Managing reputation loss in China: in-depth analyses of financial restatements

Purpose This paper aims to investigate, in China stock market, whether the reputation loss of a firm caused by financial restatements will lead to significant economic consequences such as financial distress and how a firm should respond to such a crisis. Design/methodology/approach This paper uses Chinese A-share listed firms from 2004 to 2013 as research samples to test research hypotheses using regression analyses. Findings This paper finds a significant relationship between restatements and financial distress, and such a relationship will be affected by both the type and the magnitude of restatements. More importantly, we find joint effects of restatements and state ownership on financial distress, which provides a unique contribution to the extant literature in restatement, financial distress and crisis management using Chinese stock markets data. It shows that ownership structure, affecting the firm reputation and crisis responses strategies, plays a significant role in consequences of restatements, and it is more important for state-owned enterprises (SOEs) to undertake an appropriate crisis response strategy to reduce the negative impact of restatements. Practical implications The results suggest that the damage to a firm’s reputation caused by restatements is affected by restatement type and state ownership. To reduce the negative consequences and avoid financial distress, firms should consider both the restatement type and their firm characteristics when deciding different actions to respond to restatements. In particular, SOEs should act in a more timely manner and take reputation-rebuilding actions such as taking the responsibility and making apologies and taking prompt remedial actions after restatements to regain the public trust and avoid more serious economic consequences. The Chinese government should strengthen their supervisions of SOEs and put more effort to help SOEs reduce administrative procedures, and to improve the efficiency of the implementation of recovery plans after restatements to reinstate firm credibility. Originality/value First, this paper is among the first to link financial restatement, including the type and magnitude of restatements, with financial distress, and the authors find a significant relationship between restatement type and financial distress in China stock markets. Second, this paper is the first to examine whether there is a joint effect of state ownership and restatements on financial distress. Third, this study examines how the magnitude and pervasiveness of restatements influence financial distress and find that both result in an increase of financial distress. Finally, this paper is among the first to connect crisis management and accounting literature to explain how a reputation loss caused by financial restatement may damage a firm’s value and subsequent performance, and based on which to suggest crisis-responses strategies.