The Economic Consequences of Financial Misreporting: Evidence from Employee Responses

Abstract

This study investigates the economic consequences of financial misreporting arising from employee responses. Specifically, we examine two employee reactions: (1) withdrawing their human capital and (2) reducing holding of employer stock, in both misreporting period and post-restatement period. We find an increase in employee turnover and a decrease in employee holding of employer stock in the post-restatement period (restatement effect) and some evidence that employees start to react in the period of misreporting (misreporting effect). We also find some evidence that the misreporting effect varies with employee tenure in the misreporting period and the restatement effect varies with the severity of misreporting in the post-restatement period. We further show that our results are not driven by labor demand, increased likelihood of executive turnover, declining stock prices, and internal control weakness disclosures, and are robust to a matched sample estimation. Overall, our study provides evidence of human capital costs of financial misreporting to misreporting firms, shedding new light on the negative consequences of accounting failures.