Why the Going-Concern Anomaly: Gambling in the Market?

Abstract

This paper investigates why the market fails to incorporate the adverse information conveyed by the going-concern (GC) opinion in a timely manner. Our main conjecture is that the lottery-like features of GC stocks attract a predominantly retail clientele who use those stocks to gamble in the market. Such trading behavior leads to the underreaction to the GC event and significant downward drift in prices over the following year. Using a sample of first time GC firms from 1993 to 2007 we show that GC stocks have extreme lottery-type characteristics. We further demonstrate that retail investors have a proclivity to be net-buyers of these stocks around the GC event, and such contrarian behavior is directly related to the lottery-like nature of GC firms. Using individual investor-level trading, socioeconomic, and demographic data we confirm that retail investors who are known to have a greater propensity to gamble are more likely to trade GC stocks. We rule out several alternative explanations for our findings, and conclude that gambling-motivated trading behavior of retail investors is the most likely driver of the anomalous short-term market reaction and the associated longer-term market response following the release of going-concern audit opinion.