Journal of Financial and Quantitative Analysis

Research Articles

Do Investors See through Mistakes in Reported Earnings?

Katsiaryna Salavei Bardosa1, Joseph Goleca2 and John P. Hardinga3

a1 Dolan School of Business, Fairfield University, 1073 N. Benson Rd., Fairfield, CT 06824.

a2 School of Business, University of Connecticut, 2100 Hillside Rd., Unit 1041, Storrs, CT 06269.

a3 School of Business, University of Connecticut, 2100 Hillside Rd., Unit 1041, Storrs, CT 06269.


This study investigates whether investors see through materially misstated earnings, and whether they anticipate earnings restatements. For firms that restate at least one annual report, we find that investors are misled by mistakes in reported earnings at the time of initial earnings announcements. Investors react positively to the component of the favorable earnings surprise that will subsequently be restated, and they attach the same valuation to it as to the true earnings surprise. We also find that investors anticipate the subsequent downward restatements and start marking stock prices down several months before a restatement announcement, so that the full impact of a restatement is about three times as large as the restatement announcement effect. Indeed, we show that investors punish restating firms because the stock price gains that shareholders enjoy when firms initially announce overstated earnings are more than reversed by the time of the restatement announcement.

(Online publication June 07 2011)


We are grateful to Paul Malatesta (the editor) and an anonymous referee for comments that substantially improved the paper. We thank Brandon Cline, Assaf Eisdorfer, Robert Faff, Carmelo Giaccotto, Neeraj Gupta, James Hilliard, Kose John, Andy (Young Han) Kim, Stanley Veliotis, Michael Willenborg, Nataliya Zaiats, and seminar participants at the Securities and Exchange Commission, the 19th Financial Management Association (FMA) Corporate Roundtable, the 2009 European Financial Management Association, the 2008 Eastern Finance Association, and the 2006 FMA doctoral student seminar. We are grateful to Reilly White, Alain Krapl, and especially Svitlana Pedorych for their research assistance. Earlier versions of the paper circulated under the title “Do Investors See through Mistakes in Financial Statements? Long-Run Evidence from Restatements.”