We re-examine the effect of financial restatements on the cost of equity vis-a-vis litigation risk. Specifically, we study the effect of litigation on post-restatement financing costs and whether market anticipates litigation before restatement announcement as evident from its effect on financing costs. In a sample of 91 restatements, although we find that the cost of equity increases subsequent to a financial restatement for all restating firms, the increase is substantially greater for firms facing litigation as a result of the restatement. We also find that investors do not adjust for the cost of equity before the announcement of a financial restatement for firms facing post-restatement litigation. Overall, our findings suggest that most of the increase in the cost of equity after restatement is concentrated in sued sub-sample and that the cost of equity is an important channel through which litigation associated with financial restatement is priced. The economic effect of post-restatement litigation is approximately 259 basis points increase in the firm’s cost of equity.
Applied Financial Economics
Salavei Bardos, Katsiaryna and Mishra, Dev, "Financial Restatements, Litigation, and Implied Cost of Equity" (2013). Business Faculty Publications. 238.
Bardos, Katsiaryna Salavei, and Dev Mishra. "Financial restatements, litigation and implied cost of equity." Applied Financial Economics 24, no. 1 (2014): 51-71. https://doi.org/10.1080/09603107.2013.864033