Do Restatements Generate Contagion? A Re-Examination

Prior studies provide conflicting evidence on what accounting restatements reveal about industry peers. Gleason, Jenkins, and Johnson (2008) suggest that restatements reflect contemporaneous earnings management within an industry, whereas Kedia, Koh, and Rajgopal (2015) argue that restatements—especially less severe ones—induce peers to begin misstating earnings. Motivated by these competing views, as well as the increasing prevalence of less severe restatements and advances in monitoring technologies, we re-examine peer firms’ reporting responses to restatements. We replicate the results of both seminal studies. However, we find that the results in Kedia, Koh, and Rajgopal (2015) are sensitive to design choices that affect the measurement of key variables. When this measurement error is minimized, we find no evidence that industry peers begin misstating following restatements. Further, when we use non-restatement-based measures, we find that peers are more likely to exhibit reduced reporting aggressiveness, particularly when prior accrual use is high. This effect is strongest among peers sharing a common auditor office with the restating firm. Overall, industry peers do not appear to increase earnings management following restatements; instead, restatements primarily reflect contemporaneous misreporting, and in some cases lead to less aggressive reporting by peers.