly greater than zero at the p = 0.05 level or better (two-tailed).
* Significantly greater than zero at the p = 0.10 level or better (two-tailed).
a
equally-weighted market portfolio return measured over various windows [either (-1,+1) or (-1, +20)] with day 0
indicating the restatement announcement; Disclosure emphasis is coded as 3 (high prominence) for any press
release that mentions the earnings restatement in the headline. Disclosure quality is coded 2 (medium prominence)
for press releases that do not mention the restatement in the headline, but that discuss the restatement in some detail
within the body of the report. A code of 1 (low prominence) is assigned to press releases that only mention the
restatement in the footnotes of the report; RESTATEMENT AMT = 1 if the press release includes information on the
amount of the restatement and 0 otherwise; HIGH_NOAMT, MEDIUM_AMT, MEDIUM_NOAMT, LOW_AMT, and
LOW_NOAMT are a series of dummy variables set equal to 1if both statements are true. For example,
HIGH_NOAMT equals one if the restatement had high prominence within the press release and the press release did
not include information on the amount of the restatement.
b
23 firms were excluded from the regression due to missing market capitalization information.
c
5 additional firms were excluded from the regression due to missing abnormal return data
45
TABLE 7
Abnormal Returns around Restatement Announcement with Controls for Earnings Surprise
CAR = + 1PROMINENCE INDEX+ 2RESTATEMENT AMT + 3SEC + 4REVENUE + 5RULE
CHANGE + 6COUNT + 7SHORT INTEREST + 8MKTCAP + 9TECH + 10FINANCIAL +
11SURPRISE + 12BEAT +

Variablea Predictions CAR = (-1,+1) CAR = (-1, +20)
Intercept ? 0.020 0.083
(0.822) (0.560)
Disclosure Variables
PROMINENCE INDEX ? -0.055 -0.023
(0.007) (0.468)
RESTATEMENT AMT (+) 0.005 0.019
(0.424) (0.323)
SEC (+) 0.054 0.007
(0.082) (0.227)
REVENUE (-) -0.070 -0.035
(0.002) (0.178)
RULE CHANGE (+) 0.046 0.014
(0.039) (0.368)
COUNT (-) 0.016 -0.039
(0.335) (0.260)
SHORT INTEREST (-) -0.001 -0.002
(0.389) (0.328)
Controls
MKTCAP ? 0.001 -0.011
(0.457) (0.321)
TECH (-) -0.007 -0.080
(0.385) (0.022)
FINANCIAL (+) 0.100 0.060
(0.011) (0.193)
SURPRISE ? 4.184 3.714
(0.037) (0.244)
BEAT ? 0.060 0.077
(0.032) (0.089)
n 113b 111c
Adjusted R2 26.65% 5.21%
46
The p-values are in parentheses under the regression coefficients. Two-tailed tests are shown for variables
without a signed prediction; one-tailed tests are shown for variables with a signed prediction.
a
equally-weighted market portfolio return measured over various windows [either (-1,+1) or (-1, +20)] with day
0 indicating the restatement announcement; PROMINENCE INDEX takes on the value of either 1, 2, or 3.
Disclosure emphasis is coded as 3 (high prominence) for any press release that mentions the earnings
restatement in the title. Disclosure quality is coded 2 (medium prominence) for press releases that do not
mention the restatement in the title, but that discuss the restatement in some detail within the body of the
report. A code of 1 (low prominence) is assigned to press releases that only mention the restatement in the
footnotes of the report; RESTATEMENT AMT = 1 if the press release includes information on the amount of
the restatement and 0 otherwise; SEC = 1 if the press release indicates an SEC inquiry and 0 otherwise;
REVENUE = 1 if any part of the restatement is due to revenue recognition problems and 0 otherwise; RULE
CHANGE = 1 if a change in accounting rules was mentioned in the press release as the reason for the
restatement and 0 otherwise; COUNT = the number of different accounting issues, as reported in the GAO
database; SHORT INTEREST = the percent of short interest [100*(number of shares sold short)/(total shares
outstanding)] as of the month prior to the restatement announcement; MKTCAP = natural log of market
capitalization (closing stock price * common shares outstanding) of the firm measured as of the end of the
fiscal year prior to t; TECH = 1 if the firm is classified as a technology firm and 0 otherwise; FINANCIAL= 1
if the firm operates in the financial services sector (SIC codes 6000-6999) and 0 otherwise; SURPRISE =
difference between actual quarterly earnings per share and the most recent consensus analyst earnings forecast
prior to the earnings announcement, both reported by I/B/E/S, scaled by stock price measured just prior to the
date of the forecast; BEAT = 1 if the firm beat analyst expectations (i.e. Surprise >0) and 0 otherwise.
b
This sample includes only those firms who announced earnings and a restatement during the same three-day
window. Additional observations were deleted due to missing analyst or stock price information and likely
outliers were deleted on the basis of news magnitude. 7 firms were excluded from the regression due to
missing market capitalization information.
c
2 additional firms are excluded from the (-1,+20) regression due to missing abnormal return data.
47
TABLE 8
Distribution of Class Action Lawsuits by Disclosure Prominence
High Medium Low

Prominence Prominence Prominence Total
Class Action Lawsuit Filed 42 31 0 73
No Class Action Lawsuit Filed 115 158 35 308

Total 157 189 35 381
Percentage of Observations
with Litigation 27% 16% 0% 19%
Chi-square (difference in lawsuit

initiation among prominence 15.065
levels) (p = 0.001)
Litigation information is from the Securities Class Action Clearinghouse website.
48
TABLE 9
Likelihood of Class Action Lawsuits following an Accounting Irregularity
LITIGATION = + 1PROMINENCE INDEX + 2RESTATEMENT AMT + 3SEC + 4FRAUD +

5REVENUE + 6RULE CHANGE + 7COUNT+ 8SHORT INTEREST + 9CONCURRENT RETURN
+ 10PRIOR STOCK RETURN + 11POST STOCK RETURN + 12SHARE TURNOVER +
13MKTCAP + 14TECH + 15FINANCIAL+
Logit Regression with Dependent Variable = LITIGATION
Coefficient Chi-square
Variablea Predictions Estimates p-value* Odds Ratio
Intercept ? -8.427 <0.001
Press Release
PROMINENCE INDEX ? 0.830 0.009 2.292
RESTATEMENT AMT ? 0.048 0.898 1.049
SEC (+) 0.978 0.017 2.660
FRAUD (+) 3.035 0.003 20.799
REVENUE (+) 0.196 0.303 1.217
RULE CHANGE (-) -1.19 0.026 0.304
COUNT (+) 0.556 0.075 1.744
SHORT INTERST (+) 0.062 0.041 1.064
CONCURRENT RETURN (-1,+1) (-) -4.890 <0.001 0.008
General Controls
PRIOR STOCK RETURN (-252,-2) ? -0.487 0.023 0.615
POST STOCK RETURN (+2,+20) (-) 0.257 0. 378 1.293
SHARE TURNOVER (+) 3.402 <0.001 30.022
MKTCAP ? 0.161 0.082 1.175
TECH (+) 0.097 0.404 1.102
FINANCIAL ? 0.649 0.267 1.914
n 347 b
- 2 log likelihood 229.93
Model Chi-square 110.60
p-value <0.001
Pseudo R-square 28%
Correctly Classified
87.4%
[baseline of no litigation is 81%]
49
* Two-tailed tests are shown for variables without a signed prediction; one-tailed tests are shown for variables
with a signed prediction.
a
Variable Definitions: LITIGATION = 1 if a class action lawsuit was filed against the firm as a response to the
restatement of their financial statements and 0 otherwise; PROMINENCE INDEX takes on the value of either 1,
2, or 3. Disclosure emphasis is coded as 3 (high prominence) for any press release that mentions the earnings
restatement in the headline. Disclosure quality is coded 2 (medium prominence) for press releases that do not
mention the restatement in the headline, but that discuss the restatement in some detail within the body of the
report. A code of 1 (low prominence) is assigned to press releases that only mention the restatement in the
footnotes of the report; RESTATEMENT AMT = 1 if the press release includes information on the amount of the
restatement and 0 otherwise; SEC = 1 if the press release indicates an SEC inquiry and 0 otherwise; FRAUD =
1 if the press release mentions an allegation of fraud and 0 otherwise; REVENUE = 1 if any part of the
restatement is due to revenue recognition problems and 0 otherwise; RULE CHANGE = 1 if a change in
accounting rules was mentioned in the press release as the reason for the restatement and 0 otherwise; COUNT
is the number of different accounting issues, as reported in the GAO database; SHORT INTEREST is the percent
of short interest [100*(number of shares sold short)/(total shares outstanding)] as of the month prior to the
restatement announcement; CONCURRENT RETURN is the compounded raw return over the (+1, -1) interval
with 0 being the date of the restatement announcement; PRIOR STOCK RETURN is the compounded raw returns
over one year, ending on the second day before the restatement announcement (-252, -2); POST STOCK
RETURN is the compounded raw return over the (+2, +20) interval with day 0 being the date of the restatement
announcement; SHARE TURNOVER = [1-(1-volume tradedt/total sharest)], accumulated over the 1-year period
ending on the second day prior to the restatement announcement date; MKTCAP = natural log of market
capitalization (closing stock price * common shares outstanding) of the firm measured as of the end of the fiscal
year prior to t; TECH = 1 if the firm is classified as a technology firm and 0 otherwise; FINANCIAL = 1 if the
firm operates in the financial services sector (SIC codes 6000-6999) and 0 otherwise.
b
23 firms were excluded from the regression due to missing market capitalization information and 11
observations were excluded due to missing PRIOR STOCK RETURN and POST STOCK RETURN data.
50
TABLE 10
Likelihood of Surviving (non-Dismissed) Class Action Lawsuits following an Accounting
Irregularity
Panel A: Distribution of Dismissed Lawsuitsa
High Medium Low

Prominence Prominence Prominence Total
Dismissed Lawsuits 10 7 0 17
Surviving Lawsuits 32 24 0 56
Total 42 31 0 73
Dismissal Rate 24% 23% 0% 23%
Chi-square (difference in dismissal 0.032

rates among prominence levels) (p = 0.858)
51
Panel B: Multivariate Tests Excluding Dismissed Lawsuits
Logit Regression with Dependent Variable = LITIGATION

Coefficient Chi-square
Variableb Predictions Estimates p-value* Odds Ratio
Intercept -8.475 <0.001
Press Release
PROMINENCE INDEX ? 0.728 0.036 2.071
RESTATEMENT AMT ? -0.061 0.880 0.941
SEC (+) 0.893 0.040 2.441
FRAUD (+) 2.700 0.015 14.886
REVENUE (+) 0.271 0.260 1.311
RULE CHANGE (-) -1.359 0.025 0.257
COUNT (+) 0.378 0.198 1.459
SHORT INTEREST (+) 0.066 0.042 1.069
CONCURRENT RETURN (-1,+1) (-) -4.713 <0.001 0.009
Controls
PRIOR STOCK RETURN (-252 -2) ? -0.612 0.012 0.542
POST STOCK RETURN (+2,+20) (-) 0.564 0.281 1.757
SHARE TURNOVER (+) 3.659 <0.001 38.805
MKTCAP ? 0.153 0.138 1.166
TECH (+) 0.331 0.227 1.393
FINANCIAL ? 1.164 0.061 3.202
n 332 c
- 2 log likelihood 288.20
Model Chi-square 95.91
p-value <0.001
Pseudo R-square 25%
Correctly Classified
88.3%
[baseline (no litigation) is 81%]
52
* Two-tailed tests are shown for variables without a signed prediction; one-tailed tests are shown for variables
with a signed prediction.
a
Dismissed lawsuits are identified by reading about the court cases for each of our litigation firms (available
on the Stanford Securities Class Action Clearinghouse website).
b
Variable Definitions: LITIGATION = 1 if a class action lawsuit was filed against the firm as a response to the
restatement of their financial statements and 0 otherwise; PROMINENCE INDEX takes on the value of either
1, 2, or 3. Disclosure emphasis is coded as 3 (high prominence) for any press release that mentions the
earnings restatement in the headline. Disclosure quality is coded 2 (medium prominence) for press releases
that do not mention the restatement in the headline, but that discuss the restatement in some detail within the
body of the report. A code of 1 (low prominence) is assigned to press releases that only mention the
restatement in the footnotes of the report; RESTATEMENT AMT = 1 if the press release includes information
on the amount of the restatement and 0 otherwise; SEC = 1 if the press release indicates an SEC inquiry and 0
otherwise; FRAUD = 1 if the press release mentions an allegation of fraud and 0 otherwise; REVENUE = 1 if
any part of the restatement is due to revenue recognition problems and 0 otherwise; RULE CHANGE = 1 if a
change in accounting rules was mentioned in the press release as the reason for the restatement and 0
otherwise; COUNT = the number of different accounting issues, as reported in the GAO database; SHORT
INTEREST = the percent of short interest [100*(number of shares sold short)/(total shares outstanding)] as of
the month prior to the restatement announcement; CONCURRENT RETURN is the compounded raw return
over the (+1, -1) interval with 0 being the date of the restatement announcement; PRIOR STOCK RETURN is
the compounded raw returns over one year, ending on the second day before the restatement announcement (-
252, -2); POST STOCK RETURN is the compounded raw return over the (+2, +20) interval with day 0 being
the date of the restatement announcement; SHARE TURNOVER = [1-(1-volume tradedt/total sharest)],
accumulated over the 1-year period ending on the second day prior to the restatement announcement date;
MKTCAP = natural log of market capitalization (closing stock price * common shares outstanding) of the firm
measured as of the end of the fiscal year prior to t; TECH = 1 if the firm is classified as a technology firm and
0 otherwise; FINANCIAL = 1 if the firm operates in the financial services sector (SIC codes 6000-6999) and 0
otherwise.
c
A total of 49 firms were excluded from this regression: 17 dismissed lawsuit firms and an additional 34 with
missing MKTCAP, PRIOR STOCK RETURN, or POST STOCK RETURN data.
53

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Stealth Disclosure of Accounting Irregularities: Is Silence Golden?

Current Draft: August 21, 2007

Keywords: accounting restatements, press release disclosure, voluntary disclosure

companies well-intentioned attempts to follow complex and changing accounting rules.1

(Financial Times, May 17, 2007).

minimal disclosure when announcing an accounting irregularity. We discovered this while

Sarbanes. We observed three levels of disclosure: Some companies disclose their

prior-period comparative balances in an earnings release, with no disclosure of the

We use these differences in disclosure prominence to investigate the broader question

penalized in the long-run for providing voluntary management forecasts.

disclosures of accounting irregularities rather than earnings shortfalls. Accounting

attention theory (Hirschleifer and Teoh 2003).

We evaluate the scenarios by first examining whether the return differences

announcement date; however, much of the reward is short-term.

severe accounting irregularity or a less transparent press release, we estimate a logistic

severity, determinants of lawsuits identified in prior research, and announcement-date

the effect is permanent.

commission formed by Secretary Paulson, in their effort to understand how restatements

impact investors and the capital markets (see introductory paragraph).

litigation results. We conclude in section VII.

reiterate it with the basic facts.

Bowen et al. (2005), we define a three-level index of disclosure prominence. We code as 3

footnotes to comparative period results.5

characteristics on returns in a three-day window centered on the restatement announcement.

the following null hypothesis:

H0 1: The extent of prominence given to an accounting restatement in the press

the following null hypothesis:

H0 2: The extent of prominence given to an accounting restatement in the press

this possibility by including announcement-period returns in testing H0 2.

III. SAMPLE SELECTION AND DATA DESCRIPTION

list of restating companies is important because it influenced passage of the Sarbanes-Oxley

the database (GAO 2002, 16).

interest to control for information available to a sophisticated investor about accounting

increases before a restatement announcement. Of direct importance to our use of short

returns distribution. The final sample consists of 381 restatement firms.

<Insert Table 1 Here>

We obtain information about litigation from the Securities Class Action

Clearinghouse (http://securities.stanford.edu/). This website covers more than 2500 issuers

peaking at 117 restatements in 2001.10 Table 2, Panel C provides a cross-tabulation of

tests to determine the effect of revenue restatements on our findings.)

<Insert Table 2 Here>

For H0 1, we use an OLS regression model to investigate whether disclosure

prominence is associated with the magnitude of returns around the restatement

announcement. For H0 2, we use a logistic regression to examine whether disclosure

Abnormal Returns Surrounding Restatement Announcements

CAR 1 PROMINENCE INDEX 2 RESTATEMEN T AMT 3 SEC

days after the announcement date (-1, +20).

INDEX, which takes on the value of 3, 2, or 1. As discussed in developing the hypotheses,

we code headline disclosure of the restatement as 3, discussion of the misstatement but

without a headline citing the restatement as 2, and footnote-only disclosure as 1. Press

know a restatement is forthcoming when it is of sufficient importance to involve the SEC,

investors react more negatively to revenue restatements than to other accounting

CHANGE coefficient to be positive because these restatements are caused by a change in

announcement), proxies for the information about accounting problems available to

for FINANCIAL firms.

Disclosure Prominence and the Likelihood of Class Action Lawsuits

We investigate the association between disclosure prominence and the likelihood of

shareholder litigation by estimating the following logistic regression model:

LITIGATION 1 PROMINENCE INDEX 2 RESTATEMEN T AMT

to their restatement and 0 otherwise.

expected to have a positive coefficient because a restatement subject to an SEC inquiry is

(Beaver and Malernee 1990).

the accounting irregularity.

V. RESULTS FOR MARKET RETURNS