Investors' Response to Revelations of Prior Uncorrected Misstatements

Abstract

This study examines investors’ response to the disclosure of prior period, auditor-waived misstatements under Staff Accounting Bulletin No. 108, Considering the effects of prior year misstatements when quantifying misstatements in the current year. Auditors’ misstatement correction decisions typically are not observable, and financial statement users have little insight into auditors’ and managers’ disposition of identified misstatements, a dimension of audit and financial statement quality. We find that investors respond negatively to the disclosure of SAB No. 108 misstatements and this response is associated with the current-period auditor initially waiving the misstatement, client importance, and misstatement characteristics. Although SAB No. 108 misstatements were waived under prevailing materiality guidance, our findings suggest that investors interpret SAB No. 108 misstatements as indicating lower perceived audit quality.

Keywords: Auditor Independence, Materiality, Staff Accounting Bulletin No. 108, Client Importance, Auditor Tenure, Misstatements

JEL Classification: M41, M42, M48