| Abstract: | There 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. |
