Restatements are absolutely relevant and essential, without question

Implications: Restatements are not triggered by Sarbanes-Oxley but are caused by management’s financial statement errors, either deliberate or inadvertent.  Thus, any arguments that restatements are unimportant are fatuous.  These opponents are asserting that it’s suitable public policy to allow managers to publish erroneous statements and then leave them that way. With regard to the lack of market reaction, the researchers face the persistent problem of figuring out when the market reacted.  It is unwise to assume the market doesn’t know about the errors until they’re announced with the result that it’s impossible to know exactly what the market reacted to.   As I see it, managers should embrace restatements as opportunities to clear the air of uncertainty that something in their statements is misleading.  They absolutely should not worry about the cost of restatements.  When compared with the potential effect on market cap, the out of pocket costs are negligible.     

Analysis: Several points in the comment-soliciting question deserve close attention because of bias they may reveal.

For example, I notice the use of the word “flood” to describe the volume of restatements.  “Flood” implies an unwelcome abundance.  Perhaps restatements are actually needed in order to bring more credibility to the markets; if so, this volume is not a flood but a welcome rain of relief.

I also notice that restatements are characterized as appropriate if they are “material to the financial statements.”  That is audit-speak.  What really matters is whether the restatements are material to those who use the statements.  When that perspective is adopted, restatements are relevant even if they’re small because they signal that management is trying to get everything in order, which is a good thing.  

I am curious as to how observers conclude that some restatements have been “clearly unnecessary.”  Because restatements are produced to correct errors (deliberate or accidental), how could any of them be obviously unnecessary?  To say they are not needed is to assert that erroneous financial statements are suitable, so why bother to get them right.

The question also uses the phrase “overly cautious.” One has to ask who is making that call and the consequences of doing so.  Given that security prices are the joint product of many factors, and that those factors include not merely financial statement content but also the credibility of the management, the auditors, GAAP, and the regulatory system, as well as volatile economic factors, how could any caution be excessive?  What comes forth is that the plaintiffs have virtually no understanding of the reasons for restating.

The fact is that restatements are important for two reasons:  providing new financial information and, perhaps more importantly, establishing that the statements are now reliable when they previously were not.  This latter point also comforts the market about the future:  if the management went to the trouble to fix the effects of this error, then perhaps they will take steps in the future to prevent any additional errors.

I also noticed the word “wrought,” which appears to be the past tense of “wring,” which implies that the threat of sanctions was the only thing that forced management to restate.  If this is so, I think the market would really like to know that fact.  A management that freely and openly admits and fixes its mistakes will experience a market premium over those managers that resist telling the truth in their statements.  There really is more to restating than new numbers.

As for the summary comment that the impact of restatement has diminished, I am not at all sure that (a) this summary of the research is valid or (b) the questioner really understands what the research shows, or doesn’t show.  Or what it implies or doesn’t imply.

What the research apparently shows is that the markets are showing less of a reaction to restatements.  That’s only to be expected because more of them are occurring.  To illustrate, I live in a neighborhood that is presently populated by a great many deer, to the point that they are well accepted and tolerated.  It wasn’t always this way, and we used to stop what we were doing and take pictures of this rare phenomenon.

Under the old pre-Sarbanes regime, restatements were tantamount to confessions of serious misdeeds.  They were unexpected and often shocking.  The markets reacted by hammering the stock because something must have been seriously wrong.

Under the new regime, restatements are more frequent because, well, managers now know that they had better restate before they’re found to have not restated.  Their voluntary actions, though somewhat compelled, are much more welcome than the forced confessions that restatements used to represent.

Here is the bottom line:  restatements are absolutely important to the capital markets.  As a result, it will always be in management’s interests to go to the trouble to accomplish them in order to remain credible and to escape the heavy discount that falls on the untrustworthy.  Managers who look at the cost of restating without considering that discount are penny wise and very pound foolish.

In the CFO article, Hal Scott is quoted as saying that the lack of reaction may indicate that restatements are not important.  I encourage him, and others who think like him, to reconsider.  It seems to me that the lack of reaction is proof that they ARE important.  They are now an accepted part of the environment and seen as essential.  You have to ask what would happen if they stopped occurring.  Surely stock prices would decline as a result of the growing uncertainty that errors are not being corrected.

In closing, those managers who would hope to find relief from being held to a high standard by a diminished reaction to restatements are hoping in vain.  Their shareholders will pay either the small cost of restating or the very high cost of a discounted market cap.  The answer is obvious when the issue is put in those terms.