When it comes to disclosure of financial misstatements in a corporate press release, companies do better to keep things quiet. The less prominent the news of the error, the fewer class-action lawsuits will result. Furthermore, the greater the prominence of the news, the greater the decline in market value for the company.

Edward Swanson

Edward Swanson, professor and Nelson D. Durst Chair in Accounting, and Senyo Tse, KPMG Professor of Accounting, along with Rebecca Files, formerly a PhD candidate at Mays, now an assistant professor at the University of Texas at Dallas, looked at how 919 firms announced misstatements between 1997 and 2002.

They separated announcements into three levels of prominence: high (headline of a press release), medium (body of a press release, but no mention in headline); and low (footnote of a press release, a.k.a. “stealth disclosure”).

They found that that firms providing less prominent press release disclosure of a restatement are rewarded with a less negative return at the announcement. Also, companies providing less disclosure are less likely to be sued for securities fraud.

Senyo Tse

The research indicates that lowering the prominence of disclosure by one level reduces the likelihood of a lawsuit by about half. The researchers controlled for other factors to isolate the effect of the placement of the announcement. They also controlled also for the severity of the misstatement. No differentiation was made about whether the restatement was due to aggressive reporting versus unintentional accounting errors.

Though it seems obvious that not trumpeting the company’s errors would be the safest policy, the researchers note that there are several reasons why managers continue to prominently announce financial errors. One possibility is that restatements occur infrequently, so managers have little experience that would allow them to anticipate how investors and litigators will react. Another possibility is that companies that value forthright communication may assume that placing the announcement anywhere other than the headline would be seen as deceptive.

As press releases are the primary timely disclosure medium for most companies, the findings of this study should be of interest to investor relations executives and other corporate managers with responsibility for disclosure communication. The researchers also suggest that regulators, especially the SEC, may want to issue guidelines to standardize press release disclosures so firms will not be rewarded for providing less prominent disclosure of accounting restatements. However, the researchers warn that such guidelines should not simply require headline disclosure for all restatements, since this could increase the number of frivolous lawsuits.

For more information

For further information, contact Swanson at eswanson@mays.tamu.edu or Tse at stse@mays.tamu.edu.

The article “Stealth disclosure of accounting restatements” appeared in The Accounting Review in 2009.