Summary
1. In recent months, there are already 60+ firms have come under scrutiny for past stock-option grants.
2. About a third of them decided to restate their financial reports upon the investigation.
3. For these restated firms, market seemed to be reacting weakly towards the news.
Analysis
Up to today, 60+ firms have come under scrutiny for their past stock-option grants, and about a third of them decided to restate their financial reports upon the investigation. How is the stock market reacting towards such news?
Using the 16 restatement firms from the WSJ table (by July 18th) and Dow-Jones Industrial Average as a benchmark, I looked into few simple tests and found that stock market actually reacted mildly upon such specific restatement events, compared to other restatements due to what I call "normal" accounting problems, such as accounting irregularities, fraud, violation of GAAP, etc.
The mean and median of (-1, +1) around event day's cumulative abnormal returns, CARs, (against DJIA) are -2.86% and -2.01%, mainly skewed by 2 firms' stock performance: Comverse Technology and Vitesse Semiconductor. No systematic pattern is found by browsing individual stock's performance. CARS of (+1, +5) shows not very attractive investment opportunities, with mean and median of -1.42% and -1.21%. For many other normal types of restatements, stock market reacts on average of -12% using 25 years of historical data!
Such mild (negative) market reaction is not surprising to me actually! I could see few reasons to explain such phenomenon. First of all, market may have already anticipated possible restatements when the regulator started to pay attention on the issue early of the year. Secondly, this type of restatements is indeed specific issue related and a one-time event. Actually, this is NOT the first time that similar situation has happened. SEC's crackdown of the improper accounting treatment of in process research and development (IP R&D) during 97-98, implementation of SAB101 in 2001-02, etc. are all, to me similar to the current stock-option event, in terms of their reflection into the stock market. Thirdly, some sophisticated investors have the capability to identify these grey-area issues and make their own adjustments, if not perfect ones, in their analysis.
