Investor Reaction to Going Concern Audit Reports

Author:

Menon Krishnagopal1,Williams David D.2

Affiliation:

1. Boston University

2. The Ohio State University

Abstract

ABSTRACT: The literature provides mixed evidence on whether investors find audit reports modified for going concern reasons to be useful. Using a substantially larger sample than previous studies, we observe negative excess returns when the going concern audit report (GCAR) is disclosed. We find that the reaction is more negative if the GCAR cites a problem with obtaining financing, suggesting that the GCAR provides new information to investors. Also, the reaction is more adverse if the GCAR triggers a technical violation of a debt covenant that restricts the firm from getting a GCAR. The evidence suggests that institutional investors drive the reaction to the GCAR, since there is no detectable reaction at low levels of institutional ownership. The market reaction gets more negative as the level of institutional ownership increases, and there is a decline in institutional ownership after the GCAR is issued. We attribute these results to sophisticated investors’ awareness of the firm’s financing needs and the covenants carried by the firm’s debt.

Publisher

American Accounting Association

Subject

Economics and Econometrics,Finance,Accounting

Reference38 articles.

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2. Financial ratios, discriminant analysis and the prediction of corporate bankruptcy;Altman;The Journal of Finance,1968

3. American Institute of Certified Public Accountants (AICPA). 1988. The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern. Statement on Auditing Standards No. 59. New York, NY: AICPA.

4. The relationship between return and market value of common stocks;Banz;Journal of Financial Economics,1981

5. Relative valuation roles of equity book value and net income as a function of financial health;Barth;Journal of Accounting and Economics,1998

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