• Voluntary Financial Restatements: The Perspectives of Management Incentives and Pressures

Abstract

The recent financial misrepresentation and accounting restatements have raised concerns regarding the reliability of financial statements. Financial restatement is the ex-post confirmation of prior poor financial statements, which may provide useful information for evaluating the credibility of present financial statements. This study investigates the incentives and pressures of firms that voluntarily restate financial statements. A sample of 162 financial restatements (117 firms) announced during 1999-2005 is examined by using a logistic regression model. We find that firms are more likely to voluntarily restate their financial statements when the severity of misrepresentation is less material (i.e., the misrepresentation is not irregularity-related, does not violate the revenue recognition principle, and is an earnings understatement or low misrepresented earnings), implying a low restatement proprietary cost and threshold level of disclosure. Next, firm CEOs with less than 1-year tenure are inclined to voluntarily restate prior misrepresented financial statements because of the incentive to respond to expectation management or mandate. Finally, firms with high ratio of outside directors and supervisors, a proxy for board independence, are more likely to restate financial statements voluntarily, suggesting that board independence plays a role in the effective implementation of governance monitoring function after misrepresented financial statements are released.

Keywords: Misrepresentation, Voluntary Restatement, Threshold Level of Disclosure, New CEO, Board Independence