Financial Misstatements in Canada: An Analysis of the Corporate Governance Response to Accounting and Audit Irregularities

Accurate financial statements provide the foundation for effective and efficient capital markets.  In addition to the statutory liability of public company issuers for financial misstatements, auditors also serve as gatekeepers who provide a measure of external assurance to investors regarding the accuracy of financial reporting.  Market confidence and the cost of capital are, in turn, driven by the ability of investors to rely on these statements when allocating capital.  Consequently, financial misstatements have the effect of eroding confidence in both the issuer and the market as a whole.  For this reason, the corporate governance and regulatory response to a financial misstatement is critical for ensuring market stability and mitigating the risk of similar irregularities in the future.  Moreover, because perceptions regarding the quality of audit services and audit quality are driven by reputation and other subjective factors an issuer’s response to financial misstatements is particularly critical for reassuring investors. 

To date, much of the literature on financial misstatements has focused on the causes of these irregularities and steps that can be taken to mitigate audit risk.  However, there has been limited analysis in Canada of how issuers respond to misstatements over the medium and long term.  This research evaluates financial restatements in Canada over a ten-year period by evaluating the governance and business challenges within the issuer prior to and at the time of the misstatement.  In particular, it explores particular attributes of the issuer, the nature of the misstatement and the governance and audit structures at the time. Following the restatement, the research examines whether there are any changes in the composition of the audit committee composition or auditor and relationship to any private litigation or public regulatory actions by securities regulators or public accounting oversight bodies.  

Despite the efforts of issuers, auditors and regulators, financial misstatements are inevitable in modern capital markets.  Therefore, it is necessary to have a clear understanding of the systems and processes that enable issuers to effectively respond to misstatements in a manner that helps restore investor confidence and limits the contagion risk to the cost of capital of other issuers.  It is anticipated that this research will provide issuers, regulators and scholars with a clearer understanding of how to respond to financial misstatements and thereby provide the foundation for enhanced governance processes and more effective regulatory responses.  In doing so, it will identify a series of corporate governance best practices and potential regulatory reforms which will help restore market confidence once the restatement is issued.