Financial Statement Restatements: Trends, Market Impacts, Regulatory Responses, and Remaining Challenges

A number of well-publicized announcements about financial statement restatements by large, well-known public companies have erased billions of dollars of previously reported earnings and raised questions about the credibility of accounting practices and the quality of corporate financial disclosure and oversight in the United States. Industry officials and academics have speculated that several factors may have caused U.S. companies to use questionable accounting practices. Some officials have stated that increased focus and guidance by the Securities and Exchange Commission (SEC) on accounting issues in the late 1990s may have prompted more companies to restate previously reported financial statements. Although the number of restating companies continues to make up a small percentage of all publicly listed companies annually, the number of restatements due to accounting irregularities grew significantly--145 percent--from January 1997 through June 2002. The 845 restating companies GAO identified had restated their financial statements for many reasons--for example, to adjust revenue, costs or expenses, or to address securities-related issues. From January 1997 to June 2002, issues involving revenue recognition accounted for almost 38 percent of the 919 announced restatements. Finally, different parties can prompt a restatement, including the restating company, an external auditor, or SEC. The 689 publicly traded companies GAO identified that announced restatements between January 1997 and March 2002 lost billions of dollars in market capitalization in the days around the initial restatement announcement. However, these losses had potential ripple effects on overall investor confidence and market trends. The growing number of restatements and mounting questions about certain corporate accounting practices appear to have shaken investors' confidence in the nation's financial reporting system. Although determining the effect of the restatements and other accounting issues on overall investor confidence is difficult to measure, various attempts to measure investor confidence have been made. With the increase in the number of restatements due to accounting irregularities, 20 percent of SEC's enforcement cases since the late 1990s were for violations resulting from financial reporting and accounting practices. To address these, SEC has sought a variety of penalties, including levying monetary sanctions, issuing cease-and-desist orders, and barring individuals from appearing before SEC or serving as officers or directors in public companies. The recent increase in the number and size of restatements and disclosures of accounting issues and irregularities underlying them have raised significant questions about the adequacy of the current system of corporate governance and financial disclosure oversight. In addition to public companies, their auditors, and SEC, investors rely on a variety of parties for oversight and financial information, including stock markets, securities analysts, and credit rating agencies, all of which have roles in the corporate governance system or provide information to the investing public. However, recent events have raised concerns about the roles played by each of these parties. On July 30, 2002, the Sarbanes-Oxley Act was enacted. The act addresses many of these concerns, including strengthening corporate governance and improving transparency and accountability to help ensure the accuracy and integrity of the financial reporting system. The act authorizes additional funding for SEC, which has faced staffing and workload imbalances that have challenged its ability to fulfill its mission.