This paper investigates a firm’s reporting behavior in restoring a damaged reputation after announcing restatements. We argue that improving earnings quality to a more conservative level should be a firm’s priority to restore financial statement credibility after experiencing restatement. This paper also tries to empirically show the linkage between restatement firms’ incentive and earnings strategy in the post-announcement period. We thus argue that firms experiencing severe restatement tend to adopt even more conservative accounting principles. The results of this study find that restatement firms barely adopt similar levels of conservatism to control firms after suffering from restatements. However, if firms restate financial statements because of overstating assets/revenues or understating liabilities/expenses, these restatements lead firms to adopt a more conservative accounting policy than control firms and firms involved in a minor restatement. This tendency is especially pronounced in the year of the restatement announcement. The conservatism level of restatement firms declines to no difference from control firms as time moves on. This research finds that restatement firms continuously adopt an aggressive accounting strategy in the pre-announcement period, but a constraint of earnings management exists as time closes to the year of announcement. Combined with the finding of conservative accounting strategy after restatement, our evidence suggests that restatement firms have a reversal of discretionary accruals behavior in the pre- and post-announcement period, especially for firms with severe restatements.
