The changes of accounting conservatism around earnings restatements: An analysis of the impact of CEO compensation

Using a sample of earnings restatements, I investigate how accounting conservatism changes after restatement announcements. Using an accrual-based measure of asymmetric timeliness of earnings, I observe an initial increase and a subsequent decrease in the accounting conservatism of restating films during the two years after restatement announcements. I also find that the initial increase in conservatism is associated with a high level of CEO option grants awarded before the announcements, while the subsequent decrease of conservatism is associated with a reduction of CEO option awards during the periods following the announcements. Further analysis reveals that after controlling for the restatement magnitude and the accounting fraud, the relationship between the initial increase in conservatism and the change in CEO option grants becomes insignificant. These results suggest that accounting conservatism may be used as a control mechanism to minimize the agency cost that results from management's opportunistic behavior induced by their compensation contracts. The results also demonstrate the significant role of restatement characteristics in explaining restating firms' financial reporting behavior.