Accounting Restatements:Market And Liquidity Impacts

Along with the development of economy globalization and the rapid development of the securities market, the construction of the securities market has achieved a great leap. The number of listed companies is increasing, attracting a large number of investors, whose investment enthusiasm is particularly high. Among the various factors that affect the reputation of one listed company, the financial report is the most important way to obtain the information of the enterprise and the important basis for the investment decision. The authenticity, integrity, efficiency, relevance and reliability are very important. At the same time, listed companies only in time to disclose the true financial information, it is possible to quickly and effectively promote the formation of healthy securities market. A healthy stock market provides a good trading environment for listed companies and investors so as to form a virtuous circle.Restatement corrects past error and could be viewed as improving reporting quality. Restatement of financial accounts and its consequences are an important issue for investors, auditors, managers and regulators. However, in recent years, the number of firms issuing account restatements with false information is on the rise in China. Restatements of financial accounts cloud the integrity of financial reports. Investors reassess their perspectives about the quality of management internal controls of the firm after accounting restatement. In addition, restating firms could take long term consequences such as litigation risk and changes to management and board.The reasons for accounting restatements include accounting complexity, second guessing of management judgment, proliferation of accounting rules and divergent implementation of guidelines/regulation. Previous researches on accounting restatements showed negative returns on stock prices of restating firms ranging from-4 percent to -10 percent after a restatement announcement. The negative stock market reaction is attributed to increase in information risk because of increased uncertainty about management credibility and transparency of financial statements. The decrease in credibility of management and increase in investors’concerns that management is opportunistically making accounting decisions leads to firm-specific information risk which is non-diversifiable risk factor that enhances the cost of capital.Another important effect of restatements is the liquidity impacts. Information risk may impact trading volume. A high level of information asymmetry will induce managers to manipulate earnings and many studies theorize that investors have difficulty in incorporating the information into asset prices. The reason is that market makers widen the bid-ask spread (a measure of liquidity) in order to protect themselves from other traders who has better information then them and to be compensated for bearing greater risk. Restating firms experience large shareholder losses at restatement announcement and this losses increase the liquidity risk (illiquidity) of the listed companies.There are limited studies to capture the impacts of accounting restatement on stock market and liquidity. Most of the studies relating to the accounting restatement put focus on the essential feature of the company and the type distribution of restatements. The main contribution of the present study is the stock market and liquidity impacts of accounting restatements. This study used 416 accounting restatements of listed companies in Chinese to study the stock market and liquidity impacts at it during 2010 to 2013. The empirical results reported in this chapter shows that stock market reacts negatively at accounting restatement. Market model supports the hypothesis that negative abnormal return would be negative in few days around accounting restatements, significantly. The impacts of accounting restatements on market liquidity is also negative but but this influence is not statistically significant. An analysis of determinants of illiquidity found that size and business cycle of a firm had a significant negative impact on illiquidity.