Going-concern Opinion Research Articles

Institutional investor inattention and audit quality

We hypothesize and provide empirical evidence that higher institutional investor inattention is associated with lower audit quality. We employ an inattention measure that captures the extent to which institutional investors are distracted by attention-grabbing events irrelevant to the focal firm. Results suggest that a higher degree of institutional investor inattention is associated with a lower propensity of a going-concern opinion, a lower probability of the auditor reporting a material internal control weakness, and a higher likelihood of the audit client misstating the financial statements. Further analyses show that these associations vary by auditor litigation risk, their workload pressure, auditor industry expertise, and analyst coverage. Overall, our findings reveal that while institutional investors play an important monitoring role, the distractions they face undermine the quality of monitoring they provide.

Does a Manager Respond to a Going-Concern Audit Opinion with an Asymmetry in Gain and Loss?

In this paper, I investigate the relationship between previous going-concern audit opinions and subsequent asymmetric timeliness in accounting. Using the time-series and price-based models and conservatism proxy, I find that firms with going-concern audit opinions subsequently report losses in a more timely manner than firms that did not receive going-concern audit opinions. Furthermore, I also find that firms exiting going-concern audit opinions are more likely to report losses rather than gains in a timely manner, compared to firms non-exiting from going-concern opinions. This study extends the prior research by exploring the association between going-concern opinions and accounting conservatism from the perspective of client firms—that is, how firms behave strategically and conservatively to bypass going-concern opinions, once the firms had received previous going-concern opinions.

Generalist CEOs and Audit Pricing

SUMMARY We analyze the consequences of a firm hiring a generalist CEO in terms of the audit fees paid by the firm. We find that audit fees of clients with generalist CEOs are higher than those of clients with specialist CEOs. This relation is robust to considering managerial ability, other CEO characteristics, various fixed effects, instrumental variables, and change analyses. We further show that fee differences are larger for firms with weaker monitoring and higher corporate litigation risks. Through path analysis, we find that both client business risk and misreporting risk contribute to the fee difference. Finally, we find that auditors are more likely to issue going-concern opinions to clients with generalist CEOs. Our study should be of interest to auditing standard setters who link management operating styles to audit risk. We shed light on how management operating styles associated with the CEOs' general or specialized skills affect audit pricing. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M41; M42.

Third-Party Consequences of Changes in Managerial Fiduciary Duties: The Case of Auditors’ Going Concern Opinions

This study examines the effect of managerial fiduciary duties on the likelihood of firms receiving going concern (GC) opinions from their auditors. We exploit an influential 1991 legal ruling that expanded fiduciary duties of corporate directors and officers in favor of creditors for near-insolvent Delaware firms. Our difference-in-differences test reveals an increase in GC opinions following the ruling for near-insolvent Delaware firms. Further tests indicate an increase in type I audit opinion errors and no change in audit risk after the ruling. Additional analysis shows that, after the ruling, near-insolvent Delaware firms are less likely to dismiss their auditors following the receipt of a GC report. Overall, our findings are consistent with managers and directors with increased fiduciary duties toward creditors exerting less pressure on auditors and allowing them to reveal more GC opinions. Our results highlight important third-party consequences of changes in managerial fiduciary duties. This paper was accepted by Shiva Rajagopal, accounting.

Auditor’s going-concern opinion prediction: the case of Slovenia

In an audit of a firm’s financial statements, the auditor assesses whether there is material uncertainty about the firm’s ability to continue as a going concern. If the existence of material uncertainty is confirmed, the auditor considers the adequacy of the firm’s disclosures regarding its going concern in the firm’s annual report. Most commonly, if the firm’s disclosures are adequate, the auditor issues a going-concern opinion in the auditor’s report. The auditor modifies his opinion on firm’s financial statements because of auditor’s going-concern doubt on the firm’s ability to continue as a going-concern rarely in specific circumstances. In the present paper we provide an auditor’s going-concern prediction model using various combinations of a firm’s economic predictors. A sample data of 14,761 firm-year observations from Slovenia during the period 2005–2013 has been used for the model. The results reveal that firms with a going-concern qualification have a worse financial structure (i.e., lower equity financing rates), worse liquidity, worse efficiency, and worse profitability in comparison to firms without this qualification. Using a logistic regression prediction model for a going concern qualification in auditor’s report, qualification can be predicted with sufficient accuracy on a sample data of Slovenian firms.

Third-Party Consequences of Changes in Managerial Fiduciary Duties: The Case of Auditors’ Going Concern Opinions

This study examines the effect of managerial fiduciary duties on the likelihood of firms receiving going concern (GC) opinions from their auditors. We exploit an influential 1991 legal ruling that expanded fiduciary duties of corporate directors and officers in favor of creditors for near-insolvent Delaware firms. Our difference-in-differences test reveals an increase in GC opinions following the ruling for near-insolvent Delaware firms. Further tests indicate an increase in Type I audit opinion errors and no change in audit risk after the ruling. Additional analysis shows that after the ruling near-insolvent Delaware firms are less likely to dismiss their auditors following the receipt of a GC report. Overall, our findings are consistent with managers and directors with increased fiduciary duties toward creditors exerting less pressure on auditors and allowing them to reveal more GC opinions. Our results highlight important third-party consequences of changes in managerial fiduciary duties.

Generalist CEOs and Audit Pricing

We analyze the consequences of a firm hiring a generalist CEO in terms of the audit fees paid by the firm. We find that audit fees of clients with generalist CEOs are higher than those of clients with specialist CEOs. This relation is robust to considering managerial ability, other CEO characteristics, various fixed effects, instrumental variables, and change analyses. We further show that fee differences are larger for firms with weaker monitoring and higher corporate litigation risks. Through path analysis, we find that both client business risk and misreporting risk contribute to the fee difference. Finally, we find that auditors are more likely to issue going-concern opinions to clients with generalist CEOs. Our study should be of interest to auditing standard setters who link management operating styles to audit risk. We shed light on how management operating styles associated with the CEOs’ general or specialized skills affect audit pricing.

Auditor Responses to Shareholder Activism

ABSTRACTIn this paper, we investigate how auditors respond to shareholder activism against their clients. Our study is important because activism may be viewed by auditors as a source of increased engagement risk, thereby impacting audit outcomes. The potential relationship between shareholder activism and audit outcomes leads us to predict that activism targets will pay higher audit fees and also will be more likely to receive adverse internal control opinions (ICOs) and first‐time going concern opinions (GCOs). Our results, which support all three predictions, suggest that the public scrutiny associated with activism campaigns heightens auditors' concerns about reputational damage and litigation risk. Consistent with this notion, we find that activism targets are more likely to experience accounting‐related lawsuits. We also find that the increased likelihood of adverse ICOs documented in our baseline tests reflects higher‐quality reporting rather than increased auditor conservatism. Overall, our findings suggest that activism campaigns spur auditor diligence while also increasing the possibility of negative outcomes that may not be fully anticipated by activist investors.

Evidence on going concern reporting before and after ASU 2014–15

Purpose This study aims to examine the impact of Financial Accounting Standard Board’s Accounting Standard Update (ASU) 2014–15 on auditors’ going concern reporting. ASU 2014–15 provides accounting guidance for managers related to going concern issues, but there is evidence that regulatory changes affect auditor behavior. The authors examine if auditors’ propensity to issue going concern opinions (GCOs) for non-bankrupt, financially distressed firms changes after ASU 2014–15 became effective, and if the proportion of client bankruptcies with prior GCOs changes after ASU 2014–15 became effective. Design/methodology/approach The authors examine audit reports for non-bankrupt, financially stressed firms three years before and after the effective date of ASU 2014–15 to see if the propensity to issue a GCO differs in the pre- vs post-period. The authors then examine bankrupt, financially stressed firms to determine if the proportion of bankruptcies preceded by a GCO differs in the pre- vs post-period. Findings The authors find a significant increase in GCO reporting for non-bankrupt, financially stressed firms in the post-ASU 2014–15 period, suggesting auditor conservatism increased. The propensity for auditors to issue a GCO to bankrupt firms also increased significantly in the post-ASU period, providing evidence that auditors became more accurate, as more bankruptcies were preceded by a GCO than in the pre-ASU period. Originality/value This study uses new legislation which creates an exogenous shock to going concern reporting. Models and techniques are combined from prior literature and extended to investigate auditors’ reporting behaviors using two important and distinct samples.

Investor Sentiment, Misstatements, and Auditor Behavior*

ABSTRACTHigh investor sentiment has been linked with opportunistic managerial behavior in the face of more optimistic investors and analysts. We extend this line of work by documenting that the likelihood of misstatements is higher when sentiment is high. Although this would suggest elevated audit risk, we posit that a contemporaneous reduction in auditors' litigation cost could drive down audit fees and going concern opinion (GCO) reporting conservatism in order to please clientele. Consistent with this notion, we document that auditors charge lower fees and report GCOs less conservatively when sentiment is high. However, this reduction in reporting conservatism is unwarranted; results reveal that auditors are less likely to issue GCOs to clients which subsequently file for bankruptcy during high sentiment periods. We conduct additional tests to examine whether auditors' litigation costs indeed vary with sentiment and document that auditors are less likely to be sued and the market reacts less negatively to misstatement announcements when sentiment is high. Collectively, our findings suggest that, although misstatement risk is increasing with sentiment, auditors' litigation risk actually declines.

Pengaruh Audit Fee, Opini Audit Going Concern, Ukuran Perusahaan, Pergantian Manajemen dan Kepemilikan Publik Terhadap Auditor Switching

ABSTRACT 
 This study is to analyze the effect of audit fees, going-concern audit opinion, company size, management change, and public ownership on auditor switching both partially and simultaneously. Sample of this study are manufacturing company that has been listed on Indonesia Stock Exchange (BEI) for period 2015-2017. The data analysis technique used is logistic regression. Partial test results show that public ownership influences the auditor switching. While the audit fee, going-concern audit opinion, company size, and management change have no effect on auditor switching. Simultaneous test results indicate that the audit fee, going-concern audit opinion, company size, management change, and public ownership are able to explain the occurrence of auditor switching in manufacturing companies listed on Indonesia Stock Exchange in 2015-2017 by seven percent and the remaining ninety three percent explained by other variables outside the research model.
 
 Keywords: Auditor switching, Audit fee, going concern audit opinion, company size, management turnover, public ownership

The effect of auditor litigation risk on clients' access to bank debt: Evidence from a quasi-experiment

We exploit staggered state-level shocks to third-party auditor legal liability in the U.S. to test whether auditor litigation risk affects client companies' access to private debt markets. We find that an exogenous increase in auditor litigation risk leads to an increase in both clients' likelihood of receiving bank loans and the average amount of the bank loans that clients receive. In support of our proposed mechanism that auditor litigation risk leads to improvements in clients' audit and financial reporting quality, we find that these same shocks lead to a reduction in accruals, an increase in going-concern opinions, a decrease in restatements, and an improvement in accruals' ability to predict future cash flows. We also find that increased auditor litigation risk leads to an increase in the contractibility of clients’ accounting numbers, as proxied by the use of debt covenants, and a decrease in the cost of borrowing.

The Effect of Auditor Litigation Risk on Client Access to Bank Debt: Evidence from a Quasi-Experiment

We exploit staggered state-level shocks to third-party auditor legal liability in the U.S. to test whether auditor litigation risk affects client companies’ access to private debt markets. We find that an exogenous increase in auditor litigation risk leads to an increase in both clients’ likelihood of receiving bank loans and the average amount of the bank loans that clients receive. In support of our proposed mechanism that auditor litigation risk leads to improvements in clients’ audit and financial reporting quality, we find that these same shocks lead to a reduction in accruals, an increase in going-concern opinions, a decrease in restatements, and an improvement in accruals’ ability to predict future cash flows. We also find that increased auditor litigation risk leads to an increase in the contractibility of clients’ accounting numbers, as proxied by the use of debt covenants, and a decrease in the cost of borrowing.

Do Client Bankruptcies Preceded by Clean Audit Opinions Damage Auditor Reputation?*

ABSTRACTThere is a maintained assumption within the accounting literature that client bankruptcies preceded by clean audit opinions (Type II going concern opinion (GCO) errors) damage an auditor's reputation. Consistent with this view, the PCAOB proposes that stakeholders may use Type II GCO errors as indicators of low audit quality. This study examines audit committee and investor responses to Type II GCO errors. I find no evidence that audit offices with Type II GCOs are more likely to be dismissed, have lower subsequent audit fees, or have a lower likelihood of being selected for new audit engagements. These findings are consistent with audit committees not using Type II GCO errors as indicators of low auditor quality. Using event study analysis, I find evidence of modest incremental negative investor responses for clients of audit offices with Type II GCO errors. However, these negative investor responses are found only during the financial crisis period of 2008–2010 and are observed only within windows of 30 days or less. Given this limited evidence that stakeholders do respond to Type II GCO errors, I examine whether stakeholders should respond to Type II GCO errors. I find that audit office Type II GCO errors are positively associated with subsequent restatements, an established measure of low audit quality. Taking the results as a whole, I do not find that audit offices incur substantial reputational costs for Type II GCO errors. However, the negative investor response and the positive association with restatements provide some evidence that Type II GCO errors may serve as indicators of low audit quality.

Do going concern opinions provide incremental information to predict corporate defaults?

Investors, regulators, and academics question the usefulness of going concern opinions (GCOs). We assess whether GCOs provide incremental information, relative to other predictors of corporate default. Our measure of incremental information is the additional predictive power that GCOs give to a default model. Using data from 1996 to 2015, initially we find no difference in predictive power between GCOs alone and a default model that includes financial ratios. However, there is an imperfect overlap between GCOs and other predictors. We show that GCOs increase the predictive power of several models that include ratios, market variables, probability of default estimates, and credit ratings. Using a model that includes ratios and market variables, GCOs increase the number of predicted defaults by 4.4%, without increasing Type II errors. Our findings suggest that GCOs summarize a complex set of conditions not captured by other predictors of default.

A multiple discriminant analysis of the auditor’s going concern opinion: the case of audit opinions in Italy

Purpose The purpose of this paper is to develop a model for assessing the audit evidence of the going-concern (GC) assumptions underlying the preparation of financial statements. Design/methodology/approach This research analyses 678 audit opinions of Italian listed firms from 2007 to 2016 and uses a multiple linear discriminant analysis to create a GC score, which includes variables suggested by the international standards on auditing (ISA) 570 and by literature on GC. Findings The model provides three cut-off scores which can orient auditors towards issuing the most appropriate GC audit opinions (unmodified opinion, unmodified opinion, which includes emphases of matter, qualified opinion or disclaimer of opinion). Research limitations/implications The development of the model is mainly based on public data and does not assess confidential information that is not disclosed in audit opinions. Practical implications This model can enable auditors to identify the most appropriate GC opinion and align auditor’s opinions in similar circumstances, thereby reducing their reliance on discretion and increasing the reliability of their judgement with a higher degree of accuracy. Moreover, this research lists additional events or conditions that may individually or collectively cast significant doubt on GC assumptions. Originality/value This study goes beyond the traditional decision-making process, apparently binary in nature, between “continuity” and “failure” or between “unmodified” and “modified” opinions. It is conceived to detect the different degrees of uncertainty that affect GC evaluations to orient auditors’ professional judgements.

Auditors’ response to readability of financial statement notes

PurposeThe main objective of the present study is to assess the potential impact of readability of financial statement notes on the auditor's report lag, audit fees and going concern opinion (GCO).Design/methodology/approachThe statistical population of this study includes all listed firms on the Tehran Stock Exchange (TSE) for the period of 2012–2017. The systematic elimination method is used for sampling and multiple regression and EViews software are used for testing the hypothesis models.FindingsThe obtained results show that there is a significant and positive relationship between audit report lags and readability of financial statements. Moreover, it is also revealed that readability of financial statements is positively associated with audit fees. Furthermore, the findings suggest a negative correlation between readability indexes and issuing GCOs, denoting hard-to-read statements is considered as a risk factor by auditors. Finally, the observations of our robustness tests suggest that the association between audit report lag and readability of financial statements is robust.Originality/valueThis is the first conducted investigation concerning auditor's response to the readability of financial statement notes in TSE. The outcome of current paper may pave the way for revising and developing Iranian accounting standards in order to give a fairer and clearer picture of financial reports.

Auditor Going Concern Opinions and Bank Systemic Risk: Evidence from the 2007–2009 Financial Crisis

SUMMARYFollowing the 2007–2009 financial crisis, regulators and investor groups alleged that auditors were reluctant to issue going concern opinions (GCOs) to distressed banks during the crisis, raising questions about the quality of auditors' GCO decisions. This paper investigates whether systemic risk influences auditors' GCO decisions during the crisis due to potential adverse spillover effects. Using 496 bank-year observations, we find that auditors are less likely to issue a GCO to systemically risky banks, and this auditor behavior reduces Type I errors without increasing Type II errors. The effects are more pronounced during the crisis period, especially for banks that are large and connected, have lower litigation risk, or are audited by Big 4 auditors or industry specialists. Overall, our findings suggest that during the crisis period, auditors were less likely to over-issue GCOs to systemically risky banks, resulting in more accurate GCOs.JEL Classifications: M42; G20.

Is an Auditor's Propensity to Issue Going Concern Opinions a Valid Measure of Audit Quality?

AbstractA number of previous studies use auditor propensity to issue a going concern opinion (GCO) as a proxy of audit quality when examining a sample of financially distressed firms. This study examines whether audit quality (measured by discretionary accruals) influences the probability of financially distressed firms receiving GCOs using a non‐specific sample of 2937 firm‐year observations from Australia over the period 2011–2015. The study first investigates the association between financially distressed firms and the issuance of GCOs. This association is then re‐tested after separating the total sample into low and high audit quality subsamples. The results indicate that financially distressed firms are more likely to receive GCOs, confirming the application of ASA 570 Going Concern. However, financially distressed firms that receive GCOs from their auditors are limited to firms that have higher‐quality audits.

Consequences of Going-Concern Opinion Inaccuracy at the Audit Office Level

SUMMARYThis paper examines whether inaccurate going-concern opinions negatively affect the audit office's reputation. Assuming that clients perceive the incidence of going-concern opinion errors as a systematic audit quality concern within the entire audit office, we expect these inaccuracies to impact the audit office market share and dismissal rate. We find that going-concern opinion inaccuracy is negatively associated with the audit office market share and is positively associated with the audit office dismissal rate. Furthermore, we find that the decline in market share and the increase in dismissal rate are primarily associated with Type I errors. Additional analyses reveal that the negative consequence of going-concern opinion inaccuracy is lower for Big 4 audit offices. Finally, we find that the decrease in the audit office market share is explained by the distressed clients' reactions to Type I errors and audit offices' lack of ability to attract new clients.