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The Effect of Accounting Restatements on Earnings Revisions and the Estimated Cost of Capital

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  • Paul Hribar

    (Cornell University)

  • Nicole Thorne Jenkins

    (Washington University in)

Abstract

This paper examines the effect of accounting restatements on a firm's cost of equity capital. We show that, on average, accounting restatements lead to both decreases in expected future earnings and increases in the firm's cost of equity capital. Depending on the model used, relative percentage increases in the cost of equity capital average between 7 and 19% in the month immediately following a restatement. The relative increase in the cost of capital dissipates as time passes and after controlling for analyst forecast biases, but continues to average between 6 and 15% in the most conservative setting. We also show that restatements initiated by auditors are associated with the largest increase in the cost of capital, and that firms with greater leverage experience greater increases in their cost of capital. Overall, our evidence is consistent with accounting restatements lowering the perceived earnings quality of the firm and increasing investors' required rates of return.

Suggested Citation

  • Paul Hribar & Nicole Thorne Jenkins, 2004. "The Effect of Accounting Restatements on Earnings Revisions and the Estimated Cost of Capital," Review of Accounting Studies, Springer, vol. 9(2), pages 337-356, June.
    • Handle: RePEc:spr:reaccs:v:9:y:2004:i:2:d:10.1023_b:rast.0000028194.11371.42
    DOI: 10.1023/B:RAST.0000028194.11371.42
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    References listed on IDEAS

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    1. Paul M. Healy & Amy P. Hutton & Krishna G. Palepu, 1999. "Stock Performance and Intermediation Changes Surrounding Sustained Increases in Disclosure," Contemporary Accounting Research, John Wiley & Sons, vol. 16(3), pages 485-520, September.
    2. Peter Easton & Gary Taylor & Pervin Shroff & Theodore Sougiannis, 2002. "Using Forecasts of Earnings to Simultaneously Estimate Growth and the Rate of Return on Equity Investment," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 40(3), pages 657-676, June.
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    Cited by:

    1. Mark T. Bradshaw & Michael S. Drake & James N. Myers & Linda A. Myers, 2012. "A re-examination of analysts’ superiority over time-series forecasts of annual earnings," Review of Accounting Studies, Springer, vol. 17(4), pages 944-968, December.
    2. Andrew C. Call & Shuping Chen & Bin Miao & Yen H. Tong, 2014. "Short-term earnings guidance and accrual-based earnings management," Review of Accounting Studies, Springer, vol. 19(2), pages 955-987, June.
    3. Juan Manuel García Lara & Beatriz García Osma & Fernando Penalva, 2011. "Conditional conservatism and cost of capital," Review of Accounting Studies, Springer, vol. 16(2), pages 247-271, June.
    4. Gopal V. Krishnan & Bin Srinidhi & Lixin (Nancy) Su, 2008. "Inventory policy, accruals quality and information risk," Review of Accounting Studies, Springer, vol. 13(2), pages 369-410, September.
    5. Cascino, Stefano & Széles, Máté & Veenman, David, 2025. "Does CEO inside debt really improve financial reporting quality?," LSE Research Online Documents on Economics 128078, London School of Economics and Political Science, LSE Library.
    6. Baruch Lev & Stephen G. Ryan & Min Wu, 2008. "Rewriting earnings history," Review of Accounting Studies, Springer, vol. 13(4), pages 419-451, December.
    7. Partha Mohanram & Dan Gode, 2013. "Removing predictable analyst forecast errors to improve implied cost of equity estimates," Review of Accounting Studies, Springer, vol. 18(2), pages 443-478, June.
    8. John Hughes & Jing Liu & Jun Liu, 2009. "On the relation between expected returns and implied cost of capital," Review of Accounting Studies, Springer, vol. 14(2), pages 246-259, September.
    9. Todd Kravet & Terry Shevlin, 2010. "Accounting restatements and information risk," Review of Accounting Studies, Springer, vol. 15(2), pages 264-294, June.
    10. Hemang Desai & Srinivasan Krishnamurthy & Kumar Venkataraman, 2006. "Do Short Sellers Target Firms with Poor Earnings Quality? Evidence from Earnings Restatements," Review of Accounting Studies, Springer, vol. 11(1), pages 71-90, March.
    11. Paul N. Michas & Dan Russomanno & Meiling Zhao, 2025. "The opportunity for partner industry knowledge sharing within audit offices and audit quality," Review of Accounting Studies, Springer, vol. 30(3), pages 2555-2606, September.
    12. Anup Srivastava, 2014. "Selling-price estimates in revenue recognition and the usefulness of financial statements," Review of Accounting Studies, Springer, vol. 19(2), pages 661-697, June.
    13. Alexander Nekrasov & Maria Ogneva, 2011. "Using earnings forecasts to simultaneously estimate firm-specific cost of equity and long-term growth," Review of Accounting Studies, Springer, vol. 16(3), pages 414-457, September.

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