Post-Sarbox, Are Restatements Relevant?

A PCAOB study shows that investors' reactions to a restatement are not as harsh as before Sarbanes-Oxley was enacted.
Sarah JohnsonOctober 16, 2007

Critics of the Sarbanes-Oxley Act have blamed the corporate governance law for the flood of restatement announcements streaming out of companies’ investor relations departments in recent years. Some of these clearly have been necessary, as the adjusted numbers would have a material effect on previously issued financial statements. On the other hand, observers contend, some have been clearly unnecessary and appear to feed the overly cautious approach that Sarbox initially wrought from finance teams and auditors.

However, according to a working paper from the Public Company Accounting Oversight Board, perhaps the larger number of restatements isn’t as much of an issue as how investors perceive them. The impact of announcing an impending restatement has diminished in the post-Sarbox world, according to two PCAOB economists.

The effect of a restatement announcement on a company’s stock price has fallen, and investor confidence in companies’ financials seems stronger, the researchers claim. “Post-SOX, investors behave as if they believe the announcements convey timelier and higher quality information, and leave them with less uncertainty about companies announcing restatements,” wrote senior financial economist Jana Hranaiova and senior financial economist Steven Byers in a report to be discussed by the PCAOB’s advisory group on Thursday.

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The report does not delve into the reasoning behind restatements. The authors acknowledge as undisputed fact that the number of restatements has risen dramatically. According to the U.S. Government Accountability Office, the volume of restatements practically doubled from July 2002 to September 2005.

The PCAOB, which itself was created by the 2002 law, called for the study to explore whether the market has reacted differently to companies’ restatement announcements before and after Sarbox was enacted. The economists looked over 518 announcements from companies listed on the New York Stock Exchange and Nasdaq between 1998 and 2005. They excluded such news from since-collapsed companies (such as Enron) and restatements stemming from changes in accounting standards, stock splits, mergers and acquisitions, issuance of dividends, and other regular business activities.

What they did include were the announcements saying that changes would be have to be made on quarterly and annual financial statements and so-called “stealth” restatements, which companies make without amending their filings, issuing a Form 8-K, or making a public announcement.

They concluded that companies’ net loss in market capitalization following a restatement announcement was an average of $207 million less after Sarbox than before. Negative investor reaction has been reduced by 71 percent during the two days following an announcement, the researchers wrote. Another apparent benefit in the post-Sarbox times is that investors express less uncertainty when a restatement is announced, the report indicated.

For Thursday’s meeting, the PCAOB has asked its Standing Advisory Group to validate some of the report’s findings. In a paper sent to the SAG members, the PCAOB asked why market reactions changed following Sarbox’s enactment, among other questions.

The SAG may want to consider that some of the examined restatements were not material enough to a company’s overall income to warrant making changes to a financial statement in the first place, suggested Hal Scott, a Harvard Law School professor and director of the Committee on Capital Markets Regulation. His group, supported by Treasury secretary Henry Paulson, made several recommendations in a report last year for ways to scale back corporate regulations. “One interpretation for why these restatements are not getting a reaction is because they’re not important,” he told

The number of unnecessary restatements could be reduced over time now that regulators have issued management guidance and a revised auditing standard for the internal-control provision of Sarbox, Scott contended. The revisions reflect a move toward a more risk-based approach and a focus on only those areas that could have a material effect on a company’s financials.

Post-Enron and post-Sarbox, the consequence of issuing a restatement is greater, considering that the Securities and Exchange Commission has more enforcement tools at its disposal. For that reason, a “ho-hum” reaction from investors shows companies could be producing “less meaningful” news than they were previously, Scott said.

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