What caused long-horizon drifts? An analysis of expert expectations and information in earnings restatement announcements

Abstract

We investigate long-term stock price drifts following earnings restatements due to accounting frauds and irregularities. Efficient market hypothesis (EMH) predicts that capital markets respond to the restatement announcements quickly because of ensuing serious economic consequences. We find share returns of restatement firms continued to drift downward by 27 % compared to benchmark portfolios over the course of 36 months after the announcements. The downward drifts are positively associated with analysts’ over-optimistic earnings forecasts. Thus, the drifts do not seem spurious. However, the long-term price drifts disappeared after 2002, the year of many high-profile accounting frauds and the eventual passage of Sarbanes-Oxley Act (SOX). Evidence suggests that the analysts were able to more accurately forecast earnings post SOX. Because of the impact on stock price valuation, we argue that regulatory bodies should require a more focused disclosure of restatements related to accounting frauds and irregularities rather than a broad spectrum treatment of earnings restatements.