Accounting restatements and the cost of debt capital

This paper examines bond market reactions to accounting restatement announcements and the impact of the announcements on the cost of restating firms' new bond issues. I collect accounting restatements from 1997 to 2003 and merge them with seasoned bond information and new issue information from the NAIC and FISD databases respectively. I find that the bondholders of restating firms on average react negatively to the restatement news. Cross-sectional analysis of determinants of bond market reactions indicates that the magnitude of negative excess bond returns is positively associated with the magnitude of accounting restatements and negatively associated with bond maturities. Finally, I document that restating firm pay higher premiums for new bonds issued after the restatement announcements relative to bonds issued before the restatement events. The findings of this study fill a void in existing restatement literature in accounting that has focused exclusively on the stock market reactions. Further, to the extent that this study sheds light on the causality relationship between accounting restatements and the cost of debt capital, it also contributes to the growing literature on quality of accounting information and cost of capital. Finally, the finding on the negative relation between excess bond returns and bond maturities contributes to the credit risk literature in finance.