Dividend payment and financial restatement: US evidence

• DOI: https://doi.org/10.1108/IJAIM-07-2021-0154
• Published date: 25 April 2022
• Date: 25 April 2022
• Pages: 427-453
• Subject Matter: Accounting & finance,Accounting/accountancy,Accounting methods/systems
• Author: Md. 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

Abstract

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

investors’confidence. Consequently, firmsmustattempttoregainlostreputationandmarketconfidence.

Design/methodology/approach –This study uses the US regulatorysetting to examine the association

between corporatedividend policy and financial restatementover the 2001–2017 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 firm’s 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.

Dividend

payment

427

Received28 July 2021

Revised20 February 2022

Accepted27 March 2022

InternationalJournal of

Accounting& Information

Management

Vol.30 No. 3, 2022

pp. 427-453

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-07-2021-0154

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

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

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 firm’s

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 firm’s 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 investors’perceptions of financialreporting risk and

firm reputation. Investors routinely rely on a firm’s 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 investors’risk

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 firm’s 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 firm’s 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 firm’s 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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