Concealing distress: financial restatements in the shadow of bankruptcy

Purpose This study aims to examine whether distressed firms that file for bankruptcy are more likely to restate their financial statements than those that reorganize successfully outside of bankruptcy. It explores whether restatements serve as a signal of impending failure and how investors react to such disclosures. Design/methodology/approach The analysis distinguishes between two groups of distressed firms: those entering formal bankruptcy proceedings and those that recover without filing. Comparative tests assess restatement behavior across these groups, with additional focus on the role of earnings management. Market reactions to restatements are also evaluated. Findings The findings indicate that pre-bankrupt distressed firms are significantly more likely to restate their financial statements than distressed firms that avoid bankruptcy. Firms engaging in earnings management are more prone to restatements regardless of bankruptcy status. Investors react more negatively to restatements by pre-bankrupt firms and to those issued by firms perceived to manipulate earnings, independent of their eventual survival. Originality/value By differentiating between bankrupt and non-bankrupt distressed firms, this study advances prior research that treats distressed firms as a homogeneous category. It highlights the signaling value of restatements in predicting failure and underscores the importance of investor perceptions of earnings management in shaping market responses.