Management Intent and CEO and CFO Turnover around Earnings

Management Intent and CEO and CFO Turnover around Earnings
Restatements: Evidence from the Post-Enron Era
Karen Hennes
Smeal College of Business
Penn State University
[email protected]
Andrew Leone
Smeal College of Business
Penn State University
[email protected]
Brian Miller
Smeal College of Business
Penn State University
[email protected]
First Version: September 2006
Current Version: January 2007
Abstract: This study examines the extent to which management’s intention to mislead investors affects
the probability that CEOs and CFOs are terminated around restatement announcements. Using a sample
of 188 restatements from 8-Ks filed in 2002-2005, we find that turnover rates are extremely high for
intentional violations compared to unintentional ones: observed turnover rates are 5 to 6 times higher
(log-odds are 11 to 25 times higher after controlling for other explanatory variables) for our intentional
GAAP violations than for unintentional violations. This evidence suggests that boards take swift action to
dismiss managers when restatements are the result of intentional misbehavior and that the relatively low
turnover rates documented in earlier restatement research is likely due to the inclusion of unintentional
violations. We also compare the turnover rates in this post-Enron era sample to those of sample of
restatements from 1997-1998, and find that without conditioning on intent, turnover rates appear to have
declined. However, after conditioning on intent, we find that turnover rates are similar across the two
time-periods. We conclude that regulation introduced to encourage boards to discipline managers for
intentional misreporting had little impact on turnover rates. This is likely due to the fact that turnover
rates were already very high in the pre-Enron era (you cannot fix what is not broken). Our findings
highlight the importance of distinguishing restatements by a meaningful measure of severity when
conducting research in a restatement setting and provide some of the first evidence on CEO and CFO
penalties for misreporting in the post-Enron period.
The authors thank the Smeal College of Business for financial support. We also thank Marty Butler, Rich Frankel,
Scott Richardson, Nicole Thorne Jenkins, Tzachi Zach and workshop participants at Barclays Global Investors,
Boston University, Dartmouth College, University of Kentucky, University of Minnesota, Penn State University and
Washington University-St. Louis for helpful comments.
Management Intent and CEO and CFO Turnover around Earnings Restatements: Evidence from
the Post-Enron Era
1.0 Introduction
This study examines the extent to which management’s intent to mislead investors affects the
probability that CEOs and CFOs are terminated around restatement announcements. Our research is
motivated by the fact that, although recent studies report that executive turnover rates around restatements
are statistically significantly different from turnover rates in a control sample of non-restaters, some
question whether the observed turnover rates are too low. 1 Abelson, for example, is one member of the
press who comments that when managers are “manipulating a company’s financial numbers to mislead
investors, the punishment is often anything but sharp and swift” (1996). Further, in a recent study on
restatements, Collins, Reitenga, and Sanchez-Cuevas (2005) conclude that “half the sample appear to
have taken little or no action to penalize management.”
One explanation for the seemingly low turnover rates is that recent studies, such as Collins et al.
(2005), draw from the U.S. General Accounting Office (GAO) database (2003), which contains
substantial variation in the types of the restatements included. Although this database has generally been
characterized as one containing cases of “aggressive accounting,” there are a large number of
restatements resulting from seemingly honest bookkeeping errors or from misinterpretations of somewhat
ambiguous GAAP. This raises the question of whether the relatively low turnover rates for executives
around restatements found in prior research are due to widespread governance problems (e.g.,
management entrenchment) or to the mixing together of both intentional GAAP violations, which merit
management turnover, and unintentional GAAP violations, which may not.
We predict that restatements due to intentional GAAP violations are much more likely to lead to
management turnover for the following reasons. First, Palmrose, Richardson, and Scholz (2004) report
that the market reaction to restatements caused by fraud is over three times more negative than in non-
1
For examples of turnover rates in studies where there is statistically significant difference in turnover rates for
restatement firms see: Desai, Hogan, and Wilkins (2006), Land (2006), Arthaud-Day, Certo, Dalton, and Dalton
(2006), and Jayaraman, Mulford, and Wedge (2004).
2
fraud cases (-20% versus -6%). Given that investors view the restatements involving fraud as more
severe, management’s intention to deliberately misreport is likely to play a significant role in boards’
decision to terminate managers when these misstatements are identified.2 Second, termination of a top
executive may be partly to punish the manager for the loss in shareholder value caused by the restatement,
but the termination is also a highly visible means of restoring financial reporting credibility.
Consequently, we predict that the turnover rates for CEOs and CFOs are much higher for restatements
related to intentional GAAP violations than for restatements related to unintentional errors.
In contrast to prior research, our study does not focus on whether turnover is in fact higher for
restating firms than for non-restating firms. Instead, we attempt to explain cross-sectional variation in
turnover rates conditional on firms restating earnings. We argue that the severity of a restatement is better
captured as a function of management intent (or at least the perception of managements’ intent as actual
intent is never fully known to anyone but the managers) than by any of the previously used measures.3
We proxy for management intent with the presence or absence of an independent investigation or with the
presence or absences of the word “irregularity” in discussions of the GAAP violation. We consider the
occurrence of investigations by (or funded by) the board of directors or investigations by external
regulatory bodies (e.g., SEC, Office of the Attorney General, U.S. Department of Labor, etc.) to indicate
that there is at least some suspicion of managerial misbehavior because, as discussed further in Section
2.1, restatements that initiate or evolve from independent investigations typically involve allegations of
intentional misreporting. As an accounting “irregularity” is an intentional misstatement by definition, we
classify these cases as intentional misstatements as well. 4
2
By definition, an intentional misstatement (that is material) is considered to be fraud. We use intent rather than
fraud because, unlike most prior research, we are including cases of suspected fraud as well as cases of prosecuted
fraud. Hence, our sample is likely different from studies looking at restatements and fraud in other contexts. It
should also be noted that settlements with the SEC in cases of fraud can often include stipulations that require
certain executives to resign from the firm. However, these settlements almost always occur at a date several years
after the initial restatement is announced.
3
As discussed in Section 2, prior research measures severity by the magnitude of the restatement (Collins et al.
2005) or by who initiated the restatement (Arthaud-Day et al. 2006 and Desai et al. 2006).
4
Statement on Auditing Standards (SAS) No. 53.
3
For our analysis, we identify 456 restatements from 2002-2005 that are announced in an 8-K
filing, include reference to an accounting error, irregularity or investigation, and meet our data
requirements. From this, randomly select 83 of the 351 (about 25%) restatements involving an error or
misapplication of GAAP but that are not prompted by and do not prompt an investigation, which we
classify as unintentional misstatements. We add to that all 105 restatements that we classify as
unintentional, giving as a total sample of 188 restatements (83 unintentional and 105 intentional). For all
188 restatements, we review 10-K filings, 8-K filings, and proxy statements to identify turnover of the
CEO or CFO in the six months preceding and the six months following the date of the initial restatement
announcement.
We find that overall CEO (CFO) turnover rates in the 13 months surrounding the restatements
(six months before to six months after) are 18% (25%). In 30% of the cases, either the CEO or CFO
leaves the firm. Turnover appears higher for CFOs, who are directly responsible for financial reporting,
than for CEOs. As expected, when we partition the restatements by managerial intent, turnover rates are
much higher for intentional GAAP violations. For CEOs (CFOs) the turnover rate is 49% (64%) but only
8% (12%) for unintentional violations. We also find that misstatements that occur in a subsidiary lead to
lower turnover rates for CEOs and CFOs than those that occur at the parent-level.5 After excluding
subsidiary-level restatements and expanding the turnover window to four-years (2 years before and 2
years after), the (untabulated) turnover rates for intentional restatements are 67% for CEOs and 85% for
CFOs. In 91% of these intentional misstatement cases, either the CEO or CFO leaves the firm. This
evidence suggests that the relatively low turnover rates documented in past research are due largely to the
inclusion of unintentional GAAP violations that typically do not warrant firing senior managers. When
the restatements are the result of intentional misbehavior, boards take swift action to dismiss managers.
To control for other factors that might give rise to CEO/CFO turnover, we estimate logistic
regressions for both CEO and CFO turnover. We find that additional controls, including leverage, the
5
Although senior management turnover is lower for subsidiary-level restatements, we find that in virtually all cases
where an intentional misstatement occurs at the subsidiary-level, the subsidiary-level managers responsible are fired
(e.g., subsidiary president and controller).
4
annual or quarterly nature of the restatement, ROA, CEO ownership, and long-window (day -90 to day
-8) cumulative abnormal returns (CARs), do not diminish the significance of our severity measure
(management intent). Our multivariate tests show that, excluding restatements related to subsidiaries, a
CEO (CFO) is almost 11 (25) times more likely to turnover if the restatement involved an intentional
violation rather than an unintentional error.
We also conduct a case-by-case analysis of non-subsidiary GAAP violations that we classify as
intentional and where neither the CEO or CFO left the firm within the 13-month turnover window. Of the
16 such cases, we find only one case where it appears that an intentional GAAP violation occurred but
there is no relevant termination of either the CEO or CFO within the 24 months before or after the
restatement. In this one exceptional case, Asconi Corp., the CEO and CFO owned 90% of the firm.
We next examine whether the high turnover rates we document for intentional misreporting are a
new phenomenon stemming from increased political and regulatory pressure in the wake of Enron and
other accounting scandals. In a 2002 statement to the U. S. Senate Committee on Banking, Housing, and
Urban Affairs, Senator Sarbanes proposed that managers who step outside of GAAP “ought to be
punished, and punished very severely.”6 To the extent that this pressure induced boards to act more
swiftly in response to misreporting, the turnover rates we document in the post-Enron era should be
higher than those in the pre-Enron era.
In order to compare board behavior in the post-Enron era to a pre-Enron period, researchers need
to consider whether the mix of restatements has changed. Since Sarbanes-Oxley restatement frequencies
have increased dramatically (GAO, 2002 and 2006), but the increase in restatements is due partly to more
restating for minor reporting infractions,7 many of which are errors (e.g., spreadsheet errors) discovered
during the course of SOX 404 compliance. This suggests that although SEC enforcement of more
6
Senator Paul S. Sarbanes, Senate Floor Statement on July 8, 2002 on the Public Company Accounting Reform and
Investor Protection Act of 2002.
7
In a speech at the Financial Executives International Meeting on November 17, 2006, Scott A. Taub, Acting Chief
Accountant of the SEC, reports that about 55% of recent restatements were due to simple data errors or unintentional
misapplications of GAAP.
5
egregious misstatements has increased in recent years, 8 the frequency of restatements for minor errors
may have increased even more. Therefore, to assess turnover rates across time it is important to also
consider changes in the mix of restatements across time.
To examine changes in turnover rates and demonstrate the importance of controlling for the type
of misstatement, we collect a sample of 139 restatements from the 2003 GAO database for the period
1997-1998. As with our post-Enron sample, we classify these restatements as intentional and
unintentional. Frequency analysis suggests that overall CEO and CFO turnover rates around restatements
have actually decreased in the period after Enron. However, we show that this change is due to major shift
in the mix of restatements over time. We find that the turnover rates for intentional misstatements have
changed very little over time. However, we do not interpret the lack of a change in turnover rates for
intentional misstatements in the post-Enron era as regulation being ineffective at increasing board
effectiveness (i.e., terminating senior managers when intentional misstatements are discovered). Instead,
we conclude that given the extremely high turnover rates for intentional misstatements (in both the preand post-Enron era), boards appear to have been effective in this regard all along. Consequently, any
regulation attempting to increase board diligence in disciplining managers for intentional misreporting,
will yield only negligible changes (i.e., you cannot fix something that is not broken).
In summary, our findings highlight the importance of distinguishing restatements by a meaningful
measure of severity. Although not a perfect measure of managerial intent (because management intent is
impossible to actually observe), our severity proxy is fairly easy to construct and appears to be very
effective at capturing the seriousness of the restatement: observed turnover rates are 5 to 6 times higher
(log-odds are 11 to 25 times higher after controlling for other explanatory variables) for our intentional
GAAP violations than for unintentional violations.
For researchers, our findings suggest that partitioning on our (fairly easy to construct) proxy for
management intent can significantly enhance the power of tests in most studies related to restatements.
8
SEC Commissioner, Harvey Goldschmidt, in a December 2, 2002 speech at Fordham University Law School,
reported that SEC enforcement actions for potential accounting fraud increased from 79 in 1999 to 163 in 2002.
6
This includes not only studies on turnover around restatements but also studies on other topics (e.g.,
insider trading, cost of capital, information content, etc.) that utilize a restatement setting. We counted
more than twenty existing studies (either published or in working paper form) that rely on the GAO
database. Because the GAO sample includes both intentional and unintentional GAAP violations, our
study suggests that the power of the test in most of these studies could be greatly enhanced with our proxy
for intent. Our study also shows that most turnover (roughly 80%) linked to a restatement occurs within a
thirteen-month window surrounding the restatement announcement (six months before and six months
after). Consequently, tests that use shorter windows (as opposed to early research that used windows as
long as five years) are likely more powerful.
The remainder of the paper is organized as follows. Section 2 discusses prior research on turnover
around restatements and develops our predictions on the relation between turnover and restatement
severity (management intent). Section 3 describes our sample selection procedures and reports descriptive
statistics. Section 4 discusses our results, and Section 5 concludes.
2.0 Prior Research on Executive Turnover around Restatements
Management of restating firms likely face reduced compensation, decreased credibility, loss of
employment, and even criminal charges depending on the severity of the GAAP violation. Although
research on the effect of restatements on managerial compensation has recently emerged (e.g., Collins et
al. (2005) and Glass, Lewis, and Co. (2005)), we follow earlier research and focus on loss of employment
as the most severe punishment implementable by the board of directors.
Some of these prior turnover studies find no evidence that restatements, even restatements linked
to explicit fraud, significantly affect the odds of CEO turnover. For example, Beneish (1999) finds no
difference in CEO turnover for firms that violate GAAP during 1987-1993 as compared to a control
sample of compliant firms, and Agrawal et al. (1999) similarly find little evidence that firms suspected of
fraud (including accounting fraud) between 1978 and 1992 have any higher executive turnover than nonfraud firms.
7
Other studies do find that accounting restatements increase the likelihood of managerial turnover,
although the number of misstating firms that do not experience any turnover is still somewhat higher than
researchers can fully explain. The percentage of firms experiencing executive turnover in prior samples
varies depending on the number of executives and the time windows considered: Desai et al. (2006) find
51% of restating firms in 1997-1998 have turnover of their CEO, Chairman, or President within 2 years
after restatement; Land (2006) estimates 45% of firms restating between 1996 and 1999 have CEO
turnover in the year after the restatement; in the 2 years after the restatement, Arthaud-Day et al. (2006)
observe CEO turnover in 43% and CFO turnover in 55% of their 1998-1999 sample of restating firms;
and Jayaraman, et al. (2004) find that 48% of their restating firms experience turnover of their CEO,
Chairman, or President and 45% experience turnover of their CFO, Treasurer, or Controller in the 4 years
after being listed in the 1999-2000 Accounting and Auditing Enforcement Releases (AAERs). Overall,
past research suggests that a considerable portion of restating firms do not replace management for
financial reporting failures.
2.1 Restatement Severity, Management Intent, and Turnover
Much of the recent research on restatements and executive turnover relies on the GAO sample,
which does not distinguish between intentional (fraudulent) and unintentional GAAP violations.9 The
information provided by the GAO is limited, so it is difficult to sort restatements by severity. The only
potential severity measures available in the GAO database are the nine categories of restatements and the
prompter of the restatement, which studies have used with somewhat mixed success (Arthaud-Day et al.
2006 and Desai et al. 2006). However, as the GAO admits, the prompter of the restatement is hard to
9
For example, in 2005 the SEC sent a letter to the AICPA that clarified the SEC’s position on the application of
GAAP for various operating lease issues. This interpretation letter prompted widespread restatements (all of which
are captured in the 2006 GAO database) across the retail sector, but these lease adjustments are likely not indicative
of aggressive accounting.
8
identify, so the coding of this variable may be inaccurate or nonexistent.10 Therefore, we consider an
alternative measure of restatement severity.
A recent study by Palmrose et al. (2004), suggests that restatements caused by fraud are likely to
be considered the most severe. The authors hypothesize that the stock price reaction is likely greater in
cases of fraud for two reasons. First, the revelation of fraud is likely to increase the discount rate because
it reduces the reliability of management disclosures. Second, it increases the cost of litigation and
regulatory actions, additional monitoring costs, and future regulatory scrutiny. The authors classify a
restatement as being due to fraud if the there is an associated AAER, or the firm acknowledges the
restatement is due to fraud/irregularity. They report that the market reaction to these restatements is -20%
compared to only -6% for non-fraud cases.
Whether management deliberately misreports has been shown to affect the costs of the
restatement to the firm as a whole, but management intent has not yet been fully explored as a factor in
executive turnover decisions. We predict that restatements that occur as a result of the company’s efforts
to intentionally mislead investors and other stakeholders are much more likely to be related to turnover as
compared to cases that result from either errors in interpretation of GAAP or clerical-type errors.
The Chicago Bridge and Iron Company (CB&I) provides an example of a restatement where the
misreporting is suspected to have been intentional: On October 31, 2005, CB&I announced that “the
delay in releasing third quarter 2005 financial results was precipitated by a memo from a senior member
of CB&I’s accounting department alleging accounting improprieties.”11 The accusation of misbehavior
prompted an investigation by the board of directors, which revealed that there were deliberate accounting
irregularities that would necessitate a restatement. Given the revelation of conscious misreporting, we
would classify this restatement as an intentional GAAP violation.
10
The GAO indicates the prompter is unknown in 35% of the restatements in their database. It is also likely that
many of the restatements attributed to the company (49%) were actually instigated by auditors’ or regulators’
concerns that were not disclosed.
11
http://www.sec.gov/Archives/edgar/data/1027884/000095012905010329/h29789exv99w1.htm
9
In contrast, an Applebee’s International restatement announcement that was included in the 2006
GAO database suggests a misinterpretation of GAAP but no deliberate attempt to mislead investors: “On
February 9, 2005… like many other companies in the restaurant, retail and other industries, it had
determined that it would correct its accounting treatment for leases.”12 As discussed previously, many
retailers restated due to lease accounting after the SEC issued a letter on February 7, 2005 regarding the
treatment of leases. It is likely that investors would believe that this common error was unintentional.
Although this error could represent a large dollar amount, the reduction in management’s reporting
credibility over this issue is likely to be quite small. Consequently, we classify this restatement as an
unintentional restatement.
We argue that managers’ intent is an important determinant of the board’s perception of severity
and should thus predict turnover around restatements. Besides the costs associated with a fraudulent
misstatement, described above, boards must also consider ways to restore credibility of financial
disclosure. Credible financial reports are vital for access to capital markets and firms must regain any
credibility lost over a restatement. For firms that unintentionally violate GAAP, restoring credibility is
likely easier, since the cause of the GAAP violation can be attributed to problems that can be corrected.
For example, clerical errors can be reduced by implementing systems to check for these potential errors.
However, the best way to credibly eliminate the problems associated with intentional misstatements is to
terminate the employees who are ultimately responsible (e.g., CEO and CFO).
2.1.1 Classifying Intentional and Unintentional Misstatements
Ideally, a firm explicitly discloses that the restatement relates to an accounting irregularity. In
those cases, we can clearly classify the GAAP violation as being intentional. Unfortunately, such explicit
disclosure is not always the case.13 Based on our reading of numerous restatement disclosures, when the
words fraud or irregularity are not explicitly used, our best distinction between an intentional and
12
http://www.sec.gov/Archives/edgar/data/853665/000085366505000063/restatement8k.txt
In roughly 60% of the observations that we classify as intentional, where we suspect the firm intentionally
misstated earnings, the word “irregularity” or “irregularities” is used.
13
10
unintentional GAAP violation is whether or not an independent investigation into an accounting matter
was initiated.
Typically, when an accounting irregularity is identified either by the firm or the firm’s auditor, an
independent investigation funded by the board will follow. Similarly, if the SEC suspects an accounting
impropriety, it will initiate its own formal or informal investigation. Therefore, we classify a restatement
as intentional if the disclosure discusses an irregularity, a board-initiated independent investigation, or an
external regulatory inquiry (e.g., SEC, the Attorney General’s Office, the Department of Labor, etc.).
Measuring managerial intent in this manner is not perfect, but it appears to be very effective as a proxy.
The most common cause of a misclassification using this methodology is when an SEC investigation
results from a disagreement about a particular accounting treatment rather than from allegations of
misconduct, but these instances are relatively rare and will only bias against our predictions. We test the
validity of our proxy for severity by reviewing disclosures, analyzing the relative market reaction to
intentional versus unintentional GAAP violations, and examining the class action lawsuits alleging fraud
in our sample (see Section 3.3).
2.2 Intentional Misstatements at the Parent-Level Versus Subsidiary-Level
In addition to intent, we also consider the level of the infraction. In many cases the GAAP
violation is isolated to a foreign subsidiary or distinct business unit within the firm. For example, Amcon
Distributing Company filed an 8-K disclosing management's investigation into potential accounting
irregularities that were discovered in the inventory accounting records of Hawaiian Natural Water Co.,
Inc., a wholly owned AMCON subsidiary. In response, the firm fired both the president and the chief
financial officer of the subsidiary. However, given that the irregularity was entirely contained within the
subsidiary, we might not expect the board to terminate the CEO or CFO at the firm level.
When intentional misstatements are isolated to a subsidiary, the CEO/CFO can attribute the
problem to subsidiary-level management and restore financial reporting credibility by firing the
subsidiary-level management team. We thus predict that CEO/CFO turnover is less likely to occur for
11
intentional misstatements that occur at the subsidiary-level than for intentional misstatements that cannot
be attributed to an isolated business unit.
2.3 Other Factors Influencing Turnover
In addition to our severity and subsidiary variables discussed in the previous sections, we also
control for other factors that prior research suggests are likely related to turnover. Prior restatement
studies (e.g., Palmrose and Scholz, 2004) argue that restatements of unaudited interim reports are viewed
as less severe than restatements of audited annual reports, so we include a dummy for annual
restatements. To control for potential entrenchment effects such as those documented in Denis, Denis, and
Sarin (1997), we consider board and CEO ownership. Many prior studies, including Gilson (1989), find
that turnover is more likely for financially distressed firms, so we also control for distress with
LEVERAGE (debt to total assets).14 Finally, we control for past stock performance, measured as the CAR
in the 90 days prior to the restatement announcement up to 8 days prior to the announcement. This
controls for potential performance-related reasons for terminating the CEO/CFO, such as those
documented by Warner, Watts, and Wruck (1988) or Mian (2001). We also control for size by including
indicator variables for size quintiles. To test our predictions for our severity measures while controlling
for all the factors described above, we estimate the following model for CEO, CFO, and CEO or CFO
turnover:
TURNOVER=β0+β1INTENTIONAL+β2SUBSIDIARY+β3INTENTIONAL*SUBSIDIARY
+β4ANNUAL+β5 CEO_EQUITY +β6LEVERAGE +β7ROA+β9CAR(t-90-t-8)
+β8Size Quintile 1+β9Size Quintile 2+ β10Size Quintile 4+ β11Size Quintile 5+ε
(1)
where
TURNOVER=1 if the CEO (or CFO) announces that he/she is leaving the firm within the 6 months
before or the 6 months after the restatement announcement and 0 otherwise.
INTENTIONAL=1 if the restatement involved either a board investigation or SEC investigation and
0 otherwise.
14
We also used the Altman (1968) Z-Score to measure financial distress but this measure caused the loss of more
observations than the loss of observations using leverage. As Z-Score was not significant in our regressions anyway,
we use LEVERAGE instead to retain more observations and reduce the likelihood of introducing a selection bias.
12
SUBSIDIARY=1 if the GAAP violation occurred in a subsidiary and 0 otherwise.
ANNUAL=1 if the firm restated a 10-K and 0 if the firm restated only 10-Qs;
CEO_EQUITY=the percentage of equity ownership of the CEO in the year prior to the restatement;
LEVERAGE=Debt (#9+#34) / Assets (#6);
ROA= Operating income after depreciation scaled by average assets (Compustat #178/#6);
CAR(t-90-t-8)= The firm’s cumulative abnormal returns from 90 trading days prior to the restatement
announcement to 8 trading days prior, and expected returns are the CRSP value-weighted returns
inclusive of dividends;
SIZE QUINTILEi= An indicator variable for size quintiles based on total assets.
3.0 Sample Selection and Descriptive Statistics
3.1 Sample Selection
Table 1 summarizes our sample selection. Restatement firms are identified by searching the 8-K
filings on the SEC Edgar site from January 1, 2002 – June 15, 2006.15 To be included in the sample, a
firm must announce an earnings restatement and reference an accounting error, an irregularity, or an
internal or SEC investigation into accounting matters. Our procedure yields a total of 630 restatements
where there is reference to an accounting error or to an independent investigation.16 Of these, 460 are
classified as unintentional GAAP violations and 170 classified as intentional. A restatement is considered
to be the result of an intentional GAAP violation if the firm announced either an SEC inquiry or a boardsponsored independent investigation, or if the firm referred to the misstatement as an irregularity.
Consistent with prior research, we further exclude firms in the financial services industry (SIC codes
6000-6999) as well as firms that do not have data available on Compustat. This leaves us with 361
unintentional and 132 intentional cases.
15
We began this data collection before the updated GAO data (2006) were released.
Beginning on August 14, 2004, the SEC now requires firms to file an 8-K with Item 4.02 (Non-Reliance of
Previously Issued Financial Statements) whenever it is determined that previously issued financial statements should
no longer be relied upon. This disclosure change likely enables us to identify more restatements in the time-period
after 2004 for two reasons. First, prior to this change, although firms often disclose restatements either at the time a
pending restatement is expected or at the time of an earnings announcement, such disclosure was not explicitly
required. Second, the new coding scheme that includes a separate category explicitly for restatements greatly
increases the accuracy of our search procedures. We do not believe this biases our tests. The specific regular
expressions used to identify restatements are available from the authors upon request.
16
13
To reduce the cost of data collection, we randomly select approximately 25% of the restatements
arising from unintentional violations. We include all intentional violations to maintain power in our tests
of intentional GAAP violations. After reading restatement announcements, we drop 10 additional
observations where the restatement had no income effect. Lastly, we eliminate 27 cases where the
accounting investigation ultimately did not lead to a restatement or is not yet completed. This leaves 83
unintentional and 105 intentional observations.
To adjust for the disproportional sampling (we select all intentional GAAP violations
restatements but only a fraction of the unintentional), we follow Manski and Lerman (1977) and weight
by estimated population proportions. Unintentional (intentional) restatements are assigned a weight of
3.9(1). The weight of 3.9 for the unintentional sample is computed by dividing the total number of
restatements identified in the population (361) by the total number of observations sampled for analysis
(93).
3.2 The Turnover Window
In contrast to many prior restatement studies, we consider turnover both before and after the
announcement date for two reasons. First, if management turnover occurs prior to the announcement, it
may be the case that new management discovered GAAP violations perpetuated by prior management. In
such a case, we would not expect current management to be dismissed for the acts of previous
management. If these pre-announcement management changes are not considered, researchers will
incorrectly conclude that the boards failed to take swift action to terminate at-fault managers. A second
reason to include the pre-restatement announcement period is that an initial investigation into
irregularities can occur many months before a restatement is publicly announced. CEOs and CFOs may
be terminated during an investigation but before the restatement is announced. These measurement
problems suggest that expanding the turnover window to include a timeframe before the restatement
announcement is appropriate.
14
In our primary analysis, we use a 13-month window (six months before and six months after)
around the restatement announcement.17 However, given the lack of consensus in past research on the
appropriate measurement window for executive turnover around restatements, we review the timing of
turnover to assess the most appropriate window. We plot the cumulative turnover rates for restatements
caused by intentional and unintentional GAAP violations beginning six months before to two years after
the restatement announcement. Figure 1 plots the cumulative turnover rates for CEOs beginning six
months prior to the restatement announcement. The plot shows that most of the turnover for both
intentional and unintentional GAAP violations occurs very close to the announcement between six
months before and six months after the restatement announcement. A total of 50 (89% of all turnover)
CEOs announce they are leaving their firm over this time period for intentional GAAP violations. Very
little turnover occurs after six months following the restatement announcement. The turnover rate is much
lower for unintentional restatements (a total of 9), but it is still concentrated around the five months
before and five months after the announcement where 7 (77%) CEO departures are announced.
Figure 2 plots cumulative CFO turnover. As in the case of CEO turnover, most of the CFO
turnover occurs close to the restatement announcement. Roughly 92% of the CFO turnover (63 out of 79)
occurs between six months prior to and six months following the restatement announcement for
intentional GAAP violations. CFO turnover is less concentrated for the unintentional cases where 10 out
of 18 restatements (55%) occur between six months prior to and six months following the restatement.
Overall, this analysis suggests that most turnover occurs close to the restatement announcement
and that using windows that cover six months before and six months after the restatement will safely
capture most of the turnover related to restatements. More importantly, the fact that most of the turnover
occurs close to the restatement suggests that the turnover is likely related to the restatement. Using longer
windows will tend to introduce more noise into the analysis (i.e., more cases of turnover unrelated to the
restatement).
17
Identifying exact announcement dates related to restatements is challenging. We use the date that an intention to
restate is first made (not the date that an initial investigation or a potential restatement is announced).
15
3.3 Validity of Severity Measure
We argue that investigations (internal and external) generally signal that the GAAP violation is
likely due to an intentional misstatement and that these misstatements are more severe than unintentional
errors. To validate that these intentional GAAP violations are correctly capturing severity, we analyze the
stock returns of our restatement firms between 90 days prior to 90 days following the restatement
announcement. Figure 3 reports population-proportion adjusted mean and median CARs from t-90 to
t+90. Expected returns used to compute CARs are CRSP value-weighted returns with dividends. To avoid
survivor bias, we do not require firms to trade on all 180 days. The number of observations ranges from
152-169.
Consistent with prior research, there is a noticeable dip in returns in the days surrounding the
restatement announcement with mean (median) CAR of -4.9% (-3.1%) from seven days before to seven
days after the announcement. These returns are not as negative as reported in earlier research. For
example, Palmrose et al. (2004) report mean (median) 2-day CARS of -9.5% (-5.1%), for restatements
announced between 1995 and 1999. However, this is potentially explained by a change in the mix of
restatements over time. We also note that returns decline prior to the announcement and we believe this
decline is largely attributable to the difficulty in measuring the “information event.” We use the date that
the firm announces that it will restate earnings as the announcement date, but firms may disclose that they
are investigating accounting issues in an earlier press release. These earlier announcements likely lead to
trading in anticipation of the restatement.
Figure 4 reports the mean and median CARs grouped by intentional and unintentional violations.
The number of observations ranges from 84 to 101 for intentional and 68 to 69 for unintentional
restatements. The CARs for our unintentional sample do not drift far from zero over the entire 180-day
period and exhibit very little reaction to the restatement announcement. The returns are actually positive
leading up to the announcement but mean (median) CARs are -1.93% (-.90%) in the 15-day window
around the announcement. In contrast, the CARs for the intentional group decline substantially. The mean
16
(median) CARs are -13.64% (-19.14%) for the intentional group around the same event window. In
addition, CARs drifted -13% (-12%) from t-90 to t-8 for the intentional restaters. Again, this downward
drift prior to the announcement dates suggests that a number of firms in our sample disclosed an expected
restatement before they announced that the actually would restate earnings. Overall, this evidence is
consistent with our proxy for intent capturing the market’s perception of the seriousness of the
restatement.
As a second validity check, we compare the frequency of class action lawsuits claiming fraud for
our INTENTIONAL and UNINTENTIONAL samples. Assuming that, all else equal, it is easier to file a
class action lawsuit for fraud (intentional misstatement), we should find that occurrence of a class action
lawsuit is highly correlated with our proxy for intent. Table 2, Panel A, reports a frequency count of our
classification of INTENTIONAL versus the filing of a class action lawsuit.18 The first three columns of
Panel A provide counts based on our classification criteria (Irregularity, SEC inquiry, Board-initiated
internal investigation). Some firms have more than one of the required conditions (e.g., SEC investigation
and internal investigation), hence the three columns sum up to more than the “Total” column. Overall, we
find only one case where a class action lawsuit was initiated but we did not code the firm as an
investigation firm.
There are 21 cases (out of 105) where we classify the restatement as intentional but there is no
corresponding class action lawsuit. Additional analysis, reported in Panel B, reveals that most these
restatements appear to be cases that might have otherwise warranted a class action law suit but the firms’
stock was not being traded at the time of the restatement (n=3), the market value of the firm was below
$25 million (n=8), the restatement occurred in a subsidiary (n=7), or the stock returns around the
restatement were positive (n=3). These findings suggest that our proxy for intent appears to work quite
well at identifying intentional misstatements. Further, it is likely better than relying on class action
18
We obtained class action lawsuit filings from the Stanford Class Action Clearinghouse
(http://securities.stanford.edu/companies.html) and Lexis/Nexis.
17
lawsuits as a proxy because using class action lawsuits will cause researchers to misclassify cases where
fraud occurs but lawyers do not find it beneficial to sue (e.g., smaller firms or limited damages).
3.4 Descriptive Statistics
Descriptive Statistics are reported in Table 3. The table contains statistics for our intentional and
unintentional GAAP violations as well as for a random sample of firm-year observations, stratified on 2digit SIC code and year, for comparison purposes. To mitigate the impact of outliers, all variables are
winsorized at the bottom and top 1%. All variables are measured in the year prior to the restatement
announcement.
Somewhat surprisingly, measures of size (sales, total assets, and market value) suggest that the
high-severity restatement firms are the largest. For example, mean (median) sales in millions of dollars of
the intentional, unintentional, and random sample groups are 3,984 (497), 2,725 (533), and 2,252 (163),
respectively. Mean (median) ROA is lower for the INTENTIONAL group (mean=-1.8%, median=3.0%)
compared to the UNINTENTIONAL group (mean=3.3% and median=5.6%), though the mean is higher
than that of the random sample (mean=-12.1%).
Mean (median) net income/assets is -2.3(2.3%), -14.2% (-3.6%), and -22.7% (2.2%) for
unintentional, intentional and random sample groups, respectively. LEVERAGE is higher for the
INTENTIONAL sample (mean=.29, median=.25) compared to the UNINTENTIONAL sample
(mean=.25, median=.17). Stock ownership of the CEO is similar between UNINTENTIONAL (mean =
9%, median = 3%) and intentional (mean = 7%, median = 2%).19 Overall, the performance characteristics
and stock ownership of the unintentional and intentional groups are fairly similar. Both groups, however,
appear to be larger than a random sample of the Compustat population.
19
We do not hand-collect ownership information for our random sample.
18
4. 0 Results
4.1 Univariate Analysis
Table 4 reports frequency information on CEO and CFO turnover rates across various groups.
Beginning with the 324 unintentional violations (actual count is 83 but count is weighted by 3.9 for
comparability to the intentional sample), we find that the turnover rate is substantially higher for CFOs;
more specifically, we observe that 8.4% (12.0%) of the CEOs (CFOs) turned over within between 6
months before and 6 months after the restatement announcement. In 15.7% of the unintentional
violations, either the CEO or CFO resigned.20 The turnover rates for the intentional cases are much
higher than the unintentional cases. In the intentional cases, the turnover rate for CEOs (CFOs) is 48.6%
(63.8%) and the combined turnover rate for either a CEO or CFO is 73.3%. This implies that a CEO
(CFO) leaves more frequently around intentional GAAP violations than around unintentional
misstatements, which is consistent with our expectation that boards are more likely to terminate CEOs
and CFOs when the GAAP violation that necessitated the restatement is perceived as intentional.
We next compare the turnover rates of the subsidiary-level restatements to the parent-level
restatements. As expected, the turnover rates for subsidiary-level restatements are lower that of parentlevel restatements in the case of intentional violations. CEO (CFO) turnover rates for subsidiary-level
restatements are 29.2% (41.7%) compared to 54.3% (70.4%) for parent-level restatements. This is
consistent with the firm attributing the intentional misstatements to managers at the subsidiary. Also
consistent with this explanation is that, in virtually every case of an intentional violation at the subsidiarylevel, we find that the firm announced that the subsidiary-level managers were terminated.21 In
untabulated results, we find that turnover rates for parent-level restatements are extremely high when a
20
It is difficult to compare the turnover rates that we document to prior restatement research because past research
investigates different time periods, different groupings of officers, and different window lengths. For nonrestatement samples, Yermack (2004) finds an unconditional annual rate of CEO turnover of 13.8% in Fortune 500
firms from 1994 to 1996. More recent research by Kaplan and Minton (2006) finds that CEO turnover in Fortune
500 firms is 16.5% over the period from 1998 to 2005. We find an annual turnover rate (6 months before to 6
months after) of 48.6% (8.4%) for the intentional (unintentional) restatement firms in our sample.
21
Although we make made no prediction about turnover rates for unintentional subsidiary-level violations, it is
somewhat surprising that the observed turnover rates are actually higher than in the case of unintentional parentlevel restatements. However, there are only 15 such cases (unweighted), which limits inferences.
19
four-year window (two years before to two years after) is considered. Over this time period, we find that
the CEO (CFO) turnover rate for intentional/parent-level restatements is 66.7% (85.2%) and in 91.4% of
the cases either the CEO or CFO leaves the firm.
Finally, we compare turnover related to annual restatements to those of quarterly restatements.
Given that quarterly financial statements have not undergone the audit process, we expect quarterly
restatements to be viewed as being less severe than annual restatements. We consider a restatement to be
annual when the 10-K is restated and quarterly when only 10-Qs are restated. The frequency of quarterly
restatements in our sample is much lower than annual restatements. There are 372 annual restatements
(281 unintentional and 91 intentional) and only 57 quarterly restatements (43 unintentional and 14
intentional). As expected, the turnover rates are higher for annual restatements in the intentional group.
Somewhat surprisingly, the turnover rates are higher for quarterly restatements in the unintentional
sample.
In summary, we observe that turnover appears to be strongly related to the underlying intent
behind the GAAP violation. Intentional violations appear to lead to greater turnover of both CEOs and
CFOs, but the turnover rates are reduced when the problem can be isolated to a subsidiary. In the next
section, we provide logistic regression analysis to further support these observations.
4.2 Multivariate Analysis
Our observations from Table 4 support our predictions that intentional GAAP violations give rise
to higher CEO and CFO turnover rates and that the turnover rates for intentional GAAP violations will be
lower when the irregularity causing the restatement occurs at the subsidiary-level. However, other factors
that cause turnover are likely to be correlated with intentional GAAP violations. To control for these
factors, we estimate logistic regressions for CEO, CFO and CEO or CFO turnover.22
22
Given the strong relation between bankruptcy and CEO turnover described in past research (e.g., Beneish 1999)
we test the sensitivity of our results to bankruptcy filings. We identify all firms that file for bankruptcy at any point
after the restatement announcement. There are 21 firms with restatements classified as intentional and only 2 with
restatements classified as unintentional. Although the turnover rate for the remainder of the intentional group
20
Table 5 reports results for our turnover regressions. Consistent with our prediction, the coefficient
on INTENTIONAL is positive and significant (p<0.01). Given a parent-level restatement, a CEO is
roughly 11 times more likely to turnover if the restatement was an intentional violation rather than
unintentional. To test whether turnover rates are lower for intentional, subsidiary-level restatements than
for intentional, parent-level restatements, we test β2 +β3<0. As reported in table 5, β2+β3 =-1.32 and is
significantly less than zero (p<.05 one-tailed test). All p-values in the remainder of this paper are reported
as one-tailed when the sign is predicted. Of the control variables, only CEO_Equity is significant and in
the expected direction (p<.05). The negative coefficient is consistent with the CEOs using their ownership
in the firm to make it more difficult for boards to fire them.
Results for CFO turnover are very similar to our CEO turnover results. The signs and significance
levels on INTENTIONAL and β2+ β3 are consistent with our predictions. The coefficient on
INTENTIONAL is 3.22 (significant at p<.01), suggesting that, conditional on a parent-level restatement,
a CFO is almost 25 times more likely to turn over if the restatement is an intentional violation rather than
an unintentional violation. β2+β3=-1.79 and is significantly less than zero (p<.05), suggesting that
turnover for CFOs is also lower for intentional misstatements if the misstatements occur at the subsidiary
level. The coefficient on CEO_EQUITY is also weakly significantly negative in the CFO regression
(p<.10) suggesting that the CEO exerts influence to retain the CFO. Finally, the size controls suggest that
the probability of CFO turnover declines with firm size.
When CEO and CFO turnover are combined, results are very similar. The signs and significance
levels of the coefficients for our predictions remain. For all models, most of our performance-related
control variables are not significant. This is consistent with our descriptive statistics in Table 3,
suggesting that performance is fairly similar for INTENTIONAL and UNINTENTIONAL restaters.
Given the CAR distributions reported in Figures 3 and 4, one question is whether our proxy for
severity (intent) is any better than simply using restatement announcement returns. In other words, our
declines, it is still significantly higher than the unintentional group. The CEO turnover rate for firms that do not file
for bankruptcy is 42.9% for intentional restatements and 8.6% for unintentional restatements.
21
measure INTENTIONAL could simply be capturing the market reaction to restatements, which is an
overall measure of severity. In table 6 we compare the effectiveness of this alternative proxy by reestimating our model substituting announcement CARs (CAR(t-7 – t+7)) for INTENTIONAL. For all
turnovers (CEO, CFO, CEO/CFO), the main effect, CAR(t-7 – t+7), is similar in sign and significance to
INTENTIONAL, though β2+β3 is not significantly different from zero. However, the explanatory power
of the model (measured by Psuedo-R2 or Log Likelihood) are much lower. For example, the log
likelihoods using CAR(t-7 – t+7) as a proxy for severity are 21.9, 33.5, and 31.5 compared with log
likelihoods of 37.2, 61.6, and 64.1 when using INTENTIONAL as a proxy for severity, for the CEO,
CFO and CEO/CFO turnover regressions, respectively. These findings suggest that, although shortwindow CARs are a good proxy for severity, INTENTIONAL is more effective, at least in explaining
turnover.
4.3 Descriptive Review of Intentional Violations with No Turnover
Although the high turnover rates that we document are suggestive of boards acting swiftly to
remove managers involved in irregularities, it is still somewhat surprising that intentional, Parent-Level
GAAP violations do not always lead to the resignation of the CEO and CFO. To understand what factors
explain why in 20% of the cases (16 of 81) neither the CEO nor the CFO left within the 13-month
window, we perform a detailed examination of each of these cases. Our review of these cases is
summarized in Table 7.
There are eight cases where either the CEO or CFO left the firm in the 18 months preceding the
13-month window (i.e., from two years to six months prior to the restatement). In these cases, it is likely
that the incoming CEO (CFO) was not blamed for (and may in fact have discovered) the misstatement as
he/she was able to attribute the problem to his/her predecessor. There are three cases where the CEO or
CFO left the firm after the six-month window but the departure occurs around the time the investigation
was concluded. These “no turnover” cases are attributable to our use of a shorter turnover window.
Finally, there are four cases where it was subsequently concluded either from the independent
22
investigation or the SEC investigation that no intentional GAAP violations occurred. This leaves only one
case, Asconi Corp., where it appears that an intentional misstatement occurred but neither the CFO nor
the CEO is terminated.23 However, Asconi’s CEO and CFO together hold over 90% of the company’s
stock. We conclude from this analysis that boards rarely fail to discipline senior management when
intentional misstatements are discovered.
4.4 Changes in Turnover Rates Pre- versus Post-Enron
In this section we compare turnover rates in the pre-Enron era to the post-Enron era. Our preEnron sample firms are identified by the GAO database (2003) as having a restatement that occurred
between January 1, 1997 and December 31, 1998. We select this time period because it provides a clean
window before the scandals and subsequent regulation is comparable to other recent research on the preEnron period (i.e., Desai et al. (2006)). The pre-Enron sample consists of 194 unique firms restating in
1997 or 1998 as identified by the GAO database. Of these, we exclude 16 firms in the financial services
industry (SIC codes 6000-6999) to be consistent with prior research, and 29 firms that have missing data.
We drop an additional 13 observations where further investigation reveals that the restatement had no
income impact, pertained only to the representation of now-discontinued operations, or was announced
contemporaneously with a merger. This results in a final sample of 136 restatements during the pre-Enron
period.
Table 8 reports logistic regression results estimating model (1) with the addition of an indicator
variable, POST, which is equal to 1 if the restatement occurred in the post-Enron era (2002-2005) and 0 if
it occurred in the pre-Enron era (1998-1999). For ease of exposition, we exclude the interaction term
between INTENTIONAL and SUBSIDIARY. Size quintile controls are included in the regression but not
reported in the table for brevity. Column (1) reports results with CEO Turnover as the dependent variable
23
Asconi Company issued ten million shares during 2003 to the company’s CEO and CFO. The issuances were
originally treated as equity transactions. SEC conducted a formal investigation and determined that the market value
of the ten million shares of Common Stock issued during 2003 should have been charged against the Company’s
income statement. The restatement resulted in the recording of $40.4 million of stock issuance expense.
23
and INTENTIONAL left out of the regression. Without INTENTIONAL, the coefficient on POST is
negative and significant (p<.01), suggesting the overall turnover rates actually declined in the post-Enron
Era. Similar results are obtained in columns (3) and (5) for CFO and CEO/CFO turnover.
When the INTENTIONAL indicator variable is added to the regressions, the significance level on
POST disappears in both the CEO turnover and CFO turnover regressions. However, the coefficient on
POST remains negative and significant in the CEO/CFO turnover regression. It is possible that the
coefficient on POST for the CEO/CFO regression is being driven by differences in turnover rates from
the unintentional restatements. To alleviate this concern and focus on our primary interest of how Boards
respond to severe misstatements (INTENTIONAL), we repeat our analysis including only
INTENTIONAL restatements.
As shown in table 9, the coefficient on POST is insignificant across all three regressions. This
indicates that turnover rates for INTENTIONAL restatements have not changed significantly in the postEnron era. Given the extremely high turnover rates in the post-Enron era, we do not interpret this as
ineffective governance continuing even after additional regulation was implemented. Instead, we interpret
this as indicating that boards continue to be effective at taking action in response to intentional
misreporting by managers.
5.0 Concluding Comments
Past research on the relation between senior executive turnover and restatements has been
surprisingly mixed. Until recently, researchers found no evidence that restatements increased the
probability of senior management turnover. Although recent research finds a statistically significant
difference between the restatements and the likelihood of turnover, the turnover rates still appear to be
relatively low. In this study, we attempt to explain the cross-sectional variation in turnover for firms that
restated earnings between 2002 and 2005. We predict that intentional GAAP violations are much more
likely to lead to CEO or CFO turnover.
24
As predicted, we find that turnover rates are much higher for intentional violations than for
unintentional errors: the turnover rate is 48.6% (63.8%) for CEOs (CFOs) for intentional cases but is only
8.4% (12.0%) for unintentional cases. This evidence suggests that boards do take swift action to dismiss
managers when the restatements are the result of intentional misbehavior and that the relatively low
turnover rates documented in earlier restatement research may be due to the inclusion of unintentional
violations in prior restatement samples. We also find that turnover caused by restatements generally
occurs within a one-year window surrounding the restatement announcement (six months before and six
months after), suggesting that shorter windows spanning both the pre-and post-announcement periods will
allow for more powerful tests.
Finally, we find that conditioning on intent is critical to interpreting changes in turnover rates
over time. Without controlling for intent, we obtain the counter-intuitive result that turnover rates have
declined in the post-Enron era. However, examining only cases where turnover would be expected
(intentional restatements), we find that turnover rates have remained constant when comparing the preand post-Enron eras.
For regulators, our findings suggest boards take swift action to remove managers when
intentional misreporting occurs and contradict concerns by Abelson (1996), who writes that when are
“manipulating a company’s financial numbers to mislead investors, the punishment is often anything but
sharp or swift.” We conclude that board governance appears to be quite effective at disciplining firm
management for financial reporting failures. In particular, CEOs and CFOs appear to face heavy penalties
for any willful misreporting.
For researchers, our finding suggests that the power of tests on the consequences of restatements
(e.g., turnover, market reaction, etc.) can be greatly enhanced by classifying restatements by a proxy for
management intent. Data sources, such as the GAO sample, mix together both intentional and
unintentional violations of GAAP, which are substantially different in perceived severity. Our proxy for
intent, presence of an independent investigation is very effective at identifying intentional misstatements
and is relatively easy to construct.
25
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27
Table 1 – Sample Selection
Unintentional
Intentional
Total
460
170
630
Financial Services
43
19
62
Firms not on Compustat
56
19
75
Total Available
Less firms not randomly
selected
361
132
493
Observations
Less cases where
restatement had no
income impact
Less cases where
investigation did not
lead to restatement or is
not complete
93
132
225
10
0
9
0
27
27
Final Sample
Weighting by population
proportion
83
105
188
3.9
1.0
Weighted Sample
324
105
Number of restatements
identified from 8-K filings
268
268
439
Notes: Our sample was obtained as follows. We identified all 8-K disclosures where firms disclosed a
restatement or intended restatement due to an error in previously reported financial statements between
January 1, 2002 and December 31, 2005. This includes 8-Ks filed specifically to announce a
restatement, to announce a change in auditor, or to announce quarterly or annual financial statements.
If a firm announced more than one restatement during this time-period, we selected the first
restatement disclosed. This process yielded 630 restatements. Of these 460 are restatements arising
from unintentional GAAP violations and 170 are from intentional violations. We classify violations as
intentional if announced either an SEC or internal investigation into the accounting misstatement or
referred to the misstatement as an irregularity. Of these we exclude firms in the financial services
industry (SIC codes 6000-6999) as well is firms that do not have data available on Compustat. This
leaves us with 361 unintentional and 132 intentional cases. To reduce the cost of data collection, we
randomly select approximately 1/4 of the restatements caused by unintentional violations. We include
all intentional GAAP violations to maintain power in our tests for this group. From this we drop 10
observations from the unintentional group where the restatement had no income impact. These
generally related to reclassifications or corrections to shares outstanding used in the computation of
EPS. Finally, we eliminate 27 intentional GAAP violation cases where the investigation ultimately did
not lead to a restatement or where the investigation is underway but a restatement has not yet been
announced.
28
Reason for classification as Intentional
SEC /DOJ
Internal
Irregularity Investigation Investigation
36
64
60
7
9
16
43
73
76
Total
Intentional
84
21
105
Total
Unintentional
1
82
83
Firms not being traded at time of announcement
Firms with market value below $25 million
Restatement was at the subsidiary-level
Firms with positive short-window returns
Total
Less multiple occurrences
Firms with at least one of the above
Misstatements coded intentional for presence of SEC investigation, but no
class action found
Total
Panel B- Classified as Intentional but No Class Action Suit
4
21
Count
3
8
7
3
21
(4)
17
Firms are classified into the intentional sample if the report an irregularity, an SEC or Department of Justice investigation, or an
internal investigation. The intentional type columns do not sum up “Total Intentional” because some restatements have more than
one type of related investigation (e.g., an irregularity and an SEC investigation and an internal investigation).
Class Action Lawsuit
No Class Action Lawsuit
Total
Panel A
Table 2 – Class Action Lawsuits and Intent Classifications
29
Unintentional
Mean
Median
2,725
533
14.7%
8.3%
2,788
405
2,247
387
3.3%
5.6%
-2.3%
2.3%
0.25
0.17
9
3
Std
6,356
42.4%
6,857
5,544
13.6%
16.5%
0.27
15
N
94
94
104
93
104
94
103
104
Intentional
Mean
Median
3,984
497
24.0%
4.7%
4,775
569
3,212
436
-1.8%
3.0%
-14.2%
-3.6%
0.29
0.25
7
2
Std
8,228
102.1%
9,683
7,250
17.6%
34.7%
0.24
15
N
179
172
180
161
176
173
178
N/A
Random Sample
Mean
Median
2,252
163
21.6%
7.2%
2,367
152
2,631
151
-12.1%
5.0%
-22.7%
2.2%
0.34
0.19
N/A
N/A
Std
6,575
97.8%
7,252
7,563
63.9%
87.3%
0.53
N/A
The amounts reported above do not always capture the restated amounts. Whether or not the Compustat values are the initially reported
amounts or the restated amounts depends on the timing of the restatements. If, for example, a firm with fiscal-year end of December 31, 2005
files a 10-K in March 2006 but later amends that filing prior to Compustat’s next “cut” of the database, say November 2006, then Compustat
uses the November 2006 data and ignores the original filing (in March 2006). In these cases, the data reported in this table are the restated
figures. If, on the other hand, a company amends a prior year after Compustat’s next “cut” of the data, the restated information will appear in
Compustat’s special restatement variables. In these cases, our descriptive statistics will not include the restated amounts.
Notes: Details of the sample selection procedure for restatement firms are provided in Table 1. In addition to the restatement sample, we also
include a random sample for comparison purposes. This random sample is stratified by industry and year to mirror the representation of the
restatement firms. Variables listed above are those reported in the year prior to the restatement (not restated). Sales is Compustat #12. Sales
growth is the change in sales from t-2 to t-1 scaled by sales in t-2. Total assets is Compustat #6. Market Value is Compustat #25*#199. ROA
is operating income after depreciation scaled by Assets (Compustat #178/#6). Income/Assets is Compustat #172/#6. Leverage is Debt
(#9+#34)/Assets (#6). CEO_Equity is the fraction of CEO ownership in the year of the restatement. In cases where we are unable to obtain
ownership information in the year of the restatement, we use the prior year. We do not collect ownership information for the random sample.
Sales
Sales Growth
Total Assets
Market Value
ROA
Income/Assets
Leverage
CEO Stock Ownership
N
80
80
82
73
82
80
82
83
Table 3 - Descriptive Statistics
30
9.1
8.3
8.3
9.1
43
281
281
43
11.1
18.2
9.1
12.5
15.3
18.2
9.1
16.7
91
14
24
81
49.5
42.9
29.2
54.3
CEO
48.6
67.0
42.9
41.7
70.4
74.7
64.3
50.0
80.2
CEO
or
CFO CFO
63.8 73.3
Intentional
Turnover %
372
57
67
362
N
429
18.4
17.4
16.3
18.6
24.8
24.3
20.8
25.5
29.8
29.5
23.8
30.9
Total
Turnover %
CEO
or
CEO CFO CFO
18.3 24.7
29.8
Notes: This table summarizes the turnover rates for intentional and unintentional GAAP violation firms partitioned on subsidiarylevel/parent-level and Annual/Quarterly. Sample selection and determination of intentional versus unintentional classifications are
described in Table 1. A subsidiary-level restatement is defined as a restatement that occurred in a subsidiary. All other restatements are
considered to be parent-level restatements. Annual restatements are those that required restatement of a 10-K filing. Quarterly filings are
those that only affected 10-Q filings. Turnover is considered to have occurred if a CEO or CFO left the firm in the six months before to
six months after the restatement or investigation announcement, whichever is first. The frequency counts for the unintentional statements
are weighted by population proportion for comparison to the intentional restatement sample. As discussed in Table 1, we selected a
random sample consisting of approximately 1/4 of the unintentional cases that we identified but analyzed all intentional cases. To
approximate the total turnover we would expect to observe in the population of all restatements, we assign 3.9 times the weight to the
unintentional cases.
Total
Subsidiary vs.
Parent Level
Subsidiary-Level
Parent-Level
Annual vs.
Quarterly
Annual
Quarterly
N
324
Unintentional
Turnover %
CEO
or
CEO CFO CFO
N
8.4 12.0
15.7 105
Table 4 – Turnover Frequency
31
Table 5 – Logistic Regression - Turnover
TURNOVER=β0+β1INTENTIONAL+β2SUBSIDIARY+β3INTENTIONAL*SUBSIDIARY
+β4ANNUAL+β5CEO_EQUITY +β6LEVERAGE +β7ROA+β8CAR(t-90-t-8)+β9Size Quintile 1
+β10Size Quintile 2+ β11Size Quintile 4+ β12Size Quintile 5+ε
Pred.
Sign
Intercept
INTENTIONAL
+
SUBSIDIARY
?
INTENTIONAL*SUBSIDIARY
-
ANNUAL
+
CEO_EQUITY
-
LEVERAGE
+
ROA
-
CAR(t-90-t-8)
-
Size Quintile 1
?
Size Quintile 2
?
Size Quintile 4
?
Size Quintile 5
?
Test of b2+b3<0
-
Psuedo-R2
Log Likelihood
N
CEO Turnover
-2.22 ***
(7.22 )
2.35 ***
(19.09 )
-0.16
(0.03 )
-1.16
(0.89 )
0.42
(0.39 )
-0.05 **
(3.43 )
-0.47
(0.25 )
-0.05
(0.00 )
-0.38
(0.20 )
0.65
(0.30 )
0.69
(0.79 )
0.15
(0.05 )
-0.27
(0.17 )
-1.32 **
(2.72 )
31.13%
37.17
164
CFO Turnover
-1.68 *
(4.26 )
3.22 ***
(26.97 )
-0.09
(0.01 )
-1.69 *
(1.79 )
0.41
(0.32 )
-0.03 *
(2.24 )
0.75
(0.86 )
-2.05
(1.28 )
-0.39
(0.21 )
-0.15
(0.02 )
-0.05
(0.01 )
-1.11 **
(2.72 )
-2.04 ***
(7.76 )
-1.79 **
(4.80 )
45.34%
61.59
164
CEO or CFO
Turnover
-1.05
(1.96 )
3.14 ***
(29.03 )
-0.55
(0.36 )
-1.32
(1.17 )
0.16
(0.05 )
-0.04 **
(4.22 )
0.45
(0.34 )
-0.24
(0.02 )
-0.78
(0.82 )
-0.03
(0.00 )
0.07
(0.01 )
-0.91 *
(2.13 )
-1.42 **
(4.85 )
-1.87 ***
(5.57 )
44.95%
64.13
164
Notes: Logistic regressions of variations of model (1) are reported above. Chi-square statistics are in parentheses.
Psuedo-R2 is the Nagelerke Psuedo-R2. Sample selection information is detailed in Table 1. We lose 24 observations
due to certain missing data on Compustat, leaving 164 observations. To approximate the total turnover we would
expect to observe in the population of all restatements, we estimate the Logistic regression assigning approximately
3.9 times the weight to the low severity cases and then normalizing the sample size. The dependent variable,
TURNOVER, is 1 if the executive left the firm in the 6 months before or 6 months after the restatement or
investigation announcement, whichever is first. INTENTIONAL is 1 if the restatement announcement discloses either
an internal board or SEC investigation and 0 otherwise. SUBSIDIARY is 1 if the restatement occurred in a subsidiary
and 0 otherwise. ANNUAL is 1 if the firm restated a 10-K and 0 if the firm restated only 10-Qs. CEO_EQUITY is the
fraction of CEO ownership in the year of the restatement. Leverage is Debt (#9+#34)/Assets (#6). ROA is operating
income before interest and taxes scaled by Assets (Compustat #178/#6). CAR(t-90-t-8) is the firm’s cumulative
abnormal returns from 90 trading days prior to the restatement announcement to 8 trading days prior, and expected
returns are the CRSP value-weighted returns inclusive of dividends. ***, **, * represent p-values at the 1%, 5%, and
10%, respectively (p-values are reported as one-tailed when the sign is predicted).
32
Table 6 – Logistic Regression –Turnover – Short-Window CARs as proxy for Severity
TURNOVER=β0+β1CAR(t-7-t+7)+β2SUBSIDIARY+β3CAR(t-7-t+7)*SUBSIDIARY+β4ANNUAL+β5CEO_EQUITY
+β6LEVERAGE +β7ROA+β8CAR(t-90-t-8)+β9Size Quintile 1+β10Size Quintile 2+ β11Size Quintile 4+ β12Size Quintile 5+ε
Pred.
Sign
Intercept
CAR(t-7-t+7)
+
SUBSIDIARY
?
CAR(t-7-t+7)*SUBSIDIARY
-
ANNUAL
+
CEO_EQUITY
-
LEVERAGE
+
ROA
-
CAR(t-90-t-8)
-
Size Quintile 1
?
Size Quintile 2
?
Size Quintile 4
?
Size Quintile 5
?
Test of β2+β3<0
-
Psuedo-R2
Log Likelihood
N
CEO Turnover
-1.50 *
(3.84 )
-3.69 **
(4.55 )
-0.86
(1.07 )
-0.13
(0.00 )
0.29
(0.20 )
-0.08 **
(3.56 )
-0.27
(0.08 )
-0.62
(0.13 )
-1.72 **
(3.81 )
0.93
(0.67 )
0.00
(0.00 )
0.35
(0.34 )
0.12
(0.04 )
-0.99
(0.07 )
19.77%
21.93
161
CFO Turnover
-0.90
(1.60 )
-4.50 ***
(6.95 )
-1.19 *
(1.79 )
-1.61
(0.17 )
0.07
(0.01 )
-0.02
(1.25 )
0.86
(1.22 )
-2.66 *
(2.39 )
-1.72 **
(4.40 )
-0.03
(0.00 )
-0.70
(1.04 )
-0.37
(0.43 )
-0.86 *
(2.25 )
-2.80
(0.37 )
27.41%
33.54
161
CEO or CFO
Turnover
-0.51
(0.58 )
-3.46 **
(4.77 )
-1.49 **
(3.05 )
-3.28
(0.71 )
-0.02
(0.00 )
-0.03 *
(2.31 )
0.70
(0.92 )
-1.10
(0.46 )
-2.21 ***
(7.44 )
0.15
(0.02 )
-0.62
(0.89 )
-0.26
(0.25 )
-0.45
(0.76 )
-4.77
(1.10 )
24.79%
31.53
161
Notes: Logistic regressions of variations of model (1) are reported above with short-term CARs to proxy for severity.
Chi-square statistics are in parentheses. Psuedo-R2 is the Nagelerke Psuedo-R2. Sample selection information is
detailed in Table 1. We lose 27 observations due to certain missing data on Compustat or CRSP, leaving 161
observations. To approximate the total turnover we would expect to observe in the population of all restatements, we
estimate the Logistic regression assigning approximately 3.9 times the weight to the low severity cases and then
normalizing the sample size. The dependent variable, TURNOVER, is 1 if the executive left the firm in the 6 months
before or 6 months after the restatement or investigation announcement, whichever is first. CAR (t-7-t+7) is the firm’s
cumulative abnormal returns from 7 trading days prior to the restatement announcement through 7 trading days after
the announcement. SUBSIDIARY is 1 if the restatement occurred in a subsidiary and 0 otherwise. ANNUAL is 1 if
the firm restated a 10-K and 0 if the firm restated only 10-Qs. CEO_EQUITY is the fraction of CEO ownership in the
year of the restatement. LEVERAGE is Debt (#9+#34)/Assets (#6). ROA is operating income before interest and
taxes scaled by Assets (Compustat #178/#6). CAR(t-90-t-8) is the firm’s cumulative abnormal returns from 90 trading
days prior to the restatement announcement to 8 trading days prior. Expected returns are the CRSP value-weighted
returns inclusive of dividends. ***, **, * represent p-values at the 1%, 5%, and 10%, respectively (p-values are
reported as one-tailed when the sign is predicted).
33
Table 7 – Analysis of Cases where neither the CEO nor the CFO Exits within the
13-month Turnover Window around the Restatement.
Count
Total number of observations classified as intentional and parentlevel where neither the CEO nor the CFO left within the 13-month
window (-6 to +6 months).
Either the CEO or CFO left the firm between 24 and 7 months
before the restatement announcement. These are cases where the
incoming officers likely attributed the misstatement to their
predecessors.
Either the CEO or CFO left the firm at a date later than 6 months
after the restatement but around the time the investigation is
concluded.
The investigation (independent internal or external) specifically
determined that the misstatement was not intentional.
Total
Case of apparent fraud where there was no turnover (Asconi)
16
8
3
4
15
1
Summary of Asconi Case:
The Company (Asconi) issued ten million shares during 2003 to the company’s CEO and CFO,
who together hold over 90% of the company’s stock. The issuances were originally treated as if
they were equity transactions. SEC conducted formal investigation and determined that the
market value of the ten million shares of Common Stock issued during 2003 should have been
charged against the Company’s income statement as compensation. The restatement resulted in
the recording of $40.4 million of expense. On 03/19/05 the SEC issued Wells notice
recommending that a civil or administrative enforcement action be brought against the company
and Alex Brinister, Asconi’s Vice President for U.S. Operations Interim CAO. Brinister resigned
01/12/06. (Investigation unresolved)
34
?
+
+
-
POST
SUBSIDIARY
ANNUAL
CEO_EQUITY
LEVERAGE
ROA
CAR(t-90-t-8)
22.28%
50.21
300
34.21%
81.00
300
CEO Turnover
(1)
(2)
*
-1.18
-1.89 ***
(5.33 )
(11.89 )
1.75 ***
(28.87 )
**
-0.65
-0.36
(3.59 )
(0.97 )
-0.23
-0.67 *
(0.30 )
(2.30 )
**
0.68
0.47
(3.49 )
(1.47 )
-0.06 ***
-0.05 ***
(8.23 )
(8.00 )
0.38
0.33
(0.44 )
(0.28 )
-1.53 **
-0.88
(3.91 )
(1.22 )
***
-2.01
-1.18 **
(12.61 )
(4.11 )
19.61%
46.09
300
37.65%
95.85
300
CFO Turnover
(3)
(4)
-0.25
-0.99 *
(0.30 )
(3.76 )
2.15 ***
(42.78 )
**
-0.62
-0.34
(3.80 )
(0.95 )
-0.40
-1.01 **
(1.09 )
(5.15 )
0.23
0.05
(0.46 )
(0.02 )
-0.01 *
-0.02 *
(2.01 )
(2.65 )
**
0.98
1.09 **
(3.52 )
(3.68 )
-1.07 *
-0.28
(2.14 )
(0.13 )
***
-1.48
-0.69 *
(9.29 )
(1.76 )
27.23%
68.02
300
46.14%
126.35
300
CEO or CFO Turnover
(5)
(6)
0.29
-0.34
(0.39 )
(0.43 )
2.39 ***
(47.71 )
***
-0.92
-0.71 **
(8.06 )
(3.70 )
-0.56 *
-1.32 ***
(2.15 )
(8.32 )
0.38
0.22
(1.26 )
(0.33 )
-0.02 **
-0.03 ***
(4.75 )
(6.53 )
**
0.88
0.94 *
(2.73 )
(2.62 )
-1.96 **
-1.02
(5.32 )
(1.48 )
***
-2.01
-1.22 **
(15.42 )
(4.82 )
Notes: Logistic regressions of variations of model (1) are reported above. Chi-square statistics are in parentheses. Psuedo-R2 is the Nagelerke Psuedo-R2. Sample
selection information is detailed in Table 1. We include the 136 firms from the pre-period and the 164 firms from the post-period that are not missing data. As
previously discussed, in the post-period we assign approximately 3.9 times the weight to the low severity cases and then normalizing the sample size. The dependent
variable, TURNOVER, is 1 if the executive left the firm in the 6 months before or 6 months after the restatement or investigation announcement, whichever is first.
INTENTIONAL is 1 if the restatement announcement discloses either an internal board or SEC investigation and 0 otherwise. POST is 1 if the restatement occurred in
1997 or 1998 and 0 if the restatement occurred between 2002 and 2005. SUBSIDIARY is 1 if the restatement occurred in a subsidiary and 0 otherwise. ANNUAL is 1
if the firm restated a 10-K and 0 if the firm restated only 10-Qs. CEO_EQUITY is the fraction of CEO ownership in the year of the restatement. In cases where we are
unable to obtain ownership information in the year of the restatement, we use the prior year. LEVERAGE is Debt (#9+#34)/Assets (#6). ROA is operating income
before interest and taxes scaled by Assets (Compustat #178/#6). CAR(t-90-t-8) is the firm’s cumulative abnormal returns from 90 trading days prior to the restatement
announcement to 8 trading days prior, and expected returns are the CRSP value-weighted returns inclusive of dividends. Size quintile controls are included in the
regression but not reported in the tables (for brevity). ***, **, * represent p-values at the 1%, 5%, and 10%, respectively (p-values are reported as one-tailed when the
sign is predicted).
Psuedo-R2
Log Likelihood
N
+
INTENTIONAL
Intercept
Pred. Sign
TURNOVER=β0+β1INTENTIONAL+β2POST+β3SUBSIDIARY +β4ANNUAL+β5CEO_EQUITY+β6LEVERAGE +β7ROA+β8CAR(t-90-t-8)+β9Size Quintile 1
+β10Size Quintile 2+ β11Size Quintile 4+ β12Size Quintile 5+ε
Table 8 – Logistic Regression- PRE Versus POST Analysis
35
Table 9 – Logistic Regression PRE Versus POST, INTENTIONAL Only
TURNOVER=β0+β1POST+β2SUBSIDIARY+β3ANNUAL+β4CEO_EQUITY +β5LEVERAGE +β6ROA+β7CAR(t-90-t-8)
+β8Size Quintile 1+β9Size Quintile 2+ β10Size Quintile 4+ β11Size Quintile 5+ε
Pred.
Sign
Intercept
POST
?
SUBSIDIARY
-
ANNUAL
+
CEO_EQUITY
-
LEVERAGE
+
ROA
-
CAR(t-90-t-8)
-
Size Quintile 1
?
Size Quintile 2
?
Size Quintile 4
?
Size Quintile 5
?
Psuedo-R2
Log Likelihood
N
CEO
Turnover
-0.46
(0.63 )
-0.17
(0.18 )
-0.97 **
(4.52 )
0.65 *
(2.17 )
-0.05 ***
(7.25 )
0.94
(1.11 )
-1.46 *
(2.19 )
-1.37 **
(4.61 )
-0.95
(1.48 )
1.12 **
(3.26 )
0.48
(0.82 )
-0.50
(0.91 )
27.84%
39.10
167
CFO Turnover
0.41
(0.51 )
0.15
(0.14 )
-1.36 ***
(8.98 )
0.64 *
(2.20 )
-0.01
(0.46 )
1.45 *
(2.63 )
-0.84
(0.84 )
-0.36
(0.37 )
-1.03 *
(1.98 )
0.47
(0.55 )
-0.88 *
(2.64 )
-1.30 ***
(5.49 )
18.86%
24.95
167
CEO or CFO
Turnover
1.09
(2.38 )
-0.18
(0.13 )
-1.80 ***
(12.59 )
0.79 *
(2.16 )
-0.03 ***
(6.61 )
3.15 ***
(6.28 )
-3.27 **
(4.78 )
-1.73 **
(5.18 )
-1.82 **
(3.81 )
0.84
(0.96 )
-0.88 *
(1.73 )
-1.76 ***
(7.01 )
37.00%
48.77
167
Notes: Logistic regressions of variations of model (1) are reported above. We exclude all unintentional
misstatement and include the 62 firms from the pre-period and the 105 firms from the post-period that are not
missing data. Chi-square statistics are in parentheses. Psuedo-R2 is the Nagelerke Psuedo-R2. Sample
selection information is detailed in Table 1. The dependent variable, TURNOVER, is 1 if the executive left
the firm in the 6 months before or 6 months after the restatement or investigation announcement, whichever
is first. CAR(t-7-t+7) is the firm’s cumulative abnormal returns from 7 trading days prior to the restatement
announcement through 7 trading days after the announcement, and expected returns are the CRSP valueweighted returns inclusive of dividends. SUBSIDIARY is 1 if the restatement occurred in a subsidiary and 0
otherwise. POST is 1 if the restatement occurred in 1997 or 1998 and 0 if the restatement occurred between
2002 and 2005. ANNUAL is 1 if the firm restated a 10-K and 0 if the firm restated only 10-Qs.
CEO_EQUITY is the fraction of CEO ownership in the year of the restatement. LEVERAGE is Debt
(#9+#34)/Assets (#6). ROA is operating income before interest and taxes scaled by Assets (Compustat
#178/#6). CAR(t-90-t-8) is the firm’s cumulative abnormal returns from 90 trading days prior to the restatement
announcement to 8 trading days prior, and expected returns are the CRSP value-weighted returns inclusive of
dividends. ***, **, * represent p-values at the 1%, 5%, and 10%, respectively (p-values are reported as onetailed when the sign is predicted).
36
Figure 1: Percentage of Firms with CEO Turnover over Time Relative to
Restatement Announcement Date
Figure 2: Percentage of Firms with CFO Turnover over Time Relative to Restatement
Announcement Date
Notes: Figure 1 reports the cumulative CEO turnover percentage from month -6 to month +24, relative
to the date of the restatement announcement. The announcement date is the first date the firm
announces that it will restate earnings, though it is possible that the firm previously announced an
investigation that could potentially lead to an investigation. A firm is grouped as an intentional GAAP
violator if the restatement announcement discloses either an internal board or SEC investigation and 0
otherwise. Sample details are reported in Table 1. Figure 2 replicates Figure 1 with CFO turnover. If a
firm has turnover more than once during the 30 month window, we select the turnover that occurred
closest to the restatement announcement and do not count other turnovers that occur, which understates
the overall turnover rates.
37
Figure 3: Cumulative Abnormal Returns 180 Days Surrounding Restatement Announcement
Figure 4: Cumulative Abnormal Returns 180 Days Surrounding Restatement Announcement
partitioned by Severity
10.0%
5.0%
0.0%
-5.0%
-10.0%
-15.0%
-20.0%
-25.0%
-30.0%
-35.0%
Mean -Intentional
Median -Intentional
Mean -Unintentional
Median -Unintentional
Notes: Figure 3 reports the mean and median cumulative abnormal returns for all restating firms beginning 90
trading days prior to the restatement announcement and ending 90 days after the restatements. Expected returns are
CRSP value-weighted returns with dividends. To avoid survivor bias, we do not require observations to trade over
the entire 180-day window. The number of observations ranges from 152 to 169. Figure 4 reports the mean and
median cumulative abnormal returns for intentional and unintentional GAAP violations. The number of observations
ranges from 84 to 101 for intentional and 68 to 69 for unintentional restatements.
38