Katsiaryna Salavei Bardos

Do Investors See Through Mistakes in Reported Earnings

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.

Importance of Catering Incentives for Growth Dynamics

This paper tests whether the dynamics of firm growth metrics, such as sales and investment growth, are consistent with firms catering to the market by delivering growth when stock prices are more sensitive to growth-related news. After developing growth valuation premium measures, we document four main results consistent with catering theory. First, time periods of high growth premium are followed by higher-than-expected growth indicators. Second, catering to the premium is more pronounced for firms whose managers care more about maximizing short-term stock prices. Third, firms whose managers care more about short-term stock prices have higher time-series volatility of median sales, investment, and PPE growth. Finally, conditional trading strategy based on timing the revenue growth premium yields 26 basis points per month after adjusting for risk and postearnings announcement drift.

Equity and Debt Issuance by Firms Violating GAAP

We examine security issuance in restated periods by firms that misreport financial statements and find that only a small per cent of such firms issues securities in the restated period. Investors are misled by mistakes made by firms issuing equity more so than other restating firms at the initial announcement of misreported earnings, but are not misled by mistakes made by debt‐issuing firms. Equity‐issuing firms that manage earnings to beat analyst expectations experience abnormally high returns in the restated period prior to security issuance. Firms that restated more reports and have higher pre‐mistake returns are more likely to issue equity. High leverage, firm size and number of restated periods are positively associated with the likelihood of debt issuance by restating firms.

Financial restatements, litigation and implied cost of equity

We re-examine the effect of financial restatements on the cost of equity vis-a-vis litigation risk. Specifically, we study the effect of litigation on post-restatement financing costs and whether market anticipates litigation before restatement announcement as evident from its effect on financing costs. In a sample of 91 restatements, although we find that the cost of equity increases subsequent to a financial restatement for all restating firms, the increase is substantially greater for firms facing litigation as a result of the restatement. We also find that investors do not adjust for the cost of equity before the announcement of a financial restatement for firms facing post-restatement litigation. Overall, our findings suggest that most of the increase in the cost of equity after restatement is concentrated in sued sub-sample and that the cost of equity is an important channel through which litigation associated with financial restatement is priced. The economic effect of post-restatement litigation is approximately 259 basis points increase in the firm’s cost of equity.

Measuring Residential Real Estate Risk and Return

This article explains how common misconceptions about residential real estate returns contribute to unrealistic expectations about house price appreciation. The article evaluates several comprehensive ways of computing residential real estate returns and discusses the relation between real estate return and risk. We review the role of real estate in household portfolios, the overall economy, and the financial crisis and discuss why decline in the real estate market imposes economy-wide risks.