Summary Burks (2011)

Are investors confused by restatements after Sarbanes-Oxley?

Jeffrey J. Burks

Introduction

There has been a sharp increase in the number of accounting restatements since passage of the Sarbanes-Oxley Act. Regulators argue that this could lead by investors to ‘confusion’ over the quality of the financial reports. So the question of the paper is: Are investors confused by the increase in restatements after SOX?

Two tests:

- The pricing tests examine whether investors systematically over- or under-react to restatements. This is done by examining long-run stock price drifts following restatements.

- The volume tests examine whether there is an increase in trading volume after controlling for price movements around post-SOX restatements announcements. The reason for this second test is that the pricing test may not detect investor confusion because prices aggregate investor beliefs.

 Research objective: This study looks for signs of investor confusion in the price and volume reactions to post-SOX restatements.

Why is this paper relevant? It helps regulators assess whether investor confusion is a valid rationale for curtailing restatements.

Contribution of the paper:

- This study contributes to the debate between regulators and investor groups over proposed reforms that would curtail the use of restatements for accounting errors.

- The study also informs a broader standard-setting question about investors’ capacity to process restatements for accounting changes other than error corrections.

Background

Controversy over the increase in restatements after SOX

Studies by GAO (US government accountability office) of the period 1997 to 2005 show a marked increase in restatements beginning in 2002. Not only SOX was the cause but also the related high-profile accounting scandals (Enron and Worldcom) likely prompted managers and auditors to become more alert in detecting and correcting accounting errors. Because of the possible investor...