- 08 Nov 2012
- Working Paper Summaries
Admitting Mistakes: Home Country Effect on the Reliability of Restatement Reporting
Executive Summary — The authors study restatements by foreign firms listed in the US, compare the extent of restatements by the foreign firms to that of domestic US firms, and examine the role of home country characteristics on the likelihood of the foreign firms restating their financials. When foreign firms list in the US, they become subject to the same accounting rules and regulations as US firms. However, results suggest that foreign firms listed in the US restate significantly less than comparable US firms. This difference is not because the foreign firms have superior accounting quality but because of opportunistic avoidance of issuing a restatement. The difference is driven primarily by firms originating from countries with weaker institutions. Overall, findings imply that restatements are a less accurate measure of the extent of reporting problems in an international setting compared to US domestic firms. Key concepts include:
- Foreign firms listed in the US are subject to a less rigorous monitoring and enforcement regime than domestic US firms.
- Weaker institutions in the firm's country of origin lower financial reporting quality of foreign firms accessing US markets, despite a common set of US rules and enforcement that apply to all foreign firms.
- An accurate reflection of accounting quality through restatement reporting is a necessary information mechanism for the US Securities and Exchange Commission (SEC) and investors to hold managers and auditors accountable. Fewer restatements can lead to a lower level of scrutiny, which is a concern from the point of view of investor protection.
We study the frequency of restatements by foreign firms listed on the U.S. exchanges. We find that the restatement rate by U.S. listed foreign firms is significantly lower than that of comparable U.S. firms and the difference depends on the home country characteristics of the foreign firm. Foreign firms from countries with a weak rule of law are less likely to restate than firms from strong rule of law countries are, despite companies from the weaker rule of law countries having higher levels of earnings management. After controlling for the materiality of the restatement, firms from weak rule of law countries are more likely to opt for less visible restatement disclosure methods. We interpret these findings as home country enforcement affecting firms' likelihood of reporting existing accounting irregularities. This suggests that for U.S. listed foreign firms, less frequent restatements can be a signal of opportunistic reporting rather than high quality earnings.