Investors’ Reactions to Revision Restatements: An Examination of Investment Position and Quantitative Reconciliation

Abstract

Revision restatements are a growing phenomenon in which firms correct errors related to prior financials. Revision restatements are permitted only when firms consider the errors individually immaterial for the periods in which they occurred, but material when combined across periods. Unlike reissuance restatements, firms do not issue a stand-alone filing but instead simply correct the historical values in the next set of issued financial statements. Archival research finds that revision restatements predict negative firm outcomes, such as future material errors and material weaknesses. I draw from psychology and accounting research to predict that investors fail to fully process these restatements. Using an experiment, I find that when a firm corrects prior earnings downward, prospective investors update their beliefs more than current investors and consider the errors to be more material. When the firm makes the revision restatement easier to process by providing a quantitative reconciliation, there is a greater increase in how much prospective investors update their beliefs compared to current investors, who do not update at all. This study contributes to the emerging literature on revision restatements, the existing accounting literature on the continued influence effect, motivated reasoning and quantitative reconciliations, and the regulatory debate on materiality.