Journal of Asset Management and Financing (Mar 2022)
Financial Restatement Impacts on Investment Inefficiencies Considering the Role of Financial Constraints
Abstract
AbstractThe purpose of this research was to investigate the effects of financial restatement on various investment inefficiencies with emphasis on the role of financial constraints. In this study, Richardson (2006)'s model of investing expectations was used to measure investment inefficiencies and categorize the sample member firms into over-invested or under-invested corporates. Also, the index defined by Kaplan-Zingales (1997) was utilized to examine the financial constraints. The sample included 174 companies that were active over 6 years (2012-2017) in the Tehran Stock Exchange. The results indicated that financial restatement could reduce the over-investment, while it exacerbated the under-investment ones. On the other hand, the companies with over-investment might experience greater financing constraints after financial restatement. This relationship was not significant for under-invested companies. Finally, the argument that financial restatement could affect investment inefficiencies by indirectly affecting financing constraints was also not approved by any groups of the compaines.IntroductionFrom the perspective of investors, restatement news not only reflect the performance problems at the previous period, but also is a kind of forecast of future problems for the company and its management. It causes investors to distrust in the management and reduce the earnings quality (Akhgar & Dadejani, 2016) so that it can lead to financing constraints and thus prevent optimal investment decisions and consequently investment inefficiency. Therefore, in this study, the effects of financial restatement on investment inefficiencies were examined. Method and DataThe sample included 174 companies listed on Tehran Stock Exchange (TSE), which were examined in the period of 2012-2017. The study was conducted by using the panel data method. To measure the investment inefficiency, we used Equation 1, which was derived from Richardson (2006)’s model of investment expectations: Eq. (1)Investi,t = β0 + β1 Growi,t-1+ β2 Leveragei,t-1 + β3 Cashi,t-1 + β4 Ln (Age) i,t-1 + β5 Ln (Size) i,t-1 + β6 Stock Returni,t-1 + β7 Investi,t-1 + i,t Also, the index defined by Kaplan-Zingales (1997) was applied to measure the financial constraints: Eq. (2)KZ = β0 - β1 - β2× - β3 × + β4×LEVi.t - β5× QTOBINi,t After sorting the data for each variable, Model No. 1 was utilized to examine the relationship between the financial restatement and financial constraints: M. (1)Logit E(FCi,t) = β0 + β1 RESi,t+ β2 SIZEi,t+ β3 ROAi,t+ β4 GROWi,t+β5 LEVi,t+1+β6 INSi,t+1+β7 First10i,t + εi,t Finally, the following model (2) was used to investigate the role of financial constraints in the relationship between financial restatement and types of investment inefficiencies: M. (2)INVi,t+1 - INVi,t-1= γ0+ γ1RESi,t+ γ2FCi,t+1+ γ3SIZEi,t+1+γ4ROAi,t+1+γ5GROWi,t+1 + γ6LEVi,t+1 + γ7INSi,t+1 + γ8First10i,t+1 + εi,t FindingsAfter estimating Model 1, the coefficient of financial restatement was found to be significant for companies with over-investment at the confidence level of 90%, but it was not significant for companies with under-investment. The coefficients of return on assets and leverage were also significant in both categories of companies at 95% confidence level. According to McFadden's coefficient of determination, the explanatory power of independent variables was greater in the group of companies with over-investment.The estimation results of Model 2 showed that the coefficient of financial restatement was negative for both groups of companies. It was significant for companies with over-investment and under-investment at the confidence levels of 95 and 90%, respectively. However, considering that the probability of financial constraints was more than 5%, this variable was significant in none of the categories of companies. Conclusion and discussion The results showed that financial restatement could reduce corporate over-investment, while it exacerbated corporate under-investment. This result might be due to the fact that the financial restatement caused shareholders to focus more on the integrity of management and accuracy of financial statements and demand for more reporting from managers. Thus, agency problems were reduced and corporate investment efficiencies were improved by reducing over-investment.The results also revealed that companies with over-investment might experience more financial constraints after financial restatement. Of course, this relationship was not significant for companies with under-investment. Due to the increased probability of financial constraints after financial restatement for companies with over-investment, these companies are advised to prepare their financial statements more carefully in order to avoid financial constraints when dealing with suitable investment opportunities so that they do not need to resubmit their financial statements.
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