Are Financially Constrained Firms More Prone to Financial Restatements?

60 Pages Posted: 31 Jul 2018

See all articles by Robert M. Bowen

Robert M. Bowen

Chapman University - The George L. Argyros School of Business & Economics; University of Washington - Foster School of Business

Shantanu Dutta

The University of Ontario Institute of Technology (UOIT)

Pengcheng Zhu

University of San Diego

Date Written: July 10, 2018

Abstract

We examine the association between firms’ financial constraints and potentially value- destroying financial restatements. How financial constraints affect managerial behavior has been labeled as a core issue in accounting and finance. Ex-ante, the nature of the relation between financial constraints and financial restatements is unclear and remains unexplored in the literature.

We find that financially constrained firms are more prone to restate their financial statements. We examine two explanations for this relation. First, consistent with managerial opportunism, we find that among financially constrained firms, weaker firm performance, greater financial leverage, and greater informational complexity are associated with higher discretionary accruals and more restatements. Second, consistent with managerial signalling, we find that although firms with greater investment opportunities and financing needs have higher discretionary accruals, they are not associated with more restatements. These firms signal positive prospects through earnings management while avoiding GAAP violations that could trigger restatements. Finally, we find that a financial constraint measure based on textual analysis outperforms traditional metrics used in most prior research.

Keywords: financial constraints, restatements, discretionary accruals, firm performance, informational complexity, financial leverage, investment opportunities, financing needs, text-based measures

JEL Classification: M41; M48; G30; G34

Suggested Citation

Bowen, Robert M. and Dutta, Shantanu and Zhu, Pengcheng, Are Financially Constrained Firms More Prone to Financial Restatements? (July 10, 2018). Available at SSRN: https://ssrn.com/abstract=3211497 or http://dx.doi.org/10.2139/ssrn.3211497

Robert M. Bowen (Contact Author)

Chapman University - The George L. Argyros School of Business & Economics ( email )

333 N. Glassell
Orange, CA 92866
United States
206.334.0911 (Phone)

HOME PAGE: http://www.chapman.edu/our-faculty/robert-bowen

University of Washington - Foster School of Business ( email )

Box 353226
University of Washington
Seattle, WA 98195-3226
United States
206.334.0911 (Phone)

HOME PAGE: http://foster.uw.edu/faculty-research/directory/robert-bowen/

Shantanu Dutta

The University of Ontario Institute of Technology (UOIT) ( email )

2000 Simcoe Street North
Oshawa, Ontario L1H 7K4
Canada

Pengcheng Zhu

University of San Diego ( email )

5998 Alcala Park
San Diego, CA 92110-2492
United States

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