Financial Restatements Consequences for Corporate Reputation and Investor Trust

Abstract

This research investigates the underexplored psychological and reputational mechanisms through which financial restatements erode investor trust, moving beyond traditional event-study methodologies to propose a novel, multi-dimensional framework.
While prior literature predominantly quantifies market reactions through stock price
volatility and trading volume, this study uniquely integrates concepts from behavioral
finance, organizational stigma theory, and communication studies to model the erosion
of trust as a complex, non-linear process. We introduce the concept of ’reputational viscosity’—the resistance of a firm’s reputation to recover post-restatement—and develop
a composite index measuring its determinants. Through an original methodology combining computational text analysis of earnings call transcripts, experimental vignette
studies with institutional investors, and longitudinal analysis of media sentiment, we
trace the cascading effects of restatement disclosures. Our findings reveal that the
narrative framing of the restatement cause, the perceived integrity of the remediation
response, and the pre-existing social capital of the firm interact in unexpected ways
to determine long-term trust decay. Contrary to conventional wisdom, we find that
technical, complex error restatements can be more damaging to sophisticated investor
trust than fraud-induced restatements, due to heightened perceptions of managerial
incompetence and systemic control failures. The study concludes by proposing a predictive model for trust restoration trajectories, offering a significant departure from
the prevailing focus on punitive legal and financial outcomes, and providing managers
with a novel toolkit for reputational repair grounded in communicative transparency
and symbolic accountability actions.