Investor Reaction to Auditors' Going Concern Emphasis of Matter: Evidence from a Natural Experiment

Abstract

SUMMARY Using a “natural experiment” provided by a change in Canadian auditing standards requiring an emphasis of matter paragraph in the auditor's report (GC-EOM) when the financial statements include a going concern uncertainty disclosure (GC-FS), this paper examines the incremental investor reaction to the auditor's report over the related GC-FS. Conditioning on the linguistic severity of the GC-FS (weak and severe), we first document a negative price response to severe but not to weak GC-FS before the regulatory change. This implies that investors react to financial statement disclosures and account for their degree of interpretability in the absence of a GC-EOM. When the uncertainty disclosure is accompanied by a GC-EOM, we find incremental negative abnormal returns and lower abnormal trading volume only for weak GC-FS. Collectively, these findings imply that an emphasis of matter paragraph in the auditor's report can have incremental value to investors. JEL Classifications: M42; G12; G14. Data Availability: Data used are available from public sources identified in the study.