Do Analysts Know But Not Tell? The Case of Going-Concern Opinions

Abstract

This study explores whether sell-side analysts recognize firms’ going-concern (GC) difficulties, and whether and how they report going-concern uncertainties to investors. We show that analysts are aware of impending firm going-concern problems on the basis of their tendency to downgrade their stock recommendations to “hold” for, and increased probability of ceasing coverage of, GC firms compared with matched non-GC firms as the GC announcement date approaches. Importantly, only 11% of stock recommendations at the GC announcement date are unfavorable (as signalled by “underperform” or “sell”) in contrast to 42% of favorable recommendations (“strong buy” or “buy”). We further show that analysts react to the publication of the GC audit report mainly by stopping covering such firms.Our results suggest that analysts recognize firms’ going-concern uncertainties but communicate their negative prospects using opaque language that likely cannot be understood in particular by retail investors who constitute the main clientele of these firms. Consistent with the SEC’s concerns about the literal interpretation of analyst recommendations, we show that investors cannot rely solely on analyst recommendations in this extreme bad news domain where their information dissemination role is particularly salient.