Auditor monitoring and restatement dark period

• DOI: https://doi.org/10.1108/IJAIM-07-2018-0079
• Pages: 73-95
• Date: 13 January 2020
• Published date: 13 January 2020
• Author: Nourhene BenYoussef,Mohamed Drira
• Subject Matter: Accounting methods/systems,Accounting & Finance,Accounting/accountancy

Auditor monitoring and

restatement dark period

Nourhene BenYoussef

Department of Accounting, School of Management, Universite de Sherbrooke,

Sherbrooke, Canada, and

Mohamed Drira

Department of Accounting and Commercial Law, School of Business,

Saint Mary’s University, Halifax, Canada

Abstract

Purpose –Prior researchhas examined the impact of corporate governance mechanisms, includingexternal

auditing, on accounting restatementslikelihood. However, little is known about auditor’s monitoring rolein

restatement disclosurepractices. The purpose of this study isto address this gap by investigating the impact

of auditor’s oversight on the timelinessof accounting restatement disclosures as measured by the length of

the restatementdark period.

Design/methodology/approach –The study examines panel data from a sample of restating publicly

traded US f‌irms. Negativebinomial regression is used to analyze the data because the dependentvariable is a

count variableand is over-dispersed.

Findings –The main study’s results indicate that longerauditor tenure and non-audit services provision

improve restatement disclosuretimeliness. Conversely, companies whose auditors exerted abnormally high

levels ofaudit effort have longer restatement darkperiods.

Originality/value –This study is the f‌irst archival research thatfocuses on auditor’s monitoring role and

its impact on the timeliness of restatement disclosures. By doing so, this study contributes to the auditing

academic research, professionalpractice and regulation by providing empirical evidence on an exasperating

issue for all participants in the f‌inancial markets.In addition, it provides a better understanding of auditor’s

monitoring role in the accountingrestatement process and offers insights to policymakers, practitionersand

investorsinterested in corporate f‌inancial transparencyand corporate governance.

Keywords Corporate governance, Corporate f‌inancial transparency, Disclosure lag,

External auditing, Financial restatements

Paper type Research paper

1. Introduction

The past two decades witnessed a signif‌icant number of accounting restatements and

f‌inancial reporting frauds (Bai and Koong, 2017;Plumlee and Yohn, 2010;Chin and Chi,

2009). This situation has raised major concerns among governments and regulators, and

undermined public conf‌idence in f‌irms’f‌inancial transparency as well as the competence

and integrity of their managers and external auditors (Hassink et al.,2010;Scholz, 2008;

GAO, 2006; Kinney et al.,2004). Prior research has examined the impact of corporate

The authors acknowledge funding from the University of Regina, Faculty of Business Dean’s

Research Grant and President’s Research Seed Grant, and from the University of New Brunswick,

Faculty of Business Administration. The authors are thankful to the participants at the annual

conferences of the Financial Reporting and Business Communication (2015) and the International

Business Research (2015).

Auditor

monitoring

73

Received10 July 2018

Revised22 July 2019

Accepted2 September 2019

InternationalJournal of

Accounting& Information

Management

Vol.28 No. 1, 2020

pp. 73-95

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-07-2018-0079

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

governance mechanisms,including external auditing, on accounting restatements likelihood

and has shown that auditors play a critical monitoring role in f‌inancial statements

restatements (Pyzoha, 2015;Loboand Zhao, 2013;Stanley and DeZoort, 2007;Agrawal and

Chadha, 2005;Abbott et al.,2004). Moreover, accounting restatements are viewed as

egregious audit failures and are widely used in the archivalauditing literature as an output-

based proxy for actual auditquality (DeFond and Zhang, 2014).

More recently, a few studies have investigated restatement disclosure practices,

especially disclosure timeliness or “dark periods.”Restatement dark periods represent the

time that elapses between “the initial notif‌ication to the SEC and the time restated f‌inancial

statements are f‌iled with the SEC”(ACIFR,2008). Longer dark periods dramatically increase

the information def‌icit and uncertaintyencountered by f‌inancial statements’users (Schmidt

and Wilkins, 2013;ACIFR,2008;Leone, 2008). They also exacerbate investors’suspicionand

lack of conf‌idence in f‌inancial markets (Badertscher and Burks, 2011). To date, researchers

have devoted scant attentionto auditor’s monitoringrole in restatement disclosure practices.

This study addresses this gap by investigating the impact of auditor oversight on the

timeliness of accounting restatement disclosures, as measured by the length of the dark

period.

Using a sample of 129 US restating public f‌irms, this study f‌inds that longer auditor

tenure and non-audit services provision improve restatement disclosure timeliness.

Conversely, companieswhose auditors expended abnormally high levels of audit effort have

longer restatement disclosure lags. These results provide strong evidence that auditor’s

competencies and incentivesplay a critical role during the f‌inancial restatementprocess and

have a signif‌icant impact on the timeliness of restatement disclosures. Moreover, our

f‌indings suggest that external auditors balance relevance and faithful representation when

monitoring the f‌inancial restatement process, consistent with both attributes being the

fundamental characteristicsof useful f‌inancial information (FASB, 2010).

This research contributes to the emerging literature on earnings restatement disclosure

practices (Badertscher and Burks, 2011;Myers et al.,2013;Schmidt and Wilkins, 2013;

Hirschey et al.,2015;BenYoussef and Khan, 2018). More specif‌ically, this study is the f‌irst

archival research that focuses on auditor’s monitoring role and its impact on the timeliness

of restatement disclosures. By doing so, this study contributes to the auditing academic

research, professional practice,and regulation by providing initial empirical evidence onan

exasperating issuefor all participants in the f‌inancial markets (such as investors, regulators,

public companies and external auditors). In addition, it provides insights to regulators,

practitioners and investors interested in corporate f‌inancial transparency and auditor’s

monitoring function. The remainder of the paper is organized as follows. The next section

reviews prior literature and develops the hypotheses. Section III describes the research

methodology. Section IV provides the results.Finally, Section V provides the conclusion for

this study.

2. Background and hypotheses development

2.1 Earnings restatements and timeliness of restatement disclosures

Financial statements restatements are listed by U.S. Securities and Exchange Commission

(SEC) (2002) as a main cause of investors’conf‌idencedeterioration in f‌inancial reporting and

market eff‌iciency. In the extant literature, it has been documented that earnings

restatements are followed by stock price decline (Palmrose et al., 2004), increased equity

capital cost (Hribar and Jenkins,2004) and debt cost (Park and Wu, 2009) and organizational

legitimacy threats(Arthaud-Day et al.,2006).

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