Measuring the market response to going concern modifications: the importance of disclosure timing
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Auditor going concern modifications (GCMs) are intended to provide market participants with information related to financial distress, and prior research suggests that the disclosure of a GCM elicits a substantial negative market reaction from investors. In this study, we investigate the market reaction to GCMs in a contemporary disclosure regime and consider whether the observed market reaction is confounded by other material disclosures. We find that the majority of GCMs are issued concurrently with earnings announcements (EAs) and that EAs in the year of new GCMs elicit large negative cumulative abnormal returns (CARs). We also find that CARs surrounding GCMs are significantly more negative when GCMs are disclosed with EAs versus following EAs. We then evaluate whether GCMs convey distress that is incremental to EA disclosures by measuring i) the market reaction to GCMs disclosed following EAs, and ii) whether EA CARs are substantially more negative for companies disclosing GCMs with EAs as opposed to after EAs. In both cases, we find that the incremental market response to GCMs is statistically weak and much smaller in economic magnitude than is suggested by prior research. Finally, we find that management disclosures in EAs, rather than the presence of a GCM, appear to convey information that investors use to anticipate bankruptcy. Taken together, these findings suggest that GCMs are confounded by other significant disclosures and that the informational benefits of GCM reporting are significantly smaller than previously thought.
KeywordsGoing Concern Modifications Market Reactions Auditor Reporting
We thank Paul Fischer (the editor) and an anonymous reviewer for their important contributions to this study. We are also grateful to Ben Anderson, Douglas Ayres, Nathan Bergland, Brian Blank, Cory Cassell, James Chyz, Bill Kinney, Tom Lopez, Bill Mayew, James Myers, Terry Neal, Patricia O’Brien, Andy Puckett, Lauren Reid, Steve Utke, Christine Weidman, and Ben Whipple for helpful suggestions, discussion, and comments. We also thank Robbie Moon for programming assistance and Yuzhou Chen, Jodi Henley, and Jenny McCallen for excellent research support. Finally, we thank workshop participants at the Hong Kong Polytechnic University, Lancaster University, University of Alabama, University of Tennessee, and University of Waterloo, as well as conference participants at the 2014 AAA Audit Midyear Meeting, the University of Arkansas 2014 Summer Research Conference, the 2015 Southeast Summer Accounting Research Conference at Georgia Tech, the 2016 Oklahoma State University Accounting Research Conference, and the 2016 European Accounting Association Annual Congress for valuable input. We thank Georgia State University’s Center for the Economic Analysis of Risk for providing funding in support of this research. Linda Myers also gratefully acknowledges financial support from the Haslam Chair of Business and the William B. Stokely Faculty Research Fellowship at the University of Tennessee.
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