The effectiveness of the auditor's going-concern evaluation as an external governance mechanism: Evidence from loan defaults

When there is significant doubt about a firm's ability to continue as a going concern, professional standards require independent auditors to disclose the uncertainty in their report. This study assesses the influence of the independent auditor's going-concern evaluation by examining default following the release of the auditor's report. We use a proprietary sample maintained by the Portuguese Central Bank on 12,199 audit reports relating to approximately 2000 firms that are liable by law to have their accounts audited on an annual basis. Empirical estimation of a logit model controlling for accounting cash- flow-related and nonaccounting variables shows that the likelihood of default for firms that received going concern opinion is 2.792 times that of firms that received a clean opinion. Likelihood ratio tests for omitted variable also confirm the incremental predictive ability of going-concern opinion over and above accounting and nonaccounting variables for the estimation and hold-out samples. In the nondefaulting group, the average default rate is 6.05%, in the defaulting group it is 17.78%. The default rate for firms in the nondefaulting group that received a going-concern opinion is 9.92% and for firms that received a clean opinion it is 5.96%. In the defaulting group, the rate for firms that received a going-concern opinion is 35.49% and for firms that received a clean opinion it is 16.96%. Checks for robustness across different asset classes, age, industries, and regions indicate that firms that receive a going-concern opinion on average default more than those that receive a clean opinion.     

The timeliness and consequences of disseminating public information by regulators

This paper documents different timeliness in disseminating sanction and enforcement information (SEI) by two types of regulatory agencies in China and the different consequences that flow from them. The China Securities Regulatory Commission (CSRC) does not make timely public disclosures of SEI and, instead, leaves it up to the firms to make a public announcement under their general obligation to disclose price-sensitive information. The firms therefore have considerable discretion in deciding whether and when to disclose SEI. In contrast, the stock exchanges in Shenzhen and Shanghai make SEI public promptly through the media and the exchanges’ official websites. Using Chinese SEI data during the period 1999–2005, we find that the CSRC approach is associated with significantly lagged corporate disclosure (compared with the timely stock exchange approach) and a significantly negative (but delayed) stock price reaction. We also show that the sanctioned firm may take advantage of the less timely CSRC approach to delay its disclosure of SEI for opportunistic reasons such as completing material transactions. We conclude that the CSRC should make immediate public announcements of SEI as these contain price-sensitive information. Furthermore, the immediate dissemination of SEI will bring the CSRC into line with the disclosure practices of China’s stock exchanges and international market regulators.     

Geographic earnings disclosure and trading volume

Beginning with Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an Enterprise and Related Information, most US multinational firms no longer disclose geographic earnings in their annual reports. Given the recent growth in foreign operations of US firms and the varying operating environments around the world, information (or lack thereof) related to geographical performance can affect investors’ information set. Using empirical tests that closely follow the [Kim, O., Verrecchia, R., 1997. Pre-announcement and event-period private information. Journal of Accounting and Economics 24, 395–419] model, we find results consistent with their predictions. Specifically, using a sample of firms with substantial foreign operations, we find evidence of a decrease in event period private information following adoption of SFAS 131 for firms that no longer disclose geographic earnings. These results suggest that decreased public information (i.e., non-disclosure of geographic earnings) reduces the ability of investors to utilize or generate private information in conjunction with the public announcement of quarterly earnings, which dampens trading. We also find evidence of a decrease in pre-announcement private information following adoption of SFAS 131. This is consistent with an overall improvement in public disclosures that has the effect of reducing differences in the precision of private information across investors in the period prior to the earnings announcement. However, such an effect is observed for both firms which no longer disclose geographic earnings and for firms that continue to disclose geographic earnings.     

Disclosure of outsourcing in the annual report: Causes and market returns effects

Firms increasingly are utilizing outsourcing to enhance or maintain their competitiveness. Prior research shows that capital markets value a firm's decision to outsource. This study uses a sample of firms announcing outsourcing arrangements in a press release to examine which factors are associated with the subsequent decision to voluntarily provide or withhold information about outsourcing in their annual report. The paper also examines whether annual report disclosure is a reliable signal of future market performance. We find that underperforming firms, larger firms, and firms experiencing negative outsourcing announcement market returns and negative long-term market returns are more likely to disclose outsourcing in their annual reports. There is also evidence that firms' disclosure of outsourcing in the annual report signals an improvement in market performance that is credible to the capital markets. We contend that the disclosure and subsequent firm performance issues we investigate apply to any type of outsourcing arrangement, and therefore our results are relevant to future information systems research on this subject. Our findings also suggest that regulatory standards could reduce private information search costs for investors by providing a common disclosure methodology for outsourcing activities.     

Non-GAAP earnings reporting following going-concern opinions

We examine non-GAAP earnings reporting following a going-concern audit opinion (GCO). Using a propensity score-matched sample, matching first-time going-concern issuing companies with firms in financial distress that did not receive a going-concern report, we find that the likelihood and frequency of non-GAAP earnings reporting are lower following GCOs. In additional analyses, we find the negative association between the announcement of GCOs and the likelihood and frequency of non-GAAP earnings reporting stronger when GCOs are issued by industry-specialist auditors and when GCOs are unexpected, but do not find litigation risk or managers' ability to affect the association. These results are consistent with a decrease in investor demand for non-GAAP earnings disclosures following GCOs.     

Do corporate payouts signal going-concern risk for auditors? Evidence from audit reports for companies in financial distress

We examine the association between payout policy changes and going-concern decisions for financially distressed clients. Extant auditing standards indicate that payout reductions, which offer a prospect of short-term cash relief, can potentially mitigate going-concern uncertainty, whereas economic theory suggests payout decreases (increases) convey mixed but mostly negative (positive) signals about a company’s future financial status. We find that, compared with a bankruptcy prediction model over short (not to exceed 1 year) and long (2–3 years) horizons, auditors seem to significantly underreact to payout decreases (i.e., negative signals) but react appropriately to payout increases (i.e., positive signals) in their going-concern decisions. Moreover, auditors are three times more likely to make Type II misclassification errors in payout-decreasing firms than in payout-increasing and no-change firms. We also find that auditors take longer to determine the appropriate opinion for clients with payout changes, especially for those who cut their payouts. Overall, our findings suggest that auditors respond differently to positive and negative signals about companies’ future prospects, reflecting the mixed nature of payout decreases relative to payout increases and the professional standards’ emphasis on the prospect of short-term cash relief from payout reductions.     

Audit opinion improvement and the timing of disclosure

Companies have been found to report positive information more quickly than they report negative information (i.e., good news early, bad news late). This paper investigates the potential impact of audit opinion change on the timeliness of financial disclosures, with improvements in audit opinion considered to be “good news.” We take both the direction and the magnitude of audit opinion change into consideration, with magnitude measuring how far the opinion is from an unqualified opinion (i.e., an unqualified opinion with explanatory paragraph is closer to an unqualified opinion than a qualified opinion is). We find that firms experiencing an improvement in their audit opinions disclose their financial results earlier, while those with audit opinion deteriorations report their financial results later, and that these effects were related to the magnitude of the opinion change. What's more, there is an asymmetric response to good audit opinion news vs. bad audit opinion news, with bad audit opinion news having a larger effect on earnings timeliness than the effect on earnings timeliness of good audit opinion news. Overall, our results support the “good news early, bad news late” notion. Finally, we also find that overall earnings timeliness has improved in China since the enactment of new reporting regulations in 2006.     

Disclosure of reserve quantum in the extractive industries

We explore why some firms in the extractive industries disclose mineral reserve quantum in their annual reports and others do not. We propose that the firms' reserve disclosure policies are a function of the extent of information asymmetries, as well as information production, litigation and proprietary costs. More specifically, we propose that a firm's decisions to disclose reserves in the annual report are a function of the stage of the firm's operations, use of project financing, and the cost of measuring reserves. Empirical tests are confirmatory.     

Disclosure of reserve quantum in the extractive industries

We explore why some firms in the extractive industries disclose mineral reserve quantum in their annual reports and others do not. We propose that the firms' reserve disclosure policies are a function of the extent of information asymmetries, as well as information production, litigation and proprietary costs. More specifically, we propose that a firm's decisions to disclose reserves in the annual report are a function of the stage of the firm's operations, use of project financing, and the cost of measuring reserves. Empirical tests are confirmatory.     

Addressing Issues Relating To Going-Gongern Audit Qualifications And Corporate Failure

This study examines the incidence of going-concern audit qualifications and of corporate failure for Australian publicly listed companies over the period 1980-90. The analysis includes a review of annual reports for companies that attracted going-concern qualifications but did not subsequently fail, in order to identify potential indicators of survival. The differences between the indicators noted for failed companies that had their last accounts qualified on the basis of going concern, and those of failed companies not qualified, was also examined. Other issues of interest include a comparison of going-concern qualifications by Big Eight (Six) and other audit firms, and the extent and location of disclosure of going-concern problems in the annual report.     

Public re-release of going-concern opinions and market reaction

This paper examines the market reaction to the public announcement of going-concern (GC) opinions through the news media. In the early 2000s, NASDAQ and AMEX required firms listed on their exchanges to publicly announce previously disclosed information, such as the issuance of a GC opinion, through a press release or the news media. We examine the stock market reaction to the re-release of GC opinions. We find significant abnormal stock return volatility and trading volume at the re-release of this information. Further, based on an analysis of intraday transactions, we find higher abnormal trading activity in small trades around the re-release of the GC opinion, but largely no changes in large trades during the same period. In this respect, the investors that initiate the small trades act as if they are surprised by the information contained in the press release of GC opinions. Such an action, in turn, can be viewed as evidence of a delayed response to the information in GC opinions by a section of investors.     

Audit opinion and earnings management: Evidence from Greece

This study examines the relationship between audit opinions and earnings management, as measured by discretionary accruals, for listed firms on the Athens Stock Exchange (ASE). We divide the qualified audit opinions into two categories: qualified for the going-concern uncertainty and qualified for other reasons. The results indicate that audit opinions are not related to earnings management. Client financial characteristics, such as profitability and size are determinants of the going-concern audit opinion decision. The decision of auditors to issue qualified opinions for other reasons is explained by the type of audit opinion issued in the previous year.     

The effect of fair disclosure regulation on timeliness and informativeness of earnings announcements

This paper examines the effect of Korea’s fair disclosure regulation on the timeliness and informativeness of earnings announcements. The present regulation for Korean listed firms requires that if a company’s sales revenue, operating income (or loss) and net income (or loss) have changed by over 30% compared to the prior year, the firm must disclose this information through a preliminary financial report (PFR) even before the company is audited by external auditors. To analyze the effects of this policy, we first investigate the timeliness of preliminary financial report disclosures. We examine the extent to which Korean listed companies actually comply with the requirement for prompt notification of information concerning material changes in financial performance. Second, we investigate the informativeness of preliminary financial reports by analyzing differential stock market reactions to different timings of preliminary financial report disclosures. Our empirical results reveal that more than half of our sample firms release their preliminary financial reports after external audits are completed, thereby potentially invalidating the effectiveness of the regulation. In addition, we find that preliminary financial reports have information value only if they are disclosed prior to annual audit report dates. This finding supports the notion that timeliness increases the informativeness of preliminary financial report disclosure by curbing insiders’ ability to potentially profit from their information advantage.     

EARNINGS SIGNALS AND INTER-FIRM INFORMATION TRANSFERS

Three potential determinants of inter-firm information transfer at earnings announcement dates are examined. They are: (1) the correlation of the announcing and nonannouncing firms' information signals, (2) the information contained in the announcing firm's signal, and (3) the pre-announcement level of uncertainty for the nonannouncing firm. These determinants expand the scope of information transfer studies by (1) moving beyond standard industry definitions and (2) including a measure of the uncertainty related to the market's expectation for the forthcoming signal of the nonannouncer. The results suggest that these three determinants are jointly associated with the return movement of the nonannouncing firms.     

Going-concern initial public offerings

We study the relation between audit reports and the capital-raising activities of small business by studying the role of going-concern (GC) audit opinions in IPOs. After controlling for other effects, we find that the presence of a GC opinion is positively related to whether a stock delists (for deleterious reasons) within two years of IPO. We also find that GC IPOs suffer less first-day underpricing. Based on Rock (1986), this implies that firms with GCs have less ex ante uncertainty in the sense that the information conveyed by a GC helps uninformed investors estimate the dispersion of secondary market values.     

Auditor economic incentives and going-concern opinions in a limited litigious Continental European business environment: empirical evidence from Belgium

Theory predicts that auditor reporting behaviour may be influenced by the perceived consequences of disclosing going-concern uncertainty in the audit report (DeAngelo 1981, Watts and Zimmerman 1986). Krishnan and Krishnan (1996) and Louwers (1998) have addressed this issue empirically in a US context. The results of Krishnan and Krishnan (1996) suggested that one of the important factors in the auditor's opinion decision is the risk of litigation. The purpose of this study is to examine the relationship between auditor economic incentives and the propensity to issue going-concern opinions in a limited litigious business environment, Belgium. In spite of the low risk of litigation and the fact that most Belgian companies are privately held, various regulations have been put into effect to safeguard audit quality in Belgium. However, the results suggest that the auditor's going-concern opinion decision in Belgium is associated with factors relating to the perceived consequences of disclosing a going-concern opinion. Specifically, the results suggest that auditors in Belgium are significantly less likely to issue going-concern opinions to clients that pay higher audit fees, and when the audit firm has lost a relatively high proportion of its clients in the preceding year. The auditor's going-concern opinion does not appear to be significantly influenced by the length of the auditor-client relationship, year of the auditor engagement period, and auditor type. The results of this study are to some extent different from the study by Louwers (1998), in which none of the incentive variables related to the auditor's loss function was significant.     

Retrieving,classifying and analysing narrative commentary in unstructured (glossy) annual reports published as PDF files

We provide a methodological contribution by developing, describing and evaluating a method for automatically retrieving and analysing text from digital PDF annual report files published by firms listed on the London Stock Exchange (LSE). The retrieval method retains information on document structure, enabling clear delineation between narrative and financial statement components of reports, and between individual sections within the narratives component. Retrieval accuracy exceeds 95% for manual validations using a random sample of 586 reports. Large-sample statistical validations using a comprehensive sample of reports published by non-financial LSE firms confirm that report length, narrative tone and (to a lesser degree) readability vary predictably with economic and regulatory factors. We demonstrate how the method is adaptable to non-English language documents and different regulatory regimes using a case study of Portuguese reports. We use the procedure to construct new research resources including corpora for commonly occurring annual report sections and a dataset of text properties for over 26,000 U.K. annual reports.     

Empirical Estimates of Beta When Investors Face Estimation Risk

We examine empirical implications of models of differential information that formalize the following intuition: securities for which there is relatively little information are perceived as relatively more risky because of the greater uncertainty surrounding the exact parameters of their return distributions. The implication that beta risk for low information firms should decline as information increases is confirmed with several data sets. We find such a decline over the first several periods subsequent to initial public offerings and initial listings. There is also an abrupt risk decline at the first annual earnings announcement.     

业绩快报的信息含量:经验证据与政策含义

业绩快报是上市公司2004年报披露中的一项制度创新。本文旨在研究业绩快报是否具有信息含量,以及业绩快报的披露是否会减少盈利公告的有用性。我们选取了2005年1月至4月间披露的70份2004年度业绩快报作为样本进行了实证研究。研究结果表明:业绩快报的披露提高了会计信息质量;业绩快报具有显著信息含量;业绩快报的披露并没有减少盈利公告的信息含量,是盈利公告的一种有益补充形式,值得提倡和推广。     

The effect of strategic and operating turnaround initiatives on audit reporting for distressed companies

Empirical research on the effect of turnaround initiatives on audit reporting is scant. This paper addresses this gap by examining audit reporting for distressed companies and its association with a broad array of strategic and operating turnaround initiatives. In particular, we study the association between business risk information and going-concern decisions for distressed clients. Using a sample of distressed firms in the US manufacturing industry, we find that both short-term cash flow potential as well as strategic growth and hence long-term cash flow potential are necessary for strategic turnaround initiatives to have a mitigating impact on the auditor’s going-concern decision. Strategic turnaround initiatives for which only one of these two conditions holds and operating turnaround initiatives appear to function as going-concern risk factors as they are associated with a higher likelihood that a going-concern opinion will be issued. We also find that specialist and non-specialist auditors assess the mitigating potential of some but not all turnaround initiatives differently. Overall, our results suggest that auditors’ strategic risk assessment (typically done in a business risk auditing context) is associated with the outcome of the audit process (the opinion).