Abstract

The purpose of this study is to examine the market' response to the prior period error corrections, especially the change in earnings response coefficients with respect to the error corrections. Thus, it investigates the magnitude of the earnings response coefficient for the firms that announce prior period error corrections and those who do not. Unlike prior studies who focus on short window in which the prior period error corrections are announced, this study extends the research window to one-year fiscal year period including the announcement period and examining the relationship. The sample includes 1,920 firm-year observations collected from Korean listed firms over the period of 2001-2004. Major findings are summarized as follows. First, there is no evidence of the existence of the simple market reaction for the prior error corrections itself during the year. The analysis considering the direction of the error corrections do not make any differences in the results. In contrast, prior studies on prior period error corrections documented significant stork price response to the announcement of the error corrections in the short research window. Combined together, we interpret these results that stock market's response at the announcement period is the response to correct inappropriate stock price. For example, when a company commit accounting errors and thus report inflated (deflated) earnings, the stock is over-priced (under-priced) than intrinsic value of the firm. Subsequently, when firm announces prior error corrections and decreases (increases) reported earnings for the current period, the stock prices decreases (increases) at the moment of the announcement. As a result, the final stock price would be adjusted to the level which is equal to the intrinsic value of the firm. In summary, combined together, it looks like that there is no response to the prior error corrections announcements for the long-window research period. Second, the earnings response coefficient decreases significantly when firms report prior period error corrections and treat the corrections as an increase of net income for the current period. In contrast, there is no earnings response coefficient changes when prior error is corrected in a way to adjust retained earnings. When the error is corrected in a way to decrease the net income, there is no change of the coefficient either. These results can be the evidence of the effect of the market's perceived credibility on the valuation implication of the accounting information. When a firm reports prior period error corrections and increase net income to adjust the error, it seems that the market does not trust the company any more and decrease market response.

Keywords

• Prior Period Error Correction
• Market Response
• Earnings Response Coefficient

Related Articles

• Different Reasons of Mandatory Auditor Designation and Market Responses to Them

  Se Yong Lee

  10(2) 171-198

  Abstract Full Text for PDF

• The Effect of Dividend on Value Relevance of Future Earnings

  Jung, Hyun-Wook

  22(3) 39-68

  Abstract Full Text for PDF

• Corporate Governance and the Effects of Long－term Orientation on Market Responses

  Kim Kyung Tae , Hee Chun Roh

  21(4) 151-182

  Abstract Full Text for PDF

• Why Analysts Issue Cash Flow Forecasts?

  Hyewon Paik

  19(1) 9-31

  Abstract Full Text for PDF

• The Effect of Abnormal Audit Hours on Information Effect of Future Earnings

  Hyun－Uk Jung

  16(4) 9-34

  Abstract Full Text for PDF