Financial Fraud and Analyst Reputation

We investigate the effect of financial restatements on security analysts. Restatement-affiliated analysts are defined as those who issue forecasts during the misstating periods of a restatement firm. We find that following irregularity restatements, restatement-affiliated analysts are more likely to be terminated and demoted to a less prestigious broker than their industry peers whose covered firms don’t experience restatements. Next, following the revelation of an irregularity-restatement, market response to a forecast revision issued by the restatement-affiliated analysts for non-restating firms declined significantly. This decline is stronger for more severe restatements, among affiliated analysts that provide underwriting services to the restating firm, and for analysts whose forecasts for the irregularity firm are more optimistic prior to the restatement announcement. Finally, the forecast optimism of irregularity-affiliated analysts declines significantly and their forecast accuracy improves following restatement announcements. Interestingly, none of these results are observed for analysts associated with error-restatements. Overall, our findings suggest that security analysts suffer a significant reputation penalty following firms’ restatements and such market mechanism plays an important role in disciplining analysts and monitoring the quality of this profession.