Stock Prices Crash by an Average of 10% Around Revenue Recognition Restatements

Revenue recognition restatements wipe out on average 10% of a company’s market value according to a new study by Audit Analytics. The study measured market reaction from 50 days before until 50 days after the announcement. By comparison the general market rose 3% over the same time periods. The finding is based on an analysis of 674 adverse restatements from 613 companies made in 2006.

In the study, stock prices dropped on average 6% prior to the revenue recognition restatement, with an additional 4% occurring after the announcement as shown in the figure below.

Figure 1
Year 2006: Restatements identifying Revenue Recognition Issues.

The way companies make these announcements also has a dramatic influence on how they are received. The market reaction was markedly more pronounced when restatements were made in event filings (8Ks and press releases), compared to periodic reports such as: 10Ks, 10KAs, 10Qs, 20Fs, 40Fs, etc. The study examined other leading causes of restatements in 2006 such as cash flow issues and stock option back-dating, and found that effects on stock price were neither as dramatic nor long lasting. When comparing the market reaction by company size, smaller companies were shown to be hit hardest.

The study can be purchased from Audit Analytics by following this link.