A large negative stock price reaction to a restatement announcement could imply a significant accounting error, or one made by a firm with a high probability of being sued. We investigate the extent to which market reactions to restatement announcements are explained by litigation risk. We model the simultaneous relation between restatement announcement abnormal returns and litigation risk and find that about half of the −9.2% average restatement announcement effect is due to expected litigation costs. We also find that the significance of the accounting error only affects abnormal return indirectly because it increases the probability of being sued.
Journal of Financial Research
Salavei Bardos, Katsiaryna; Golec, Joseph H.; and Harding, John P., "Litigation Risk and Market Reaction to Financial Statement Restatements" (2013). Business Faculty Publications. 237.
Bardos, Katsiaryna Salavei, Joseph Golec, and John P. Harding. "Litigation risk and market reaction to restatements." Journal of Financial Research 36, no. 1 (2013): 19-42. https://doi.org/10.1111/j.1475-6803.2013.12001.x