Market consequences of sovereign accounting errors

Abstract

This paper investigates the market consequences of sovereign accounting errors, opening a new area of research on sovereign accounting quality in the accounting literature. Eurostat, a division of the European Commission, provides semi-annual assessments of financial reports produced by the member states of the European Union (EU), and issues reservations that detail financial reporting errors. Using a sample of Eurostat reservation issuances across 28 EU countries from 2004-2018, we find that sovereign bond yields abnormally increase during a reservation announcement window, especially when a reservation explicitly mentions deficit or debt, when it quantifies the extent of errors, or when the errors relate to recent fiscal data. Consistent with a home bias after the release of negative news, we find that domestic holdings of sovereign debt increase after the issuance of a reservation. Overall, our evidence suggests that sovereign accounting errors have significant market consequences and raises further questions for future research in sovereign accounting quality.