THE COST OF CAPITAL IN THE BOND MARKET. WHEN THE FIRMS ALLEGEDLY RESTATED EARNINGS

This paper studies the market reaction to an inconvenient event, i.e. the accounting restatement of earnings, occurring when the firms acknowledge that they released financial statements that were not in accordance with GAAP. Through an empirical test on 133 bonds issued by restating firms from 26 IFRS-adopting countries, we find that due to restatements the cost of financing increases among bonds, similar to those increases previously observed among stocks and private debt. Hence, restatements signal lower firm value, as the results indicate that they impair corporate bond ratings and increase bond yield spreads. Furthermore, the increase in bond yield spreads is significantly larger when the error is more severe. Our findings suggest that rating agencies and bondholders perceive restatements as a critical determinant of the risk of debt financing. Overall, our research fills an important void in the extant restatements literature and completes the framework for measuring the feasible impact of restatements on the corporate cost of capital.