The auditor’s going concern decision and Types I and II errors: The Coase Theorem, transaction costs, bargaining power and attempts to mislead

Abstract

It is shown that, in the absence of transaction costs and in line with the Coase Theorem, the going concern decision is efficient in the sense that bias arising from either Type I or II errors is not expected. However, when transaction costs in the form of legal costs, are introduced, bias is expected. The direction of the error depends upon the auditor’s relative bargaining power. It is also shown that its relative bargaining power provides an incentive for the client company to mislead. Finally, certain empirical observations pertinent to this analysis are discussed together with the regulatory implications.