Material Weakness Disclosures and Restatement Announcements

We examine the joint pricing effects of restatement announcements and associated MW disclosures. First, we analyze whether a dual disclosure of both a MW and restatement is viewed more adversely by the market at the time of restatement. We show that firms that announce both a restatement and an associated MW, either before, concurrent with, or after the restatement experience significantly more negative returns and a higher increase of implied volatility than do firms whose restatements were not associated with an MW disclosure. We also find that the joint disclosure of a MW and restatement triggers more class action lawsuits than does a single disclosure of a MW. Second, we examine the PCAOB’s premise that MW disclosures are warnings of potential financial misstatements by examining the market reaction to restatements conditional on prior MW disclosures. Our evidence suggests that the market reacts more negatively to restatements that are preceded by a MW disclosure compared to restatements that went unwarned. Overall, our study provides new insights on how capital market participants incorporate information about internal control quality into their perceptions about financial reporting quality.