When Auditors Say 'No', Does the Market Listen?

European Accounting Review

58 Pages Posted: 18 May 2014 Last revised: 11 Mar 2019

See all articles by Shimin Chen

Shimin Chen

China Europe International Business School (CEIBS)

Bingbing Hu

Hong Kong Baptist University (HKBU)

Donghui Wu

The Chinese University of Hong Kong; Center for Institutions and Governance

Ziye Zhao

Shanghai University of Finance and Economics

Date Written: March 1, 2019

Abstract

Previous research on whether the market responds to auditors’ opinions has provided mixed results. We revisit this issue in China, where the stock market is dominated by individual investors who are more likely to neglect value-relevant information. In addition, China permits modified audit opinions (MAOs) on violations of accounting standards or disclosure rules (GAAP/DISC MAOs), which are subtler in valuation implications than going concern opinions (GCOs) and are more likely to be mispriced. The Chinese stock market thus gives us the best chance of detecting MAO mispricing. We find that, ceteris paribus, MAO recipients underperform in the future and have higher incidence of other outcomes that are adverse to investors, and the market reacts negatively to MAOs during the short window around MAO disclosure. Importantly, MAO disclosure is not followed by negative long-term stock returns, suggesting that stock price adjustments to MAOs are speedy and unbiased. These findings hold for both GCOs and GAAP/DISC MAOs. Together, our findings support the informativeness of audit opinions and cast doubt on the argument that investors inefficiently price audit opinions due to information processing bias.

Keywords: audit modifications; information content; capital market efficiency

JEL Classification: G14; M42

Suggested Citation

Chen, Shimin and Hu, Bingbing and Wu, Donghui and Zhao, Ziye, When Auditors Say 'No', Does the Market Listen? (March 1, 2019). European Accounting Review, Available at SSRN: https://ssrn.com/abstract=2438167 or http://dx.doi.org/10.2139/ssrn.2438167

Shimin Chen

China Europe International Business School (CEIBS) ( email )

Shanghai-Hongfeng Road
Shanghai 201206
Shanghai 201206
China

Bingbing Hu

Hong Kong Baptist University (HKBU) ( email )

Department of Economics
Kowloon, Hong Kong
Hong Kong

Donghui Wu (Contact Author)

The Chinese University of Hong Kong ( email )

Sha Tin
N.T.
Hong Kong
852-3943 7836 (Phone)
852-2603 5114 (Fax)

HOME PAGE: http://www.bschool.cuhk.edu.hk/staff/wu-donghui/

Center for Institutions and Governance ( email )

Room 1033, 10/F
Cheng Yu Tung Building, No. 12 Chak Cheung Street
Hong Kong
China

HOME PAGE: http://www.bschool.cuhk.edu.hk/centres/centre-for-institutions-and-governance/

Ziye Zhao

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

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