Identifying Unintentional Error in Restatement Disclosures

Abstract

Regulatory oversight bodies and audit researchers are interested in restatements as a reliable indicator of audit quality. This paper describes the construction and validation of a new proxy for restatements that correct unintentional error. This proxy classifies less than one third of restatements as correcting unintentional error, in contrast to current proxies that classify over half of all restatements as correcting error. I find, for years with auditor’s Sarbanes-Oxley Act Section 404 (SOX 404) opinions, that restatements that correct unintentional error are associated with less net income smoothing, less earnings persistence, and less positive accruals than other restatements. Automated text searches of restatement announcements, for language asserting or implying lack of management intent, are used to identify restatements that correct unintentional error. This more refined proxy will contribute to future research by enhancing the power of tests used to study associations between unintentional error and the expertise and incentives of CFOs, audit committees, and auditors.

Keywords: unintentional error proxy, financial restatements, financial reporting quality

JEL Classification: M41