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THE ACCOUNTING REVIEW American Accounting Association

Vol. 90, No. 1 DOI: 10.2308/accr-50869


2015
pp. 129

The Economic Consequences of Financial


Restatements: Evidence from the Market for
Corporate Control
Amir Amel-Zadeh
University of Cambridge
Yuan Zhang
The University of Texas at Dallas

ABSTRACT: Makalah ini menyelidiki apakah dan bagaimana penyajian kembali keuangan
mempengaruhi pasar untuk pengendalian perusahaan. Kami menunjukkan bahwa
perusahaan yang baru-baru ini mengajukan penyajian kembali keuangan secara signifikan
cenderung tidak menjadi target pengambilalihan daripada skor kecenderungan yang sesuai
dengan sampel perusahaan yang tidak berunding. Bagi perusahaan penyajian yang
menerima tawaran pengambilalihan, tawaran lebih cenderung ditarik atau memakan waktu
lebih lama untuk menyelesaikannya dibandingkan dengan yang dilakukan pada perusahaan
yang tidak menagih. Akhirnya, ada beberapa bukti bahwa nilai kelipatan nilai secara
signifikan lebih rendah untuk target penyajian dibandingkan target non-penyajian ulang.
Analisis kami menunjukkan bahwa risiko informasi yang terkait dengan perusahaan
penyajian kembali adalah pendorong utama dari hasil ini. Secara keseluruhan, penelitian ini
menemukan bahwa penyajian kembali keuangan memiliki konsekuensi mendalam untuk
alokasi sumber daya ekonomi di pasar untuk pengendalian perusahaan.

Keywords: financial restatements; market for corporate control; mergers and acquisi-tions;
information risk; corporate governance.
JEL Classifications: D82; G14; G34; M41.

Data Availability: Data are available from sources identified in the paper.

I. INTRODUCTION

Makalah ini menyelidiki apakah dan bagaimana penyajian kembali keuangan


mempengaruhi pasar untuk pengendalian perusahaan. Bukti sebelumnya
menunjukkan bahwa penyajian kembali keuangan dikaitkan dengan konsekuensi
ekonomi yang signifikan. Sebuah literatur besar meneliti efek pasar modal
We appreciate helpful comments from John Harry Evans III (senior editor), Bin Ke (editor), and two anonymous
reviewers. We also thank John Core, Wei Jiang, Sarah McVay, Geoff Meeks, Raghu Rau, seminar participants at Columbia
University, The Ohio State University, University of California, Irvine, University of Cambridge, University of Illinois at
UrbanaChampaign, The University of Texas at Dallas, and conference participants at the 2011 American Accounting
Association Annual Meeting for helpful comments and suggestions. All errors are our own.
Editors note: Accepted by Bin Ke.

Submitted: June 2012


Accepted: June 2014
Published Online: July 2014

1
2 Amel-Zadeh and Zhang

penyajian keuangan (Anderson dan Yohn 2002; Hribar dan Jenkins 2004; Palmrose, Richardson,
dan Scholz 2004), konsekuensinya terhadap pasar tenaga kerja (Srinivasan 2005; Desai, Hogan,
dan Wilkins 2006b; Kedia dan Philippon 2009), dan biaya hukum terkait (Palmrose dan Scholz
2004; Karpoff, Lee, dan Martin 2008). Namun, penelitian kecil telah memeriksa konsekuensinya
bagi pasar untuk pengendalian perusahaan.
Mengapa penyajian kembali keuangan bisa berpengaruh pada pasar pengambilalihan? Pasar
untuk kontrol perusahaan memberikan peran disipliner dalam manajemen perusahaan karena
memberikan insentif yang kuat bagi orang luar untuk campur tangan dengan tawaran
pengambilalihan untuk perusahaan yang tidak dikelola secara efisien untuk menghilangkan
kesalahan manajemen dan meningkatkan nilai pemegang saham (Manne 1965; Jensen dan
Ruback 1983). Secara teori, kinerja perusahaan yang kurang baik di pasar modal harus menjadi
sinyal salah urus, menawarkan peluang keuntungan bagi pengakuisisi potensial. Namun, studi
empiris telah menghasilkan hasil yang beragam pada hubungan antara harga pasar dan
pengambilalihan (Agrawal dan Jaffe 2003; Edmans, Goldstein, dan Jiang 2012). Apalagi, sejauh
kinerja keuangan inferior disamarkan melalui salah saji laba, inefisiensi cenderung tidak
terdeteksi oleh pasar.
Oleh karena itu, pengajuan klaim dapat dianggap sebagai sinyal yang terlihat dari kegagalan
tata kelola perusahaan dan pengendalian internal yang tidak efektif sehingga sulit bagi orang luar
untuk mendeteksi (Ashbaugh-Skaife, Collins, dan Kinney 2007). Selain itu, karena penyajian
kembali keuangan, secara rata-rata, terkait dengan return saham yang negatif secara signifikan,
baik di sekitar pengumuman maupun dalam jangka menengah sampai jangka panjang (Anderson
dan Yohn 2002; Palmrose et al., 2004), penawar potensial dapat menyimpulkan bahwa
perusahaan-perusahaan ini dapat diperoleh dengan harga yang relatif rendah. Dengan demikian,
acquirer akan memiliki insentif untuk mengendalikan perusahaan-perusahaan ini untuk
mengembalikannya ke potensi mereka. Dengan demikian, perusahaan yang bertumpu kembali
kemungkinan besar akan menjadi target pengambilalihan di pasar untuk pengendalian perusahaan
setelah penyajian kembali mereka.
Di sisi lain, penyajian kembali keuangan mungkin juga mengarah pada kemungkinan yang lebih
rendah untuk menerima tawaran pengambilalihan. Laporan keuangan memainkan peran penting dalam
pemantauan tindakan manajerial secara efektif dan alokasi sumber keuangan yang efisien (Healy dan
Palepu 2001). Meskipun penyajian kembali merupakan koreksi pasca salah pernyataan akuntansi
sebelumnya, pengumuman penyajian kembali keuangan meningkatkan asimetri informasi antara orang
dalam dan orang luar (Bhattacharya, Desai, dan Venkataraman 2010), memberi sinyal risiko informasi
tinggi (Kravet dan Shevlin 2010) dan oleh karena itu meningkatkan biaya seleksi buruk Asimetri
informasi semacam itu sangat merugikan keputusan investasi utama seperti pengambilalihan.
Pengusaha potensial harus bergantung pada informasi yang tersedia untuk umum pada tahap awal
proses pengambilalihan dalam menentukan apakah suatu tawaran harus dilakukan. Mereka juga hanya
mendapatkan informasi di dalam yang sangat terbatas begitu perjanjian kerahasiaan ditandatangani
dalam persiapan untuk negosiasi mengenai kesepakatan sebelum akuisisi dilakukan.11 Oleh karena itu,
risiko informasi yang melekat pada perusahaan yang ditinjau kembali diharapkan dapat mengurangi
insentif bagi calon pengakuisisi untuk dibuat. penawaran pengambilalihan
Secara keseluruhan, walaupun kurangnya manajemen dan kontrol yang efektif pada perusahaan
yang melakukan perulangan meminta intervensi dari luar melalui pengambilalihan, risiko informasi
dari perusahaan-perusahaan ini dapat mengurangi insentif semacam itu dari pengalokasi potensial.
Apakah biaya risiko informasi lebih besar daripada manfaat potensial dari pengambilalihan setelah
penyajian kembali keuangan adalah pertanyaan empiris yang kami selidiki dalam penelitian ini.
Kami berusaha memberikan bukti tentang konsekuensi penyajian kembali keuangan mengenai
kemungkinan, hasilnya, dan penilaian pengambilalihan. Lebih khusus lagi, pertanyaan penelitian
pertama kami menguji apakah perusahaan yang mengajukan penyajian ulang keuangan lebih atau
kurang cenderung menjadi target pengambilalihan dalam 12 bulan berikutnya daripada kelompok
kontrol yang sama dari perusahaan yang tidak menyajikan kembali pendapatan. Berdasarkan sampel
sebesar 1.963 kecenderungan skor pasangan pasang ulang perusahaan penyajian dan non-penyajian
selama
2001-2008, kami menemukan bahwa perusahaan yang bertumpu pada pengalaman memperoleh
kemungkinan yang jauh lebih rendah untuk menerima tawaran pengambilalihan daripada
perusahaan non-penyajian. Teknik pencocokan skor kecenderungan memastikan bahwa kelompok
kontrol kami sangat serupa dalam kemungkinan mereka menjadi firma perimbangan berdasarkan
karakteristik perusahaan yang diidentifikasi dalam literatur sebelumnya (Beneish 1999; Dechow,
Ge, Larson, dan Sloan 2011), kecuali bahwa perusahaan-perusahaan ini melakukan bukan file
restatements Dalam analisis regresi, kami menemukan bahwa perusahaan yang tidak berunding
rata-rata memiliki kemungkinan 5,7 persen untuk menerima tawaran pengambilalihan versus 3,2
persen untuk rekan mereka yang bertumpu pada keseimbangan, yang mencerminkan perbedaan
44 persen secara ekonomi dan statistik yang signifikan dalam kemungkinan pengambilalihan.
Kami juga menemukan bahwa penyajian kembali karena kesalahan dan penyimpangan
akuntansi memiliki dampak negatif yang serupa terhadap kemungkinan pengambilalihan, yang
menunjukkan bahwa pengaitan potensial secara luas berkaitan dengan ketidakpastian informasi,
terlepas dari apakah ketidakpastian ini disebabkan oleh salah saji yang disengaja oleh manajemen
atau penerapan GAAP yang keliru. Analisis lebih lanjut menunjukkan bahwa hasil kami tidak
didorong oleh risiko litigasi, kelemahan pengendalian internal, atau turnovers CEO yang terkait
dengan penyajian kembali keuangan.
Pertanyaan penelitian kedua kami menguji apakah tawaran pengambilalihan yang dilakukan
untuk menetapkan target lebih kecil kemungkinannya untuk ditarik daripada target yang tidak
diulang. Kami menduga bahwa setelah penawaran awal telah dilakukan dan kesepakatan
diumumkan secara terbuka, risiko informasi yang lebih tinggi dari target penyajian dapat
meningkatkan kemungkinan penawaran ditarik jika due diligence peserta tender mengungkapkan
informasi yang merugikan. Pertanyaan penelitian ketiga dan terakhir kami menyelidiki apakah
penyajian kembali sebelumnya mempengaruhi penetapan harga target pengambilalihan. Informasi
spesifik perusahaan target memainkan peran penting dalam menilai sinergi akuisisi (Martin dan
Shalev 2009). Risiko informasi yang meningkat terkait dengan penempatan kembali perusahaan
target mempengaruhi biaya modal mereka, yang diharapkan memiliki dampak buruk pada
penilaian pengakuisisi terhadap target.
Berdasarkan sampel 2.271 tawaran pengambilalihan yang dilakukan antara tahun 2002 dan
2009, kami menemukan bahwa penawaran yang dilakukan terhadap target penyajian kembali
secara signifikan lebih mungkin ditarik atau memakan waktu lebih lama dari penawaran yang
diajukan ke target yang tidak diulang. Selanjutnya, hasil kami pada kelipatan harga penawaran
memberikan beberapa bukti bahwa perusahaan target dengan penyajian keuangan sebelumnya
mendapatkan valuasi akuisisi yang lebih rendah dibandingkan dengan perusahaan target yang
tidak diulang. Diskon berkisar antara 25 persen dan 28 persen, meskipun efek ini tidak konsisten
kuat di berbagai ukuran penilaian dan oleh karena itu, harus ditafsirkan dengan hati-hati.
Secara keseluruhan, hasil yang disajikan dalam makalah ini menunjukkan bahwa penyajian
kembali keuangan memiliki konsekuensi signifikan untuk alokasi sumber daya ekonomi di pasar untuk
pengendalian perusahaan. Hasil ini menambah literatur terbaru yang meneliti konsekuensi ekonomi
dari penyajian kembali keuangan (Desai et al 2006b; Hribar dan Jenkins 2004; Karpoff et al 2008;
Gleason, Jenkins, dan Johnson 2008; Wilson 2008). Kami memberikan bukti konsekuensi tak
terdokumentasikan sebelumnya dari penyajian kembali keuangan yang menunjukkan bahwa
perusahaan yang bertumpu pada posisi signifikan cenderung tidak menjadi target pengambilalihan.
Penawaran pengambilalihan yang dilakukan pada perusahaan penyajian kembali juga lebih cenderung
ditarik dan memiliki kelipatan dengan kelipatan yang lebih rendah, sesuai dengan biaya modal yang
lebih tinggi untuk perusahaan perimbangan (Hribar dan Jenkins 2004; Kravet dan Shevlin 2010). Hasil
ini juga melengkapi penelitian sebelumnya mengenai implikasi penyajian kembali keuangan untuk
alokasi sumber daya dan keputusan investasi. Penelitian sebelumnya mendokumentasikan dampak
ekonomi negatif dari penyajian kembali atas keputusan investasi perusahaan yang sebelumnya
menggunakan salah saji (McNichols dan Stubben 2008; Kedia dan Philippon 2009), sementara kami
fokus pada investasi pada perusahaan yang sebelumnya menggunakan salah saji.
Selain itu, makalah ini juga berkontribusi terhadap literatur keuangan perusahaan mengenai
karakteristik target pengambilalihan (Jensen 1988; Mitchell dan Lehn 1990; Andrade dan Stafford
2004; Gorton, Kahl, dan Rosen 2009) dan faktor penentu valuasi pengambilalihan (Eckbo dan Langohr
1989 Petugas 2003; Bates dan Lemmon 2003). Hasil kami memiliki implikasi penting bagi perusahaan
yang terlibat dalam kegiatan merger dan akuisisi, memberikan wawasan untuk strategi seleksi dan
penawaran target. Misalnya, karena tawaran yang diajukan ke perusahaan yang baru-baru ini
mengajukan penyajian kembali keuangan
Overall, the results presented in this paper suggest that financial restatements have significant
consequences for the allocation of economic resources in the market for corporate control. These
results add to the recent literature that examines the economic consequences of financial restatements
(Desai et al. 2006b; Hribar and Jenkins 2004; Karpoff et al. 2008; Gleason, Jenkins, and Johnson 2008;
Wilson 2008). We provide evidence of previously undocumented consequences of financial
restatements showing that restating firms are significantly less likely to become takeover targets.
Takeover offers made to restating firms are also more likely to be withdrawn and have lower deal
multiples, consistent with a higher cost of capital for restating firms (Hribar and Jenkins 2004; Kravet
and Shevlin 2010). These results also complement prior research on the implications of financial
restatements for resource allocation and investment decisions. Prior research documents negative
economic effects of restatements on investment decisions of firms that previously engaged in
misstatements (McNichols and Stubben 2008; Kedia and Philippon 2009), while we focus on
investments in firms that previously engaged in misstatements.
Furthermore, this paper also contributes to the corporate finance literature on the characteristics of
takeover targets (Jensen 1988; Mitchell and Lehn 1990; Andrade and Stafford 2004; Gorton, Kahl, and
Rosen 2009) and the determinants of takeover valuations (Eckbo and Langohr 1989; Officer 2003;
Bates and Lemmon 2003). Our results have important implications for firms that engage in mergers
and acquisitions activities, providing insights for target selection and bidding strategies. For example,
because bids made to firms that recently filed financial restatements are

more likely to be withdrawn due to adverse selection costs, potential acquirers would benefit from
more diligent information acquisition before making an offer.
Several recent studies (Martin and Shalev 2009; Marquardt and Zur 2013; Skaife and
Wangerin 2013) also examine the implications of other measures of financial information quality
for mergers and acquisitions, without examining how financial information quality affects the
takeover decisions in the first place. We provide empirical analyses on this important question. In
addition, our focus on financial restatements is arguably more likely to capture low information
quality attributable to managerial choices than these studies focus on accruals-based earnings
quality measures. Accruals-based information quality measures are often constructed to capture
the mapping of accruals into cash flows and, thus, are partly attributable to firm fundamentals.
Furthermore, unlike these accruals-based measures, restatements provide a directly observable
signal of low information quality, a characteristic that is useful in practice.
Next, Section II discusses the prior literature on restatements and takeovers and develops our
predictions. Section III describes the sample selection and matching procedure. Sections IVVI
present empirical results and discussions of each of our three research questions. We conclude in
Section VII.

II. RELATED LITERATURE AND PREDICTIONS

The prior literature on financial restatements has shown that firms that restate their earnings
experience significant shareholder losses (Anderson and Yohn 2002; Palmrose et al. 2004), have
higher costs of capital (Hribar and Jenkins 2004), incur substantial fines and reputational costs
(Karpoff et al. 2008), and face a higher likelihood of litigation (Palmrose and Scholz 2004).
Beyond these direct capital market effects, accounting restatements also have important labor
market consequences for the involved managers and directors. Management and directors of firms
that announce restatements face a higher likelihood of being replaced and subsequently face
poorer employment prospects (Srinivasan 2005; Desai et al. 2006b). Moreover, restatements have
negative consequences for aggregate employment and investments in their respective industries
(Kedia and Philippon 2009).
Despite this large body of literature on the effects of restatements on capital and labor
markets, we know of no direct evidence on the consequences of restatements for investment
decisions in the market for corporate control. This study attempts to fill this gap.
Financial Restatements and Takeover Likelihood

Our first research question examines whether firms with recent filings of financial
restatements face a higher or lower likelihood of becoming a takeover target. Firms that engage in
aggressive earnings management and subsequently file financial restatements are associated with
ineffective internal controls (Ashbaugh-Skaife et al. 2007), signaling agency costs. Takeovers are
an important mechanism for mitigating these agency costs through replacement of inefficient
management and the improvement of internal governance (Morck, Shleifer, and Vishny 1989;
Shivdasani 1993; Schwert 2000). Furthermore, the significantly negative stock returns after
restatement announce-ments documented in prior research (Anderson and Yohn 2002; Palmrose et
al. 2004; Desai, Krishnamurthy, and Venkataraman 2006a; Karpoff et al. 2008) can also make the
2
restating firms attractive takeover targets.

2 For example, Palmrose et al. (2004) find average abnormal returns of about 9 percent over two days around the
restatement announcements.

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January 2015
Consequences of Financial Restatements: Evidence from the Market for Corporate Control 5

FIGURE 1
Schematic Diagram of a Friendly Takeover Process after Financial Restatement Filings

This figure sketches the timeline of the general process during takeover negotiations after announcements of financial
restatements, and the extent of the bidders access to information about the target.

However, several other studies argue that financial restatements increase the information
asymmetry between insiders and outsiders (Diamond and Verrecchia 1991; Bhattacharya et al.
2010). Kravet and Shevlin (2010) further show that financial restatements increase information
risk, which may raise the cost of adverse selection in the acquisition process. Figure 1 illustrates
that during the preliminary due diligence, the acquirer must rely exclusively on publicly available
information as the basis for the decision to approach a potential target. Even during negotiations
of the initial deal terms, the acquirer is granted only limited private information from the target
(Wangerin 2012). Therefore, the information risk and uncertainty inherent in restating firms may
reduce potential acquirers incentives to initiate takeovers.
Overall, while poor performance and weak governance of restating firms may provide
incentives for potential acquirers to make takeover offers, their higher information risk and the
greater cost of adverse selection may reduce such incentives. The effect of financial restatements
on the likelihood of a firm to become a takeover target is, thus, an empirical question. These
considerations might also affect takeover outcomes once acquiring firms have decided to launch a
bid, which we discuss next.

Financial Restatements and the Likelihood of Withdrawal of Takeover Bids

Our second research question examines how financial restatements filed in the 12 months prior to
the takeover bid affect the likelihood that the bid will be withdrawn. When the information risk is high
and the credibility of the targets management low, bidders are likely to perform more diligent analyses
of the targets financial statements (Wangerin 2012). The higher information risk of the restating targets
may increase the likelihood of an initial bid being withdrawn, either because the takeover parties could
not agree on the final acquisition price, or because of remaining risks exposed by the bidders due
diligence once the takeover bid is initiated and the acquisition agreement signed. Despite the binding
nature of the acquisition agreement, investigation covenants and other closing conditions, such as
material adverse change clauses or termination clauses in the agreement, enable the bidder to withdraw
if the due diligence fails to confirm the accuracy of the representations and warranties made by the
target (Wangerin 2012; Skaife and Wangerin 2013).

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6 Amel-Zadeh and Zhang

Martin and Shalev (2009) and Marquardt and Zur (2013) examine the effects of target firm-
specific information and accruals quality, respectively, on takeover outcomes. Both studies find
that the likelihood of withdrawal of an acquisition offer decreases with the targets information
quality. Our research differs from this literature, which examines the effects of financial reporting
on investment decisions conditional on the acquisition decision having been made. In contrast,
our first research question examines whether and how financial reporting quality affects the
decision to make a takeover bid in the first place.
Furthermore, restatements signal low financial reporting quality that can be more reliably
attributed to aggressive accounting or earnings management. In contrast, the financial reporting quality
measures examined in these prior studies are often constructed to capture the mapping of accruals into
cash flows or the ability to predict future earnings. Low financial reporting quality as measured in these
studies could stem from earnings volatility or high growth rather than aggressive accounting/earnings
management alone. Francis, LaFond, Olsson, and Schipper (2005) similarly suggest that the
conventional accruals-based measures of financial reporting quality are related to both economic
fundamentals and management choices, which are expected to have different implications for potential
acquisition decisions. Finally, financial restatements are readily observable signals, in contrast to
accruals-based measures that require estimating regression models.

Financial Restatements and Deal Valuation

Our last research question examines whether acquirers value restating targets differently from
non-restating targets. The offer price reflects the acquirers valuation of the target, as well as
achievable synergies based on knowledge of the target firm obtained from publicly available
financial reports and possibly from private information. The quality of the information is, thus,
pivotal for the pricing of the target.
A number of studies examine the association between the targets information environment
and takeover premiums. For example, Martin and Shalev (2009) and Raman, Shivakumar, and
Tamayo (2013) show that expected synergies are positively correlated to the targets information
quality. However, Martin and Shalev (2009) find that target shareholder returns from an
acquisition decrease with information quality of the target firm. A possible explanation is that the
market corrects previous underpricing of target firms with low information quality upon the
announcements of takeovers. This possibility is particularly relevant for restating firms because
the market might overreact to restatements. Thus, market-based measures of deal value are
affected by not only expected deal synergies, but also other factors such as misvaluation of the
target, probability of bid failure, and competition during acquisitions. Therefore, we choose to
follow Officer (2007) and focus on deal multiples in the form of ratios of offer prices to firm
fundamentals, which more unambiguously reflect bidders decision making.
Our analyses of deal multiples also help shed light on the results in Hribar and Jenkins (2004)
that financial restatements increase the firms cost of capital. Their evidence is consistent with
Easley and OHara (2004) and Lambert, Leuz, and Verrecchia (2007), who show that the quality
of accounting information affects the cost of capital. This suggests that acquirers incorporate a
higher cost of capital in valuing the target and make lower takeover offers.

III. SAMPLE SELECTION

We obtain data on takeover transactions from the Securities Data Corporation (SDC) database.
Consistent with Martin and Shalev (2009), we only consider deals in which the acquirer seeks to
purchase 100 percent of a public target so that the acquirer does not have access to private information
prior to the bid. The restriction to public targets ensures the availability of restatement information and
other financial data. These requirements yield a total of 3,762 takeover bids during 20022009.

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Consequences of Financial Restatements: Evidence from the Market for Corporate Control 7

3
For the sample period of 20012008, we obtain 4,143 financial restatements from Audit
4
Analytics for firms that are also covered in Compustat. Our empirical tests employ two different
samples based on different intersections between the sample of takeover transactions and the
sample of financial restatements. For our first research question addressing the effects of financial
restatement on takeover likelihood, we obtain a propensity score matched sample between
restating and non-restating firms based on estimated propensity scores of reporting material
accounting misstatements. We first collapse our financial restatements to a sample of 3,756
restating firm-years because some firms had multiple restatements in one year. We then identify
all firm-years in Compustat that filed no financial statements during 20012008. We pool these
two samples and use the filing date of the last financial restatement in the year (the fiscal year-
end) as the event date for the restating (non-restating) firm-years.
For this pooled sample, we estimate a propensity score for reporting material accounting
misstatements based on a modified logistic regression model developed in Dechow et al. (2011). The
Dechow et al. (2011) model focuses on predicting AAERs (Accounting and Auditing Enforcement
Releases by the Securities and Exchange Commission [SEC]), which often lead to financial
restatements. However, AAERs are likely to capture more extreme forms of earnings management and
are also subject to other potential selection biases, as described by Dechow et al. (2011, 18). Starting
5
with the Dechow et al. (2011) model, we add the following additional controls for other firm
characteristics that are likely to differ between restating and non-restating firms: size, leverage, return
on assets, earnings-price ratio, and liquidity (DeFond and Jiambalvo 1994; Dechow and Dichev 2002;
Doyle, Ge, and McVay 2007; Ashbaugh-Skaife, Collins, Kinney, and LaFond 2008; Sun, Yung, and
6
Rahman 2012). For each of our restating firm-years, we identify the non-restating firm in the same
year and industry that has the closest propensity score with less than 0.02 in score difference. This
procedure leads to a final matched sample of 1,963 pairs of restating and non-restating firms with data
7
available for all required control variables. We merge the matched sample with the above takeover
sample of 3,762 deals. If the firm receives a takeover bid within 12 months after the event date, then
we code TAKEOVER as 1, and 0 otherwise. All variables are defined in Appendix A.
Our second and third research questions examine the effects of financial restatements on the
likelihood of takeover withdrawal and on deal valuation. Starting with the sample of 3,762 takeover
transactions, if the firm filed any financial restatements in the 12 months prior to the bid announcement
based on our sample of 4,143 restatements, then we code RESTATE as 1, and 0 otherwise. Our
regression analyses for these two research questions are based on 2,271 deals or smaller samples,
8
depending on the availability of other information required for the specific analyses.

3 Our research design requires a one-year lag between the restatement sample period and the takeover sample period.
4 About 10 percent of the restatements during our sample period in the Audit Analytics database are income-increasing.
Excluding these restatements in the sample does not affect the inferences of this study.
5 For space considerations, we refer the readers to Dechow et al. (2011) for the details of their model specification. We
start with their model 3 (Table 7), in which the authors employ financial statement, accruals quality, off-balance sheet,
and market-based variables as determinants of misstatements. A similar model is used in Beneish (1999).
6 As a robustness check, we also use a simple one-to-one matching procedure by size, industry, and year instead of the
propensity score matching procedure. The results of our analyses remain qualitatively similar.
7 Our modified model has a concordant rate of 62 percent and a correct prediction rate of 60 percent, comparable to
those reported in Dechow et al. (2011).
8 We do not use a propensity score matched sample in our deal outcome and valuation analyses because of sample size
limitations. Only 161 restating firms are acquired, and requiring deal values and matching pairs would further reduce
the sample size significantly. For example, we can only get 45 pairs of matching restating and non-restating firms that
have information on the ratio of deal value to EBITDA (earnings before interest, taxes, depreciation, and amortization).
Such a small sample size fails to provide reliable estimates that can offer useful insights. Therefore, we use the
unmatched sample design in these regressions, but control for a comprehensive list of variables, including the variables
used in the propensity score model.

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8 Amel-Zadeh and Zhang

IV. FINANCIAL RESTATEMENTS AND TAKEOVER LIKELIHOOD

Research Design and Descriptive Statistics

This section examines how prior financial restatements affect the probability of receiving a
takeover bid. Based on the 1,963 pairs of restating and non-restating firms matched on propensity
scores, our test employs the following regression model:
X X
ProbTAKEOVER 1 f b0 b1 RESTATE bi CONTROLi yiYEARi e :
1

Based on prior literature estimating takeover likelihood, we include controls for firm size,
measured as the log of market value (SIZE) as in Hasbrouck (1985) and Palepu (1986), book-to-
market (BM) as in Dong, Hirshleifer, Richardson, and Teoh (2006), and the earnings-to-price ratio
(EP) as in Garvey, Milbourn, and Xie (2011). We proxy for performance using ROA, calculated
as operating income before depreciation and amortization over total assets (Jensen and Ruback
1983; Cremers, Nair, and John 2009).
Following Palepu (1986) and Ambrose and Megginson (1992), we control for sales growth
(SGROW) and leverage (LEVERAGE), which are both expected to be negatively associated with
takeover likelihood. We further include tangibility of assets (TANG) and liquidity (LIQUIDITY), based
on Ambrose and Megginson (1992) and Berger and Ofek (1996). We also construct a growth-resource
dummy variable (GRDUMMY) similar to Palepu (1986), which is equal to 1 if the firm either has low
growth, high liquidity, and low leverage, or high growth, low liquidity, and high leverage, and equal to
0 otherwise, where high and low reflect the respective variable values above and below the Compustat
median in the year. Finally, we control for the percentage of institutional ownership (INST) as a proxy
for effective monitoring (Shleifer and Vishny 1986; Cremers et al. 2009). All of our control variables
are measured as of the end of the event year. We include year dummies in all of our regressions to
control for takeover waves (Harford 2005).
Figure 2 plots the frequency of matching pairs in our sample. We observe the highest number
of restatement filings in 2006 and the lowest number in 2001. This figure also plots the time-
series of the percentages of restating and non-restating firms receiving takeover bids in the
subsequent year. In every year, a lower percentage of restating firms than non-restating firms
receive takeover bids.
Table 1 reports descriptive statistics for the control variables used in Model (1) for the
restating and non-restating firms, respectively. All continuous variables are winsorized at the 1st
and 99th percentiles. Table 1 reports no statistically significant differences in means of the control
variables of restating versus non-restating firms, and small differences in medians in earnings-to-
price ratio and return on assets, suggesting covariate balance and effective matching. Overall,
Table 1 suggests that our restating and non-restating sample firms are generally similar, except for
the incidence of restatements.

Empirical Results

Table 2 reports the test results of the effects of filing financial restatements on the likelihood
of receiving a takeover bid. Panel A cross-tabulates the frequency of takeovers for the restating
and non-restating firms and provides univariate tests. Consistent with Figure 2, restating firms are
less likely to receive takeover bids than non-restating firms. Of the 1,963 restating firms, only 75
(3.8 percent) receive takeover offers within 12 months of the event date, compared to 132 (6.7
percent) of their matched non-restating counterparts. This difference in frequencies is statistically
significant at less than 1 percent level (Chi-square 16.77).

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Consequences of Financial Restatements: Evidence from the Market for Corporate Control 9

FIGURE 2
The Time-Series of Financial Restatements

This figure is based on 1,963 pairs of restating and non-restating firms matched on propensity of financial misstatements
estimated based on a modified Dechow et al. (2011) model. The sample period is 20012008. The figure shows the time
trend of the number of restating firms and percentage of restating and non-restating firms that receive takeover bids in the
next year.

We next examine our research question in more robust multivariate logistic regressions (Model
(1)). The dependent variable is TAKEOVER, which is equal to 1 if the firm received a takeover bid,
and 0 otherwise. Standard errors are clustered at the two-digit SIC industry level, as in all other
regressions in this study. The regression results are reported in Column (1) of Table 2, Panel B.
Consistent with univariate results, the coefficient on RESTATE is significantly negative at 0.60 (p
, 0.01). We estimate the probability of receiving a takeover bid for a restating (non-restating) firm
when RESTATE is set at 1 (0) and all other variables are set at their respective sample averages.
When RESTATE 0, the predicted probability of takeover is 5.7 percent, and when RESTATE
1, the predicted probability is 3.2 percent. Thus, the marginal effect of RESTATE on takeover
9
likelihood is 2.5 percent, a 44 percent (2.5 percent/5.7 percent) decrease.
Consistent with the prior literature, the likelihood of a takeover bid is negatively associated
with sales growth and positively associated with leverage, the growth-resource dummy, and the percent
2
of institutional holdings. All other control variables are generally insignificant. The R of the
regression in Column (1) in Table 2, Panel B is 1.85 percent and is in line with the generally low

9 As discussed in Section II, our focus on financial restatements is different from the earnings quality measure used in
Marquardt and Zur (2013) and Raman et al. (2013). Nevertheless, we also estimate their measure, which follows
Dechow and Dichev (2002), for our sample and find a correlation of 0.06 between RESTATE and their measure,
suggesting that they indeed capture different aspects of financial information quality. In untabulated results, we add this
measure to Model (1) and reestimate the regression. The coefficient on RESTATE remains statistically negative, while
the earnings quality variable is not.

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10 Amel-Zadeh and Zhang

TABLE 1
Descriptive Statistics of Matched Restating and Non-Restating Sample
Variable n Mean Median P25 P75 Std. Dev.

RESTATE 1
SIZE 1,963 5.44 5.44 4.04 6.81 1.94
BM 1,963 0.48 0.45 0.24 0.73 1.80
EP 1,963 0.22 0.01*** 0.13 0.05 0.97
LEVERAGE 1,963 0.18 0.11 0.00 0.28 0.21
SGROW 1,963 0.15 0.07 0.04 0.21 0.53
LIQUIDITY 1,963 0.34 0.30 0.15 0.49 0.22
TANG 1,963 0.26 0.18 0.07 0.39 0.23
ROA 1,963 0.02 0.08*** 0.00 0.14 0.25
GRDUMMY 1,963 0.35 0.00 0.00 1.00 0.48
INST 1,963 0.42 0.39 0.05 0.75 0.34
RESTATE 0
SIZE 1,963 5.55 5.54 3.92 7.11 2.18
BM 1,963 0.46 0.45 0.25 0.75 2.01
EP 1,963 0.24 0.03 0.09 0.06 1.36
LEVERAGE 1,963 0.18 0.12 0.00 0.28 0.20
SGROW 1,963 0.15 0.08 0.02 0.21 0.51
LIQUIDITY 1,963 0.33 0.28 0.16 0.47 0.22
TANG 1,963 0.27 0.18 0.08 0.41 0.24
ROA 1,963 0.03 0.10 0.02 0.15 0.27
GRDUMMY 1,963 0.36 0.00 0.00 1.00 0.48
INST 1,963 0.44 0.44 0.06 0.77 0.34

*, **, *** Indicate two-sided significance levels of 10 percent, 5 percent, and 1 percent, respectively, for the difference
between the restating firms and the non-restating firms, based on t-tests for means and Wilcoxon tests for medians. This
table is based on 1,963 pairs of restating and non-restating firms matched on propensity of financial misstatements
estimated based on a modified Dechow et al. (2011) model. The sample period is 20012008. RESTATE equals 1 if the
firm filed financial restatement in the year, and 0 otherwise. All variables are measured at the end of the year of the
restatement filing. All continuous variables are winsorized at 1 percent and 99 percent. All variables are defined in
Appendix A.

explanatory power of tests on acquisition likelihoods (Ambrose and Megginson 1992; Powell
1997).
Different types of restatements may have a different impact on the acquirers perception of the potential
costs and risks involved. During our sample period, we observe two types of restatements that are less likely
to be driven by information risk: those related to leases and stock options backdating. The Financial
Accounting Standards Boards (FASB) clarification on accounting for operating leases in February 2005 led
to a wave of restatements, primarily by industries with significant amounts of leases on equipment and real
estate. These restatements most likely reflect a misunderstanding of the standard prior to the FASB
clarification, as opposed to deliberate attempts to mislead investors. Similarly, restatements related to stock
options backdating might be more related to poor governance of the firm rather than a signal of poor
financial reporting quality and information risk (Collins, Gong, and Li 2009).
We identify 304 firm-years that have restatements related to either leases or stock options
backdating. Column (2) of Table 2, Panel B reports the results of a modified Model (1) with
separate indicators for these types of restatements (LEASE/BACKDATING) and all other
restatements (OTHER). The coefficient for LEASE/BACKDATING is marginally significant at

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Consequences of Financial Restatements: Evidence from the Market for Corporate Control
TABLE 2
Takeover Likelihood

Panel A: Univariate Test Results


TAKEOVER
RESTATE 0 1 Total
0 1,831 132 1,963
[93.3%] [6.7%]
1 1,888 75 1,963
[96.2%] [3.8%]
Total 3,719 207 3,926
[94.7%] [5.3%]
2
v 16.77***
p-value ,0.0001

Panel B: Logistic Regression Results


(1) (2) (3)
All Restatements Lease/Backdating vs. Others Nature of Misstatements
2 2 2
Coefficient v p-value Coefficient v p-value Coefficient v p-value
RESTATE 0.60 13.79*** 0.00
LEASE/BACKDATING 0.42 2.77* 0.10
OTHER 0.64 12.83*** 0.00
ERROR 0.56 9.62*** 0.00
IRREGULARITY 0.92 3.41* 0.07
FRAUD 0.10 0.05 0.82
SIZE 0.09 2.18 0.14 0.09 2.23 0.14 0.14 4.46** 0.03
BM 0.05 1.68 0.19 0.05 1.68 0.20 0.09 1.61 0.21
EP 0.09 2.49 0.11 0.09 2.45 0.12 0.27 6.53*** 0.01
LEVERAGE 0.73 7.27*** 0.01 0.74 7.41*** 0.01 0.16 0.06 0.81
SGROW 0.59 9.01*** 0.00 0.59 8.88*** 0.00 0.41 3.03* 0.08
(continued on next page)

11
TABLE 2 (continued)

12
(1) (2) (3)
All Restatements Lease/Backdating vs. Others Nature of Misstatements
2 2 2
Coefficient v p-value Coefficient v p-value Coefficient v p-value
LIQUIDITY 0.15 0.10 0.75 0.15 0.10 0.75 0.63 0.79 0.37
TANG 0.34 0.66 0.42 0.32 0.59 0.44 0.53 1.00 0.32
ROA 0.11 0.09 0.76 0.11 0.10 0.76 0.51 2.50 0.11
GRDUMMY 0.50 15.05*** 0.00 0.50 14.96*** 0.00 0.32 3.40* 0.07
INST 0.84 4.79** 0.03 0.83 4.62** 0.03 1.13 10.92*** 0.00
Intercept 3.23 52.38*** 0.00 3.20 51.43*** 0.00 2.90 30.25*** 0.00
Year dummies Yes Yes Yes
Obs. 3,926 3,926 1,978
2
R 1.85% 1.86% 2.04%
*, **, *** Indicate two-sided significance levels of 10 percent, 5 percent, and 1 percent, respectively.
2
Panel A cross-tabulates frequencies for RESTATE and TAKEOVER and reports the result of the v test of differences in the takeover frequencies conditional on restatements. Panel B
reports logistic regression results for the matched sample on the dependent variable TAKEOVER. Column (1) shows the regression results on all restatements, and Column (2)
separates the restatements into those related and unrelated to stock options backdating and lease accounting. Both columns are based on 1,963 pairs of restating and non-restating
firms matched on propensity of financial misstatements estimated based on a modified Dechow et al. (2011) model. Column (3) separates the restatements into errors, irregularities,
and frauds based on the 989 pairs of the propensity score matched sample using the GAO restatement data provided by Hennes et al. (2008), as well as the Audit Analytics data. All
regressions control for year fixed effects. All continuous variables are winsorized at 1 percent and 99 percent. All variables are measured at the end of the year of the restatement
filing. Standard errors are clustered at the industry level.
All variables are defined in Appendix A.
2015JanuaryReviewAccounting
The
Consequences of Financial Restatements: Evidence from the Market for Corporate Control 13

0.42 (p 0.10). In contrast, the coefficient for OTHER is significantly negative and much
higher in magnitude at 0.64 (p , 0.01). These results are consistent with information risk being one
important driver of the lower likelihood of takeover bids for restating firms.
Financial restatements can be caused by fraud, less serious accounting irregularities such as
intentional aggressive accounting, or simply clerical errors. Ex ante, it is not clear how
prospective acquirers might view these differently. On the one hand, regardless of the motivation
of the initial misstatements, restatements signal unreliable financial information and low earnings
quality. On the other hand, accounting fraud and irregularities might be viewed as more severe
than clerical errors, given that prior research has shown that accounting irregularities have
significantly more adverse effects on the capital market and the CEO/CFO turnover decision than
accounting errors (Hennes, Leone, and Miller 2008).
10
We use the GAO restatements data provided by Hennes et al. (2008) to examine possible
different implications of restatements due to errors and those due to accounting irregularities. To
further identify possible differential effects of accounting frauds, we merge these data with fraud cases
identified from the Audit Analytics database. We apply the same matching procedure as before and
obtain 989 pairs of restating and non-restating firms with all required data available during 2001
11
2006, among which 756 are classified as errors, 190 as irregularities, and 43 as fraud.
We first estimate Model (1) based on this alternative sample for comparability and find
similar results as in Column (1) of Table 2, Panel B (not tabulated). Specifically, the coefficient on
RESTATE is 0.57 (p , 0.01). We next modify Model (1) by separating RESTATE into three
indicator variables, ERROR, IRREGULARITY, and FRAUD, and report the results in Column
(3) of Table 2, Panel B. The coefficient on IRREGULARITY ( 0.92) is larger in magnitude than
that on ERROR ( 0.56), and both are significantly negative. However, they are not statistically
different from each other. The coefficient on FRAUD, on the other hand, is insignificant, possibly
due to lack of testing power from the infrequent fraud cases.
Overall, to the extent that both accounting irregularities and accounting errors significantly
decrease takeover likelihood, our results suggest that prospective acquirers are concerned about
low accounting quality in general, irrespective of whether the reason for the low quality is due to
intentional misstatements or erroneous application of GAAP. Unreliable accounting numbers
increase information asymmetry and uncertainty, which impedes the acquirers assessment of the
targets value and demotivates them from making acquisition offers.

Additional Analyses

In this subsection, we examine the implications of several alternative factors associated with
financial restatements for acquisition decisions: litigation risk, internal control weaknesses, and
CEO turnover.

Litigation Risk
Financial restatements impose significant litigation risk on the restating firms (Palmrose and
Scholz 2004). Unless an acquisition is structured as an asset purchase, the acquirer generally

10 An updated version of the sample of restatements from the Government Accountability Office (GAO) database
differentiated into errors and irregularities is available on Andy Leones webpage at: http://sbaleone.bus.miami.edu/.
We thank Hennes et al. (2008) for making the data publicly available.
11 Hennes et al. (2008) combine fraud and irregularity cases in their irregularity category, possibly due to the infrequency
of fraud cases, which is also evident in our merged sample. As Hennes et al. (2008) do not separately identify fraud
cases in their sample, it is not clear how many of the fraud cases included in their study overlap with those included in
the Audit Analytics database.

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14 Amel-Zadeh and Zhang

assumes all existing and contingent liabilities of the target (Reed, Lajoux, and Nesvold 2007) and,
thus, presumably will take the litigation risk of the restating firms into account when considering
an offer.
We estimate whether the litigation risk of the restating firms influences the takeover decision
of a prospective acquirer by splitting our RESTATE variable into two indicator variables, LITI
and NOLITI, which identify, respectively, our sample firms that are and are not subject to
12
litigation during the period from one year prior to the event date to one year after. The litigation
13
data are obtained from the Securities Class Action Clearinghouse at Stanford University.
Table 3, Column (1) presents our estimation results. Both LITI and NOLITI have significantly
negative coefficients with similar magnitude ( 0.58 and 0.60, respectively), suggesting litigation
risk has little incremental explanatory power for acquisition decisions. Thus, litigation risk is less
likely driving our main results, and information risk of the restating firms plays the more
14
important role in the takeover decision.

Internal Control Weaknesses

Restating firms often (although not always) have ineffective internal control systems in financial
reporting. Like restatements, internal control weaknesses also signal low financial reporting quality
(Doyle et al. 2007) and weak governance. However, arguably, many internal control weaknesses, such
as lack of segregation of duty, are more likely reflective of governance problems that can potentially be
alleviated by installing a more effective management team after takeovers.
We are able to obtain information from Audit Analytics on the effectiveness of internal controls
based on Section 302 or 404 disclosures as required by the Sarbanes-Oxley Act for 2,884 (1,442 pairs)
firm-years in our sample during 20042008. About 48 percent of restating firms report ineffective
internal controls (WEAKIC) compared to 8 percent of non-restating firms. The correlation between
RESTATE and WEAKIC is 0.44, suggesting that internal control weaknesses potentially represent
different underlying firm characteristics than financial restatements.
We add WEAKIC to Model (1) and also interact WEAKIC with RESTATE to examine how
internal control weaknesses affect the effects of financial restatements on takeover bids. Table 3,
Column (2) shows that the coefficient on RESTATE remains significantly negative ( 0.79, p ,
0.01). The coefficient on both WEAKIC and its interaction with RESTATE are positive, but
insignificant. We leave it to future research for a comprehensive analysis on the effects of internal
control weaknesses on acquisitions.

CEO Turnover

The prior literature shows that there is a higher likelihood of top management turnover
following financial restatements (Srinivasan 2005; Desai et al. 2006b). If restating firms choose to

12 According to Palmrose and Scholz (2004), it is significantly less likely that shareholder lawsuits are filed against
restating firms more than one year after the restatement announcement. This is consistent with the statute of limitations
in securities law under Section 1658(b) related to the filing of lawsuits claiming violation of Section 10(b), which limits
the right to litigate to two years from the discovery of a misstatement (which usually occurs before the restatement
announcement). We also include a one-year window prior to the restatements because a number of firms in our sample
have other restatements earlier in the year.
13 We are grateful to Mary Billings for providing the litigation data from Billings (2010).
14 In untabulated robustness analyses, instead of using actual litigation filed, we estimate an ex ante measure of litigation
probability based on Palmrose and Scholz (2004). We identify restating firms within the top quintile of the litigation
probability as having high litigation risk (HIGHLITI) and the rest as having low litigation risk (LOWLITI). We use
HIGHLITI and LOWLITI to replace RESTATE in Model (1). Both LOWLITI and HIGHLITI have significantly
negative coefficients ( 0.70 and 0.91, respectively) that are insignificantly different from each other.

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Consequences of Financial Restatements: Evidence from the Market for Corporate Control
TABLE 3
Takeover Likelihood: Additional Analysis
(1) (2) (3)
Litigation Internal Control CEO Turnover
2 2 2
Coefficient v p-value Coefficient v p-value Coefficient v p-value
LITI 0.58 4.15** 0.04
NOLITI 0.60 11.12*** 0.00
RESTATE 0.79 9.64*** 0.00 0.71 3.34* 0.07
WEAKIC 0.43 1.85 0.17
RESTATE WEAKIC 0.23 0.25 0.62
TURNOVER 0.58 1.33 0.25
RESTATE TURNOVER 0.04 0.00 0.95
SIZE 0.09 2.14 0.14 0.01 0.01 0.91 0.31 6.93*** 0.01
BM 0.05 1.69 0.19 0.04 0.17 0.68 0.07 0.74 0.39
EP 0.09 2.46 0.12 0.07 0.63 0.43 0.06 0.18 0.67
LEVERAGE 0.73 7.29*** 0.01 0.96 9.93*** 0.00 0.41 0.56 0.45
SGROW 0.59 8.96*** 0.00 0.58 5.61** 0.02 0.08 0.02 0.88
LIQUIDITY 0.15 0.10 0.75 0.31 0.31 0.58 0.65 0.47 0.49
TANG 0.34 0.65 0.42 0.07 0.02 0.90 0.73 1.76 0.19
ROA 0.11 0.09 0.76 0.82 3.00* 0.08 1.36 0.60 0.44
GRDUMMY 0.50 14.95*** 0.00 0.30 3.70** 0.05 0.33 1.48 0.22
INST 0.84 4.87** 0.03 0.61 3.60* 0.06 0.98 3.08* 0.08
Intercept 3.23 51.37*** 0.00 3.96 60.39*** 0.00 13.91 190.46*** 0.00
Year dummies Yes Yes Yes
Obs. 3,926 2,884 1,346
2
R 1.85% 1.95% 3.65%
*, **, *** Indicate two-sided significance levels of 10 percent, 5 percent, and 1 percent, respectively.
This table reports logistic regression results for the propensity score matched sample of restatements on the dependent variable TAKEOVER. Column (1) examines restatements with
and without litigation in one year separately around the restatements. Column (2) examines the implications of internal control weaknesses based on data in Audit Analytics. Column
(3) examines the implication of CEO turnover based on data in ExecuComp. All regressions control for year fixed effects. All variables are measured at the end of the year of the
restatement filing. All continuous variables are winsorized at 1 percent and 99 percent. Standard errors are clustered at the industry level. All variables are defined in Appendix A

15
16 Amel-Zadeh and Zhang

proactively address governance problems by replacing incumbent management, then this can
mitigate the incentives for external acquirers to intervene, which provides an alternative
explanation to our main results in Table 2. We, therefore, investigate whether CEO turnover
affects the relation between financial restatements and the takeover likelihood.
Our data source of CEO turnover is ExecuComp. In order to increase our sample size and, hence,
the power of our tests, we regenerate our propensity score matched pairs based on all firms that are
covered by ExecuComp with all other procedures exactly the same as described in Section
III. We obtain 673 pairs of restating and non-restating firms with all required data available. A
total of 114 (17 percent) of restating firms and 68 (10 percent) of non-restating firms experience
CEO turnover in the event year. The difference in turnover frequency between the two groups of
firms is statistically significant (p , 0.01), consistent with prior research that restating firms are
more likely to replace CEOs.
We add an indicator variable, TURNOVER, and its interaction with RESTATE to our regression
Model (1). Table 3, Column (3) reveals that the coefficient on RESTATE remains significantly
negative at 0.71 (p 0.07), suggesting that the negative effects of financial restatements on the
takeover likelihood is robust to controls for the effects of CEO turnover. The coefficients on
TURNOVER and its interaction with RESTATE are both insignificant.
Overall, this section provides robust evidence that the filing of financial restatements is
negatively associated with the likelihood of receiving a takeover bid. This effect is both
statistically and economically significant. Further analyses show that our results are robust to
controlling for additional factors, including litigation risk, internal control effectiveness, and CEO
turnover, suggesting that information risk is most likely the driving factor in potential acquirers
hesitation to make takeover offers to restating firms.

V. FINANCIAL RESTATEMENTS AND LIKELIHOOD OF TAKEOVER WITHDRAWAL

Research Design and Descriptive Statistics

This section examines our second research question, how a previous financial restatement
affects the likelihood of withdrawal of a takeover bid, by applying the following model for our
empirical tests:
X X
ProbWITHDRAW 1 f b0 b1 RESTATE bi CONTROLi yiYEARi e :
2

The dependent variable is WITHDRAW, which takes a value of 1 if the deal status was coded as
withdrawal in SDC, and 0 otherwise. The variable of interest is RESTATE, which takes a value of 1 if
the target firm filed any restatements in the 12 months prior to the takeover announcement, and 0
otherwise. Following Skaife and Wangerin (2013), we control for both deal characteristics and target
characteristics measured as of the fiscal year-end prior to the takeover announcement. In general, the
prior literature suggests that most of the same target characteristics that make firms attractive takeover
targets, such as SIZE, BM, and INST, are associated with takeover completion likelihood, as well
(Ambrose and Megginson 1992; Schwert 2000; Dong et al. 2006; Cremers et al. 2009; Gorton et al.
2009). Therefore, we include all control variables from Model (1). In addition, we control for insider
holdings (INSIDER) following Moeller (2005), where insider holdings proxies for entrenched and
more powerful boards that are better able to oppose takeover bids.
Prior evidence also suggests a strong association between deal characteristics and takeover
completion rates. Following this literature (Betton, Eckbo, and Thorburn 2008; Schwert 2000; Bates
and Lemmon 2003; Moeller, Schlingemann, and Stulz 2004; Skaife and Wangerin 2013), we

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Consequences of Financial Restatements: Evidence from the Market for Corporate Control 17

FIGURE 3
The Time-Series of Takeover Activities

This figure is based on 2,271 takeover bids during 20022009. The figure shows the time trend of the number of takeover
bids and percentage of takeover target firms that restate financial statements in the previous year.

include the following deal characteristics: diversifying takeovers (DIV), multiple bidders (MBID),
hostile bids (HOST), tender offers (TENDER), the percentage of stock used as payment
(PCTSTOCK), and existence of termination fee clauses for bidder and target (ATERM and TTERM).
We obtain 2,271 deals with data available for all control variables during 20022009. Figure
3 plots the frequency of takeover bids and the percentage of restating firms over time for this
sample. Largely consistent with economic cycles, we observe the highest number of takeover bids
in 2006 2007 and the lowest number during the financial crisis of 20082009. The percentage of
restating targets generally follows the pattern in Figure 2, with a higher frequency of restating
targets in 20052006 and a lower frequency in 2002 and 2009.
Table 4 reports descriptive statistics of all variables used in Model (2) separately for the
takeover deals with restating targets (RESTATE 1) in Panel A, and for all other takeover deals
in the sample (RESTATE 0) in Panel B. On average, the 161 restating targets have
significantly lower sales growth (4 percent versus 15 percent) and significantly lower liquidity (38
percent versus 43 percent) than the 2,110 non-restating targets, but significantly higher leverage
(19 percent versus 16 percent) and significantly higher insider holdings (5 percent versus 3
percent). Differences in medians are generally much smaller in magnitude and/or insignificant.
All other target characteristics are not statistically different between the two groups.
Table 4 also reports that restating targets are more likely to be diversifying (56 percent versus
49 percent) and less likely to receive tender offers (6 percent versus 13 percent) than non-restating
targets. All other deal characteristics are not significantly different. On average, 11 percent (9
percent) of restating (non-restating) targets receive multiple bids, 6 percent (6 percent) receive
hostile offers, 20 percent (16 percent) have acquirer termination fee clauses, and 61 percent (59

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18 Amel-Zadeh and Zhang

TABLE 4
Descriptive Statistics of the Takeover Sample

Panel A: Restating Firms (RESTATE 1)


Variable n Mean Median P25 P75 Std. Dev.
SIZE 161 5.14 5.18 3.93 6.68 1.98
BM 161 1.37 0.51 0.31 0.78 11.88
EP 161 1.01 0.01 0.10 0.06 6.42
LEVERAGE 161 0.19* 0.13 0.00 0.30 0.23
SGROW 161 0.04*** 0.05* 0.06 0.15 0.23
LIQUIDITY 161 0.38*** 0.33*** 0.16 0.57 0.24
TANG 161 0.22 0.12 0.04 0.37 0.24
ROA 161 0.03 0.08 0.01 0.12 0.21
GRDUMMY 161 0.39 0.00 0.00 1.00 0.49
INST 161 0.41 0.37 0.06 0.73 0.34
INSIDER 161 0.05** 0.00* 0.00 0.03 0.11
MBID 161 0.11 0.00 0.00 0.00 0.31
HOST 161 0.06 0.00 0.00 0.00 0.23
DIV 161 0.56* 1.00* 0.00 1.00 0.50
TENDER 161 0.06*** 0.00*** 0.00 0.00 0.23
PCTSTOCK 161 16.71 0.00 0.00 0.00 34.87
ATERM 161 0.20 0.00 0.00 0.00 0.40
TTERM 161 0.61 1.00 0.00 1.00 0.49

Panel B: Non-Restating Firms (RESTATE 0)


Variable n Mean Median P25 P75 Std. Dev.
SIZE 2,110 4.99 4.96 3.54 6.55 2.19
BM 2,110 1.87 0.52 0.29 0.86 31.14
EP 2,110 2.25 0.03 0.13 0.06 23.77
LEVERAGE 2,110 0.16 0.08 0.00 0.25 0.21
SGROW 2,110 0.15 0.06 0.04 0.20 0.75
LIQUIDITY 2,110 0.43 0.40 0.20 0.66 0.26
TANG 2,110 0.21 0.11 0.03 0.30 0.23
ROA 2,110 0.02 0.07 0.01 0.13 0.25
GRDUMMY 2,110 0.35 0.00 0.00 1.00 0.48
INST 2,110 0.42 0.38 0.09 0.71 0.33
INSIDER 2,110 0.03 0.00 0.00 0.02 0.07
MBID 2,110 0.09 0.00 0.00 0.00 0.28
HOST 2,110 0.06 0.00 0.00 0.00 0.23
DIV 2,110 0.49 0.00 0.00 1.00 0.50
TENDER 2,110 0.13 0.00 0.00 0.00 0.33
PCTSTOCK 2,110 18.16 0.00 0.00 0.00 34.85
ATERM 2,110 0.16 0.00 0.00 0.00 0.36
TTERM 2,110 0.59 1.00 0.00 1.00 0.49

*, **, *** Indicate two-sided significance levels of 10 percent, 5 percent, and 1 percent, respectively, for the difference
between the restating targets and the non-restating targets, based on t-tests for means and Wilcoxon tests for medians. This
table is based on 2,271 takeover bids during 20022009. RESTATE equals 1 if the target firm filed financial restatements
in the year prior to the bid announcement, and 0 otherwise. Panel A shows descriptive statistics for RESTATE 1 and
Panel B shows descriptive statistics for RESTATE 0. All variables are measured at the end of the fiscal year prior to the
takeover announcements. All continuous variables are winsorized at 1 percent and 99 percent. All variables are defined in
Appendix A.

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Consequences of Financial Restatements: Evidence from the Market for Corporate Control 19

percent) have target termination fee clauses. The percentage of stock used in the acquisition of
these targets is, on average, 16.7 percent for restating versus 18.2 percent for non-restating firms.

Empirical Results

Table 5, Panel A reports the contingency table between RESTATE and WITHDRAW for the
sample of 2,271 deals of Model (2). Among the 161 deals with restating targets, 33 (20.5 percent)
were eventually withdrawn compared to 273 (12.9 percent) among the 2,110 deals with non-
restating targets. This difference in frequencies is statistically significant at 0.01 (Chi-square
7.33).
Column (1) of Table 5, Panel B provides logistics estimates of Model (2) that includes target
and deal characteristics as control variables. Column (2) additionally includes variables from the
Dechow et al. (2011) model we use in our matching procedure in the previous section
(coefficients suppressed in the table). In both columns, the coefficient on RESTATE is positive
and statistically significant (0.71 and 0.59, p 0.01 and p 0.05, respectively). In Column (1),
restating targets have a 15.4 percent likelihood of withdrawal compared to 8.2 percent for non-
restating targets, setting all other variables at their corresponding sample means. Thus, previous
financial restatements increase the likelihood of takeover bids being withdrawn by almost 88
percent relative to takeover bids to non-restating targets.
Columns (1) and (2) further show that the likelihood that takeover bids will be withdrawn is
negatively correlated with firm size, tender offers, and the existence of target termination fee
clauses, and positively associated with institutional ownership, insider holdings, the presence of
multiple bidders, hostile bids, and diversifying mergers. There is also a higher likelihood of
withdrawal with increasing percentage of stock used in the acquisition. The signs of the
2
coefficients on the control variables and the explanatory power of the model (R around 20
percent) are generally consistent with prior evidence (Golubov, Petmezas, and Travlos 2012;
Skaife and Wangerin 2013).

Additional Tests

Financial restatements may not only increase the likelihood of bid withdrawal, but also lead
to a lengthier transaction process. Once the takeover bid is initiated and the acquisition agreement
signed, the bidder begins the due diligence process to verify the targets financial information and
to gain more current information to value the targets assets and liabilities. If the information risk
is higher in takeover attempts of target firms that have previously filed financial restatements,
then we expect the acquirer to exert more effort during the due diligence. Following the prior
literature, we count the number of days between the acquisition announcement and the day of
completion as a proxy for the effort in the due diligence (Wangerin 2012; Marquardt and Zur
2013). We use the decile ranks of this time lag as our dependent variable TIME.
Table 6 presents the OLS regression results for time to completion. We use the same control
variables as before (except for the indicator variables for termination fee clauses), following the prior
literature (Golubov et al. 2012; Wangerin 2012; Marquardt and Zur 2013). Specifically, Column (1)
includes target and deal characteristics as control variables, and Column (2) additionally includes the
misstatement determinant variables from Dechow et al. (2011). The coefficients on RESTATE are
positive and statistically significant in both specifications (0.56 and 0.73, both p 0.04), suggesting
that transactions involving restating targets take significantly longer to complete. We interpret this as
evidence that bidders exert more effort and care in the due diligence for acquisitions of targets with
higher information risk. Wangerin (2012) provides corroborating evidence using other target
characteristics as proxies for information risk, and Marquardt and Zur (2013) similarly find a negative
relation between accounting quality and time to

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20 Amel-Zadeh and Zhang

TABLE 5
Likelihood to Withdraw

Panel A: Univariate Test Results


WITHDRAW
RESTATE 0 1 Total
0 1,837 273 2,110
[87.1%] [12.9%] [92.9%]
1 128 33 161
[79.5%] [20.5%] [7.1%]
Total 1,965 306 2,271
[86.5%] [13.5%]
v2 7.33***
p-value 0.00

Panel B: Logistic Regression Results


(1) (2)

Coefficient v2 p-value Coefficient v2 p-value


RESTATE 0.71 7.45*** 0.01 0.59 3.96** 0.05
SIZE 0.15 10.01*** 0.00 0.14 7.17*** 0.01
BM 0.01 1.21 0.27 0.02 2.49 0.11
EP 0.02 1.29 0.26 0.03 2.62 0.11
LEVERAGE 0.16 0.22 0.64 0.12 0.11 0.75
SGROW 0.05 0.92 0.34 0.04 0.25 0.62
LIQUIDITY 0.19 0.15 0.70 1.15 1.37 0.24
TANG 0.57 1.30 0.25 2.16 4.56** 0.03
ROA 0.20 0.26 0.61 0.09 0.06 0.81
GRDUMMY 0.22 2.41 0.12 0.19 1.20 0.27
INST 0.71 5.46** 0.02 0.69 3.21* 0.07
INSIDER 1.77 3.96** 0.05 0.95 1.10 0.29
MBID 2.27 143.04*** 0.00 2.24 77.82*** 0.00
HOST 2.89 76.82*** 0.00 2.77 55.62*** 0.00
DIV 0.55 15.95*** 0.00 0.66 21.44*** 0.00
TENDER 0.74 8.69*** 0.00 0.76 7.32*** 0.01
PCTSTOCK 0.01 20.95*** 0.00 0.01 13.97*** 0.00
ATERM 0.33 2.12 0.15 0.29 2.53 0.11
TTERM 0.81 14.68*** 0.00 0.94 12.80*** 0.00
Intercept 2.52 30.52*** 0.00 4.39 18.22*** 0.00
Further controls No Yes
Year dummies Yes Yes
Obs. 2,271 1,654
R2 20.01% 22.01%
*, **, *** Indicate two-sided significance levels of 10 percent, 5 percent, and 1 percent, respectively.
2
This table is based on 2,271 takeover bids during 20022009. Panel A reports the v test for the contingent distribution between
WITHDRAW and RESTATE. RESTATE equals 1 if the target firm filed restatements in the year prior to the bid announcement,
and 0 otherwise. WITHDRAW equals 1 if the bid is coded as withdrawal by SDC, and 0 otherwise. Panel B reports logistic
regression results on the dependent variable WITHDRAW. Column (2) includes determinant variables for financial restatements
from Dechow et al. (2011) as controls (coefficient estimates not tabulated), in addition to
(continued on next page)

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Consequences of Financial Restatements: Evidence from the Market for Corporate Control 21

TABLE 5 (continued)

variables included in Column (1). All regressions control for year fixed effects. All variables are measured at the end of
the fiscal year prior to the takeover announcements. All continuous variables are winsorized at 1 percent and 99 percent.
Standard errors are clustered at the industry level.
All variables are defined in Appendix A.

completion. Consistent with the prior literature, bids involving larger targets, targets with higher
leverage, higher profitability, higher percentage of stock used as payment, as well as hostile bids,
take longer to complete. On the other hand, targets with higher sales growth, higher insider
holdings, and higher institutional ownership are associated with a shorter time to completion.
To summarize, the results in this section suggest that acquirers are not only less likely to make
takeover bids to restating firms, but if they make bids to such firms, then the bids are also more

TABLE 6
Time to Deal Completion
(1) (2)
Coefficient t-stat p-value Coefficient t-stat p-value
RESTATE 0.56 2.13** 0.04 0.73 2.12** 0.04
SIZE 0.36 6.72*** 0.00 0.39 6.37*** 0.00
BM 0.00 1.43 0.16 0.00 0.70 0.48
EP 0.00 1.46 0.15 0.00 0.34 0.73
LEVERAGE 0.78 1.91* 0.06 0.73 1.77* 0.08
SGROW 0.17 2.30** 0.02 0.18 1.86* 0.07
LIQUIDITY 0.33 0.49 0.62 0.88 1.06 0.30
TANG 0.28 0.45 0.65 0.72 0.75 0.46
ROA 1.15 3.06*** 0.00 0.47 1.12 0.27
GRDUMMY 0.28 2.13** 0.04 0.13 0.72 0.47
INST 1.55 3.37*** 0.00 0.44 1.39 0.17
INSIDER 2.21 2.57*** 0.01 0.15 0.18 0.86
MBID 0.56 1.27 0.21 0.99 2.61*** 0.01
HOST 3.82 6.02*** 0.00 3.38 4.45*** 0.00
DIV 0.16 0.74 0.46 0.09 0.60 0.55
TENDER 2.78 9.00*** 0.00 2.33 10.30*** 0.00
PCTSTOCK 0.02 6.06*** 0.00 0.02 6.10*** 0.00
Intercept 4.37 9.79*** 0.00 4.23 3.76*** 0.00
Further controls No Yes
Year dummies Yes Yes
Obs. 1,595 1,122
R2 29.62% 30.47%
*, **, *** Indicate two-sided significance levels of 10 percent, 5 percent, and 1 percent, respectively.
This table reports results of OLS regressions on the dependent variable TIME, which is the decile rank of the number of
days from announcement to completion of the takeover. RESTATE equals 1 if the target firm filed restatements in the year
prior to the bid announcement, and 0 otherwise. The sample period is 20022009. Column (2) includes determinant
variables for financial restatements from Dechow et al. (2011) as controls (coefficient estimates not tabulated), in addition
to variables included in Column (1). All regressions control for year fixed effects. All continuous variables are winsorized
at 1 percent and 99 percent. All variables are measured at the end of the fiscal year prior to the takeover announcements.
Standard errors are clustered at the industry level. All variables are defined in Appendix A.

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22 Amel-Zadeh and Zhang

likely to be withdrawn. Furthermore, we find evidence that takeover offers for restating targets
require more effort from the bidder during the due diligence and take longer to complete. These
results provide further support to the conjecture that financial restatements and the resulting high
information risk introduce frictions to the market for corporate control, impeding the efficient
allocation of economic resources.

VI. FINANCIAL RESTATEMENTS AND TAKEOVER DEAL VALUATIONS

Research Design and Descriptive Statistics

We examine whether takeover bids for restating targets are associated with lower takeover deal
valuation. Following Officer (2007), we examine valuation ratios provided by the SDC database: deal
value excluding assumed liabilities to EBITDA, deal value excluding assumed liabilities to sales, and
offer price to book value per share. As explained in more detail in Section II, we focus on valuation
multiples instead of market-based measures to understand how financial restatements affect the
decision making by acquiring firms. Our control variables follow the prior literature and include both
target and deal characteristics (Moeller et al. 2004; Officer 2007; Betton et al. 2008).
Descriptive statistics and univariate tests for the three ratios are provided in Table 7, Panel A.
15
For the ratio of deal value to EBITDA, the mean and the median of the 105 deals involving
restating targets are 14.41 and 9.83, respectively, versus a mean of 19.70 and median of 11.06 for
the 1,343 deals involving non-restating targets, where only the difference in means is statistically
significant (at the 0.01 level). For the second ratio, deal value to sales, the mean (median) for the
141 deals involving restating targets is 1.77 (1.31) versus a mean (median) of 3.01 (1.67) for the
1,852 deals involving non-restating targets. The differences in means and medians are both
statistically significant at the 0.01 and 0.05 levels, respectively. For offer price to book value per
share, the means and medians are lower for the 127 acquisitions of restating targets (2.96 and
2.28, respectively) than for the 1,689 acquisitions of non-restating targets (3.39 and 2.34,
respectively), but the differences are not statistically significant.

Empirical Results

Table 7, Panels B, C, and D report OLS regression estimates on the deal valuation ratios.
Column (1) includes target and deal characteristics as controls, and Column (2) additionally
includes restatement determinants from Dechow et al. (2011) (coefficients suppressed in the
table). In Panel B, the dependent variable is the ratio of deal value to EBITDA. The results are
based on a sample of 1,448 and 1,056 takeovers with non-missing data, respectively. The
coefficients on RESTATE are 3.40 (p 0.03) and 6.57 (p , 0.01), respectively, suggesting that,
ceteris paribus, takeover bids for restating targets have, on average, lower deal values by about
five times of EBITDA (the average of 3.40 and 6.57). Considering that the average ratio of deal
value to EBITDA for acquisitions of non-restating targets (reported in Table 7, Panel A) is 19.70,
this represents a discount of about 25 percent.

15 This earnings-based multiple should be interpreted with caution because it is truncated and only meaningful and
reported by SDC when EBITDA is positive, which is why we also examine non-earnings-based multiples. One possible
way to address this issue is to use the inverted ratio by dividing EBITDA with deal value excluding assumed liabilities,
each reported by SDC individually. However, the inverted ratios are not a linear transformation of the original valuation
ratios, which can change the relation between these deal multiples and our independent variables, especially
considering that we estimate a linear regression. Moreover, the inverted ratios are not what investors use for valuation
and, thus, may not be helpful in understanding acquirers valuation of the target. In untabulated analyses, we use the
inverted ratio EBITDA to deal value as our dependent variable. RESTATE is insignificant in this specification.

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Consequences of Financial Restatements: Evidence from the Market for Corporate Control 23

TABLE 7
Ratios of Takeover Offer Prices to Fundamentals
Panel A: Univariate Test Results
Variable n Mean Median P25 P75 Std. Dev.

RESTATE 1
Deal Value/EBITDA 105 14.41*** 9.83 6.72 16.20 17.33
Deal Value/Sales 141 1.77*** 1.31** 0.59 2.49 1.65
Offer Price/Book Value 127 2.96 2.28 1.56 3.28 2.87
RESTATE 0
Deal Value/EBITDA 1,343 19.70 11.06 6.70 18.04 35.73
Deal Value/Sales 1,852 3.01 1.67 0.68 3.26 5.76
Offer Price/Book Value 1,689 3.39 2.34 1.48 3.59 5.45

Panel B: Regression Results (Dependent Variable: Deal Value/EBITDA)


(1) (2)
Coefficient t-stat p-value Coefficient t-stat p-value

RESTATE 3.40 2.25** 0.03 6.57 3.51*** 0.00


SIZE 0.15 0.18 0.86 0.07 0.10 0.92
BM 0.03 0.58 0.56 0.03 0.61 0.54
EP 0.07 1.30 0.20 0.08 1.33 0.19
LEVERAGE 12.86 1.83* 0.07 7.31 1.36 0.18
SGROW 6.60 1.37 0.18 7.10 1.81* 0.07
LIQUIDITY 20.18 1.88* 0.06 3.33 0.49 0.62
TANG 1.65 0.37 0.71 48.59 4.23*** 0.00
ROA 75.06 4.42*** 0.00 97.01 5.20*** 0.00
GRDUMMY 2.15 1.08 0.28 1.26 0.66 0.51
INST 10.42 2.35** 0.02 1.56 0.42 0.68
INSIDER 5.41 0.63 0.53 8.86 0.89 0.38
MBID 0.27 0.08 0.94 2.58 0.96 0.34
HOST 3.33 1.38 0.17 3.47 1.51 0.14
DIV 2.28 1.09 0.28 4.72 3.16*** 0.00
TENDER 7.49 2.00** 0.05 2.30 1.34 0.19
PCTSTOCK 0.07 3.29*** 0.00 0.01 0.53 0.60
Intercept 13.54 2.02** 0.05 64.09 6.99*** 0.00
Further controls No Yes
Year dummies Yes Yes
Obs. 1,448 1,056
R2 13.03% 30.32%

Panel C: Regression Results (Dependent Variable: Deal Value/Sales)


(1) (2)
Coefficient t-stat p-value Coefficient t-stat p-value

RESTATE 0.80 2.51*** 0.01 0.87 2.24** 0.03


SIZE 0.50 5.58*** 0.00 0.50 3.62*** 0.00
BM 0.00 0.72 0.48 0.01 1.22 0.23
(continued on next page)

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24 Amel-Zadeh and Zhang

TABLE 7 (continued)
(1) (2)
Coefficient t-stat p-value Coefficient t-stat p-value
EP 0.00 0.67 0.51 0.00 0.49 0.63
LEVERAGE 0.49 0.45 0.65 0.01 0.01 0.99
SGROW 1.36 1.58 0.12 1.53 1.12 0.27
LIQUIDITY 3.08 1.90* 0.06 6.60 3.15*** 0.00
TANG 0.87 1.51 0.14 12.18 3.01*** 0.00
ROA 5.21 2.08** 0.04 4.97 2.58*** 0.01
GRDUMMY 0.35 1.02 0.31 0.24 1.01 0.32
INST 0.03 0.04 0.97 0.43 1.09 0.28
INSIDER 1.45 1.96** 0.05 1.17 1.21 0.23
MBID 0.26 0.72 0.48 0.70 1.50 0.14
HOST 0.28 0.39 0.70 0.62 0.66 0.51
DIV 0.15 0.50 0.62 0.19 0.50 0.62
TENDER 0.89 2.68*** 0.01 0.83 2.64*** 0.01
PCTSTOCK 0.01 1.45 0.15 0.01 1.26 0.21
Intercept 1.11 0.88 0.38 14.58 3.47*** 0.00
Further controls No Yes
Year dummies Yes Yes
Obs. 1,993 1,451
R2 13.25% 23.10%

Panel D: Regression Results (Dependent Variable: Offer Price/Book Value)


(1) (2)
Coefficient t-stat p-value Coefficient t-stat p-value

RESTATE 0.51 1.45 0.15 0.33 0.94 0.35


SIZE 0.29 1.64 0.11 0.51 1.99** 0.05
BM 0.08 2.24** 0.03 0.13 1.45 0.15
EP 0.06 1.02 0.31 0.04 0.82 0.41
LEVERAGE 5.78 1.87* 0.07 8.21 2.52*** 0.01
SGROW 0.44 1.93* 0.06 0.30 0.91 0.36
LIQUIDITY 2.47 2.21** 0.03 5.23 3.06*** 0.00
TANG 0.21 0.19 0.85 0.34 0.19 0.85
ROA 1.75 1.22 0.23 2.01 1.40 0.17
GRDUMMY 0.18 0.54 0.59 0.38 1.05 0.30
INST 0.49 0.72 0.47 0.98 1.38 0.17
INSIDER 0.45 0.52 0.60 0.10 0.10 0.92
MBID 0.12 0.28 0.78 0.31 0.71 0.48
HOST 0.64 2.54*** 0.01 0.72 2.66*** 0.01
DIV 0.07 0.28 0.78 0.33 1.65* 0.10
TENDER 0.75 2.16** 0.04 0.20 0.62 0.54
PCTSTOCK 0.00 0.43 0.67 0.00 0.02 0.98
Intercept 0.52 0.46 0.64 3.00 1.22 0.23
Further controls No Yes
Year dummies Yes Yes
Obs. 1,815 1,292
R2 6.13% 10.58%
(continued on next page)

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Consequences of Financial Restatements: Evidence from the Market for Corporate Control 25

TABLE 7 (continued)

*, **, *** Indicate two-sided significance levels of 10 percent, 5 percent, and 1 percent, respectively.
This table is based on takeover bids during 20022009. RESTATE equals 1 if the target firm filed financial restatements
in the year prior to the bid announcement, and 0 otherwise. Panel A shows descriptive statistics and univariate tests for
restating and non-restating firms. Tests of differences are based on t-tests for means and Wilcoxon tests for medians.
Panels BD report OLS regressions on three different transaction valuation multiples of the target firm. Deal values
exclude assumed liabilities. Column (2) includes determinant variables for financial restatements from Dechow et al.
(2011) as controls (coefficient estimates not tabulated), in addition to variables included in Column (1). All regressions
control for year fixed effects. All variables are measured at the end of the fiscal year prior to the takeover announcements.
All continuous variables are winsorized at 1 percent and 99 percent. Standard errors are clustered at the industry level. All
variables are defined in Appendix A.

In Table 7, Panel C, the dependent variable is the ratio of deal value to sales, and the sample
size is 1,993 for Column (1) and 1,451 for Column (2). In both columns, the coefficient on
RESTATE is significantly negative ( 0.80 and 0.87, p 0.01 and p 0.03, respectively).
Compared to the mean deal value to sales ratio of 3.01 for non-restating targets, on average,
restating targets are offered an approximately 28 percent discount. In Panel D, the dependent
variable is the ratio of offer price to book value per share. The coefficients on RESTATE are
negative, albeit insignificantly so ( 0.51 and 0.33, p 0.15 and p 0.35, respectively). Table 7,
Panels B, C, and D also provide some evidence (although not in all specifications) that takeover
deal valuations are increasing in target firms size, leverage, sales growth, liquidity, and for tender
offers, but decreasing in the target firms tangibility, ROA, insider holdings, for hostile bids, and
diversifying deals, which is broadly consistent with the prior literature (Moeller et al. 2004;
Officer 2007; Betton et al. 2008).
Overall, we find some evidence, albeit not consistently strong across different measures, that
targets that have previously restated their financial statements are valued at lower deal multiples by
acquirers than similar non-restating targets. Although one has to exercise caution in interpreting these
deal multiples, these results complement our earlier analyses by showing that financial restatements not
only affect the likelihood of takeover, but also the valuation of restating firms, consistent with the
notion that the higher information risk of restating targets increases their cost of capital.

VII. CONCLUDING REMARKS


In this study, we examine the consequences of financial restatements for the market for
corporate control. We find that firms that recently filed financial restatements are significantly less
likely to become takeover targets than a sample of matched non-restating firms. Our results
further show that takeover bids made to restating firms are also more likely to be withdrawn, and
take longer to complete, than takeover bids to non-restating firms. Finally, there is some evidence
that deal value multiples of completed acquisitions are significantly lower for restating targets
than for target firms that did not previously restate their earnings.
Our results complement prior research on the economic consequences of financial
restatements by showing that financial restatements affect takeover decisions and valuations in the
market for corporate control. We show that higher information risk after restatement filings deters
potential bidding firms from correcting inefficiencies within restating firms via the forces of the
disciplinary takeover.

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APPENDIX A
Variable Definitions
Variable Definition
ATERM Indicator variable equal to 1 if there is a termination fee clause for the acquirer
in place, and 0 otherwise (data from SDC).
LEASE/BACKDATING Indicator variable equal to 1 if the restatement is related to stock options
backdating or lease accounting, and 0 otherwise (data from Audit Analytics).
BM Book-to-market ratio [CEQT/(PRCC CSHO)].
DIV Indicator variable equal to 1 if takeover is diversifying, and 0 otherwise, where
diversification is based on two-digit SIC codes.
EP Earnings-to-price ratio [EPSPX/PRCC].
ERROR Indicator variable equal to 1 if the restatement is due to error based on GAO
restatements provided by Hennes et al. (2008), and 0 otherwise.
FRAUD Indicator variable equal to 1 if the restatement is due to fraud as identified by
Audit Analytics, and 0 otherwise.
GRDUMMY Growth-resource mismatch dummy following Palepu (1986). Equal to 1 for
firms with low growth (SGROW), high liquidity (LIQUIDITY), and low
leverage (LEVERAGE) or for firms with high growth, low liquidity, high
leverage, and 0 otherwise, where low and high for each variable is defined
relative to Compustat median in the year.
HOST Indicator variable equal to 1 if takeover bid is classified as hostile, and 0
otherwise (data from SDC).
(continued on next page)

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Consequences of Financial Restatements: Evidence from the Market for Corporate Control 29

APPENDIX A (continued)
Variable Definition

INSIDER Percentage of insider holdings (data from Thomson Reuters).


INST Percentage of institutional ownership (data from Thomson Reuters).
IRREGULARITY Indicator variable equal to 1 if the restatement is due to irregularity based on
GAO restatements provided by Hennes et al. (2008), and 0 otherwise.
LEVERAGE Financial leverage [(DLTT DLC)/AT].
LIQUIDITY Liquidity [(CHE RECT)/AT].
LITI Indicator variable equal to 1 if restating firm has been subject to shareholder
litigation in the year around the restatement filing, and 0 otherwise (data from
Billings [2010]).
MBID Indicator variable equal to 1 if multiple bidders are involved in the takeover
process, and 0 if only one bidder is involved (data from SDC).
NOLITI Indicator variable equal to 1 if restating firm has not been subject to shareholder
litigation in the year around the restatement filing, and 0 otherwise (data from
Billings [2010]).
OTHER Indicator variable equal to 1 if the restatement is not related to either stock
options backdating or lease accounting, and 0 otherwise (data from Audit
Analytics).
PCTSTOCK Percentage of stock offered as payment in the acquisition by the bidding firm
(data from SDC).
RESTATE Indicator variable equal to 1 if firm has restated earnings, and 0 otherwise (data
from Audit Analytics).
ROA Return on assets [INCOME/AT].
SGROW Sales growth rate [SALEt/SALEt 1 1].
SIZE Natural logarithm of market value of equity [PRCC CSHO].
TAKEOVER Indicator variable equal to 1 if firm has received a takeover offer, and 0
otherwise (data from SDC).
TANG Tangibility [PPENT/AT].
TENDER Indicator variables equal to 1 if takeover classified as tender offer, and 0
otherwise (data from SDC).
TIME Decile rank of the number of days from announcement of the takeover to
completion (data from SDC).
TTERM Indicator variable equal to 1 if there is a termination fee clause for the acquirer
in place, and 0 otherwise (data from SDC).
TURNOVER Indicator variable equal to 1 if the firm experiences a change in CEO in the
event year, and 0 otherwise (data from ExecuComp).
WEAKIC Indicator variable equal to 1 if the firm reports ineffective internal control based
on Section 302 or 404 disclosures required by the Sarbanes-Oxley Act, and 0
otherwise (data from Audit Analytics).
WITHDRAW Indicator variable equal to 1 if takeover offer has been withdrawn, and 0
otherwise (data from SDC).

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January 2015
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