Dividend payment and financial restatement: US evidence

Published date25 April 2022
Date25 April 2022
Subject MatterAccounting & finance,Accounting/accountancy,Accounting methods/systems
AuthorMd. Borhan Uddin Bhuiyan,Fawad Ahmad
Dividend payment and f‌inancial
restatement: US evidence
Md. Borhan Uddin Bhuiyan
School of Accountancy, Massey University, Albany, New Zealand, and
Fawad Ahmad
School of Accountancy, Massey University, Palmerston North, New Zealand
Purpose The purpose of this paper is to investigate the impact of f‌inancial restatement on corporate dividend
payment. Firms that announce f‌inancial restatements rupture their corporate reputation and adversely affect
investorsconf‌idence. Consequently, f‌irmsmustattempttoregainlostreputationandmarketconf‌idence.
Design/methodology/approach This study uses the US regulatorysetting to examine the association
between corporatedividend policy and f‌inancial restatementover the 20012017 f‌inancial years.
Findings The f‌indings evidencea robust positive associationbetween f‌inancial restatement and dividend
payouts, indicating that f‌irms pay higher dividends following the year of f‌inancial restatement. Several
sensitivitytests were conducted to conf‌irm the robustness of the f‌indings.
Originality/value Prior research indicatesthat corporate dividend payouts enhance a f‌irms reputation
by reducing information asymmetryand providing a positive signal to investors regarding future f‌inancial
performance.This study provides valuable evidence that dividend payout can be usedas a channel for image
restorationby f‌irms with lost reputations because of f‌inancialrestatement.
Keywords Financial restatement, Dividend payment, Signalling mechanism
Paper type Research paper
1. Introduction
We examine whether f‌irms use dividend policy to regain corporate reputation following the
issuance of f‌inancial restatement. A restatement indicates that managerial oversights are not
credible and its f‌inancial statements are of lower quality. Prior empirical research has evidenced
that following f‌inancial restatement, auditors either resign (Huang and Scholz, 2012), put more
effort in or engage highly experienced audit staff (resultingin heightened audit fees) (Chi and Pan,
2021;Feldmann et al., 2009). Moreover, increased audit efforts also raise the restatement
disclosure lag, suggesting that auditors perceive the f‌inancial information quality of restatement
f‌irms to be low, i.e. auditors spend more time on such audit engagements (BenYoussef and Drira,
2019). Cao et al. (2012) report that f‌irm reputation is at stake followingevidence of poor f‌inancial
information quality, such as restatement. Matozza et al. (2019) report that f‌irms engage in higher
environmental performance as a mechanism to recover corporate reputation following a f‌inancial
restatement. While empirical research shows that a change in monitoring and governance
structure and corporate social responsibility reporting are both potential mechanisms to regain
corporate reputation following f‌inancial restatement (Srinivasan, 2005;Cowen and Marcel, 2011;
Zhang et al.,2021),we examine an unexplored avenue, that of corporate dividend policy.
The authors thank 18th Auckland Regional Accounting Conference participants, Auckland, New
Zealand, and the participants of the 26th Annual New Zealand Finance Colloquium for their
insightful comments.
Received28 July 2021
Revised20 February 2022
Accepted27 March 2022
InternationalJournal of
Accounting& Information
Vol.30 No. 3, 2022
pp. 427-453
© Emerald Publishing Limited
DOI 10.1108/IJAIM-07-2021-0154
The current issue and full text archive of this journal is available on Emerald Insight at:
Lower-quality f‌inancial statements increase information asymmetry and worsen the agency
problem (Diamond, 1985;Verrecchia, 1982). Financial restatement causes a perceived
information gap between managers and the users of f‌inancial statements. It thus has
signif‌icant negative reputational and economic consequences, such as an increase in the f‌irms
idiosyncratic risk (Yin and Sun, 2021), along with a negative market response (Lambert et al.,
2018;Robbani and Bhuyan, 2010). Consequently, f‌irms attempt to minimise the negative
impact of a f‌inancial restatement by undertaking various measures, including penalising outside
directors and audit committee members (Srinivasan, 2005;Cowen and Marcel, 2011), dismissal of
external auditors (Mande and Son, 2013), dismissal of chief executive off‌icer (CEOs)/chief f‌inance
off‌icer (CFOs) (Arthaud-Day et al.,2006) and increasing corporate social responsibility disclosures
(Zhang et al.,2021). A change in corporate governance mechanisms (such as audit committees or
CEOs/CFOs) ref‌lects a fundamental internal control weakness that is likely to negatively affect
the f‌irms corporate governance and f‌inancial restatements (Velte, 2021). However, others believe
that these efforts might be the minimum required to restore corporate reputation. For example,
Calvano et al. (2021) f‌ind that inf‌luential audit committee members are removed from the
committee after restatement but remain on the board. In addition, earlier research provides strong
evidence indicating that auditors and capital markets negatively respond to f‌inancial
restatements. Further, f‌irms react to f‌inancialrestatement by restructuring corporate governance,
changing auditors or enhancing corporate social responsibility disclosures. However, f‌irms
corporate f‌inance policy response to f‌inancial restatements, such as dividendp ayment, is still in
its infancy. Our study contributes to the literature by examining whether restated f‌irms use
dividend policy to mitigate the information asymmetry and agency conf‌lict arising from sub-
optimal corporate governance and poor f‌inancial reporting practices.
Financial reporting quality is a vital consideration when stakeholders make investment
decisions. Financialrestatements affect investorsperceptions of f‌inancialreporting risk and
f‌irm reputation. Investors routinely rely on a f‌irms purported strong reputation when
making investment decisions.Bryan et al. (2005) report that f‌irms experience a 15% drop in
stock price and reduced credit ratings following the f‌iling of f‌inancial restatements.
Fombrun and Shanley (1990) posit that managers attempt to inf‌luence investorsrisk
assessment processes by emitting positive signals through accounting numbers and
strategic postures. We argue that f‌irms may choose dividends as a positive signal to
circumvent the negative impact of the f‌inancial restatement on corporate reputation. Indeed,
the corporate reputation literature suggests that f‌irms with a higher expropriation risk pay
higher and stable dividends to mitigate the negativeimpact of such risk on their reputation
(Li et al.,2014). However, the f‌inance literature suggests that dividend payments convey
mixed messages to investors. On a positive note, dividendpayments signal a f‌irms current
and future prof‌itability, resulting in a competitive advantage in investment decisions.
However, the market does not consider all dividend increases to be good news, nor all
dividend decreases to be bad news (Elfakhani,1998). This leads to the empirical question of
how a f‌irm addresses its reputationalconcern following its dividend policy.
Linter (1956) concludes that dividend payout is primarily affected by a f‌irms current
earnings and targeted level of dividend payout. Subsequent researchers argue that f‌irm
dividend payout policy is framed based on prof‌itability and f‌inancial f‌lexibility. For
example, Kumar and Vergara-Alert (2020) report that f‌irms with better f‌inancial f‌lexibility
pay more dividends [1]; in other words, f‌inancial constraints reduce a f‌irms dividend
payment capacity. A related stream of literature reports that f‌irms facing f‌inancial
constraints rely on dividend reinvestment plans (DRPs) instead of dividend payout [2].
However, a reduction in cash dividendsaccompanied by DRPs results in a negative market
response (Feito-Ruizet al., 2020). An alternate stream of the literature suggests that dividend

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