The effect of financial constraints on accounting restatements: Spanish evidence

This paper studies the effect of financial constraints and financial distress on accounting restatements; specifically, we empirically analyse whether several firm-specific characteristics—namely, the level of leverage, the cost of debt, and the interest coverage ratio—influence the likelihood of an accounting restatement. To do so, we use a sample of Spanish listed companies in the period from 2000 to 2017. The results show that the level and cost of debt and financial distress are associated with a higher incidence of accounting restatements. Our evidence is consistent with the argument that financially constrained firms—that is, firms with higher levels of leverage, especially in the short-term, facing a higher cost of debt—and financially distressed firms probably engage in more aggressive accounting practices or opportunistic reporting to clean up their financial statements, leading to an increase in accounting restatements. Financially constrained firms could be motivated to manage financial statements in order to prevent a debt covenant violation, obtain new financing or obtain financing at a lower cost. In the case of financially distressed firms, the motivation could be to prevent bankruptcy costs. The findings are consistent with previous literature, which has shown that firms employ accounting restatement as an instrument for earnings management.