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 nancial
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 nancial restatement on corporate dividend
payment. Firms that announce nancial restatements rupture their corporate reputation and adversely affect
investorscondence. Consequently, rmsmustattempttoregainlostreputationandmarketcondence.
Design/methodology/approach This study uses the US regulatorysetting to examine the association
between corporatedividend policy and nancial restatementover the 20012017 nancial years.
Findings The ndings evidencea robust positive associationbetween nancial restatement and dividend
payouts, indicating that rms pay higher dividends following the year of nancial restatement. Several
sensitivitytests were conducted to conrm the robustness of the ndings.
Originality/value Prior research indicatesthat corporate dividend payouts enhance a rms reputation
by reducing information asymmetryand providing a positive signal to investors regarding future nancial
performance.This study provides valuable evidence that dividend payout can be usedas a channel for image
restorationby rms with lost reputations because of nancialrestatement.
Keywords Financial restatement, Dividend payment, Signalling mechanism
Paper type Research paper
1. Introduction
We examine whether rms use dividend policy to regain corporate reputation following the
issuance of nancial restatement. A restatement indicates that managerial oversights are not
credible and its nancial statements are of lower quality. Prior empirical research has evidenced
that following nancial 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 nancial information quality of restatement
rms to be low, i.e. auditors spend more time on such audit engagements (BenYoussef and Drira,
2019). Cao et al. (2012) report that rm reputation is at stake followingevidence of poor nancial
information quality, such as restatement. Matozza et al. (2019) report that rms engage in higher
environmental performance as a mechanism to recover corporate reputation following a nancial
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 nancial 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 nancial 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 nancial statements. It thus has
signicant negative reputational and economic consequences, such as an increase in the rms
idiosyncratic risk (Yin and Sun, 2021), along with a negative market response (Lambert et al.,
2018;Robbani and Bhuyan, 2010). Consequently, rms attempt to minimise the negative
impact of a nancial 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 ofcer (CEOs)/chief nance
ofcer (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) reects a fundamental internal control weakness that is likely to negatively affect
the rms corporate governance and nancial restatements (Velte, 2021). However, others believe
that these efforts might be the minimum required to restore corporate reputation. For example,
Calvano et al. (2021) nd that inuential 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 nancial
restatements. Further, rms react to nancialrestatement by restructuring corporate governance,
changing auditors or enhancing corporate social responsibility disclosures. However, rms
corporate nance policy response to nancial restatements, such as dividendp ayment, is still in
its infancy. Our study contributes to the literature by examining whether restated rms use
dividend policy to mitigate the information asymmetry and agency conict arising from sub-
optimal corporate governance and poor nancial reporting practices.
Financial reporting quality is a vital consideration when stakeholders make investment
decisions. Financialrestatements affect investorsperceptions of nancialreporting risk and
rm reputation. Investors routinely rely on a rms purported strong reputation when
making investment decisions.Bryan et al. (2005) report that rms experience a 15% drop in
stock price and reduced credit ratings following the ling of nancial restatements.
Fombrun and Shanley (1990) posit that managers attempt to inuence investorsrisk
assessment processes by emitting positive signals through accounting numbers and
strategic postures. We argue that rms may choose dividends as a positive signal to
circumvent the negative impact of the nancial restatement on corporate reputation. Indeed,
the corporate reputation literature suggests that rms 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 nance literature suggests that dividend payments convey
mixed messages to investors. On a positive note, dividendpayments signal a rms current
and future protability, 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 rm addresses its reputationalconcern following its dividend policy.
Linter (1956) concludes that dividend payout is primarily affected by a rms current
earnings and targeted level of dividend payout. Subsequent researchers argue that rm
dividend payout policy is framed based on protability and nancial exibility. For
example, Kumar and Vergara-Alert (2020) report that rms with better nancial exibility
pay more dividends [1]; in other words, nancial constraints reduce a rms dividend
payment capacity. A related stream of literature reports that rms facing nancial
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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