Riding a Tiger without Being Eaten: How Companies and Analysts Tame Financial Restatements and Influence Corporate Reputation

The primary objective of financial statements is to provide capital market participants with information that enables them to make informed decisions. They also serve to alleviate the so-called ‘agency problem’ – through true and fair disclosures, financial statements contribute to keeping the interest of outsiders (shareholders) aligned with those of the insiders (executives). Material errors, however, will render these financial statements unreliable and can cause great uncertainties to investors and other stakeholders. Subsequent correction of these errors – restatements – often leads to the following question: Can management still be trusted? And subsequently: Where were the gatekeepers? The avalanche of accounting scandals a few years ago, coupled with the current global credit crises, reiterate that our knowledge of corporate governance failures needs continuous upgrading. This dissertation contributes to understanding why the watchdogs did not bark, and also dissects how common human biases affect the mechanisms of corporate monitoring roles, in particular during restatement crises. Three connected studies were conducted. A first qualitative study develops a model for gauging restatement severity and provides insight into the forces blurring the 20/20 vision on restatement situations. A second quantitative study is the first study to comprehensively elicit analysts’ perceptions of CEO pressures and behaviours during restatements. A third study corroborates our findings through in-depth interviews with analysts. Combined the studies show that bounded awareness and common human biases heavily influence functioning of executives and gatekeepers in safeguarding corporate reputation during restatements.