In Financial Statements We Trust

Abstract

How prior trust moderates investor responses to restatements is unknown. We examine how societal trust affects the changes in institutional investors' shareholdings around a restatement. We consider two competing hypotheses based on the erosion of trust and confirmatory bias. We find the change in institutional investors' shareholdings around a restatement is more negative for investors from high trust areas compared to low trust areas, consistent with an erosion of trust where high trust institutional investors view the restatement as a violation of trust. Further analyses show that our findings vary with the regulatory or economic environment, type of institution, and type of restatement. Our results are also robust to different tests that address endogeneity and use alternative societal trust measures. Overall, we contribute to the literature by examining the role of societal trust in a dynamic setting where investors' trust-based beliefs about the credibility of accounting information are not realized. Show more