Regulators have expressed concern that investors are confused by the large number and questionable materiality of accounting restatements since passage of the Sarbanes-Oxley Act (SOX). This study looks for evidence of investor confusion by examining stock returns and trading volume. I find that the initial price reaction to restatement announcements becomes significantly less negative after SOX, even after controlling for the less egregious nature of post-SOX restatements. To assess whether the less negative reaction represents under-reaction, I test whether stock prices drift negatively over the months and years after the initial reaction. I find no evidence of statistically negative drifts unique to the post-SOX period. In fact, I find that post-SOX drifts are statistically less negative than pre-SOX drifts, suggesting that price efficiency actually improves after SOX. Finally, I find no evidence that post-SOX restatements have higher trading volume after controlling for contemporaneous returns, suggesting no increase in disagreement among investors about the restatements. Thus, the findings provide little evidence that investors are confused by post-SOX restatements.

We gain unique insights into materiality judgments about accounting errors by examining SEC comment letter correspondence. We document that managers typically use multiple quantitative benchmarks in their materiality analyses, with earnings being the most common benchmark. In most of the cases we review, managers deem the error immaterial despite its exceeding the traditional “5 percent of earnings” rule of thumb, often in multiple periods and by a large degree. Instead of attempting to conceal these overages, managers tend to forthrightly acknowledge them, often asserting that the benchmark is abnormally low during the violation period. We find that 17–26 percent of these “low benchmark” assertions are suspect (although none of these “low benchmark” assertions are challenged by the SEC). We also document substantial variation in the extent to which qualitative factors are mentioned as considerations. The SEC generally is deferential toward managers' arguments and judgments but is more likely to challenge immateriality claims when managers admit there are qualitative factors that indicate errors are material.

We test conjectures about the determinants of materiality judgments by examining a financial reporting choice made by firms that discover errors in prior years' financial statements. From late 2004 to mid-2006, more than 250 U.S. firms uncovered and corrected operating lease accounting errors either by formal restatement—required for errors deemed material—or by a less visible current-period “catch-up” adjustment. We test the role of materiality considerations outlined in SAB No. 99 as well as factors outside authoritative guidance in explaining the correction method chosen. Although both quantitative and qualitative materiality considerations cited in the guidance explain a large portion of the variation in firms' error correction decisions, we find that the prior actions of other firms also appear to play a major role. We also find that clerical considerations, but not strategic disclosure concerns, help explain cross-sectional variation in the timing of firms' error correction announcements.

When the fair value of an investment security falls below amortized cost and there is significant doubt that the firm can hold the security until the fair value recovers, an other-than-temporary impairment (OTTI) is recognized in net income. Thus, an OTTI is a disclosure about the prospect of recovering an unrealized loss. Our findings suggest that investors priced banks' OTTI recognition during and after the financial crisis. Investors were unable to fully anticipate reported OTTIs, and priced OTTIs incrementally to reported unrealized gains/losses. After banks were required to bifurcate OTTIs, investors priced only the portion of OTTI recognized in earnings. Our results suggest that reporting unrealized losses in earnings via an OTTI changes how investors price the losses. The results inform recent standard-setting initiatives to expand disclosure about changes in fair value. JEL Classifications: M41; M42; M44. Data Availability: Data are available from sources identified in the paper.

Critics argue that fair value provisions in U.S. accounting rules exacerbated the recent financial crisis by depleting banks' regulatory capital, which curtailed lending and triggered asset sales, leading to further economic turmoil. Defenders counter-argue that the fair value provisions were insufficient to lead to the pro-cyclical effects alleged by the critics. Our evidence indicates that these provisions did not affect the commercial banking industry in the ways commonly alleged by critics. First, we show that fair value accounting losses had minimal effect on regulatory capital. Then, we examine sales of securities during the crisis, finding mixed evidence that banks sold securities in response to capital-depleting charges. However, the sales that potentially resulted from the charges appear to be economically insignificant, as there was no industry- or firm-level increase in sales of securities during the crisis. JEL Classifications: M41; M42; M44. Data Availability: Data are available from sources identified in the article.