Explaining the causes of business failure using audit report disclosures

Abstract

This paper examines the ability of audit report disclosures to explain the causes of business failure. Despite incremental interest in organizational failure, much of the existing literature has used accounting ratios to foresee why firms fail. We hypothesise that the audit report can also be employed for this purpose because it provides information regarding any material uncertainty relating to events that may warn users about possible causes of business default. Using a matched sample of 808 failed and non-failed firms, our results suggest that audit report disclosures significantly explain the causes of business failure. Moreover, these findings are consistent with the results of studies that integrate both deterministic and voluntaristic perspectives into the examination of the antecedents of organizational failure, as disclosures about both external and internal factors are mentioned in the audit report and contribute to assessing default. Managers, auditors, regulators and other users may consider the audit report to be useful as a tool to anticipate business failure.