The Asymmetric Market Reaction of Stockholders and Bondholders to the Implementation of Early-Warnings Pre Going Concern Opinion

Abstract

Auditing standards requiring auditors to issue going concern opinions (GCOs) have existed for several decades. The FASB exposure draft of June 2013 suggests early disclosures of uncertainties about an entity’s ability to continue as going concerns (GCUs). The FASB’s board argues that the proposed amendments would improve the timeliness and the quality of disclosures of going concern opinions. In Israel, since 2008, about 70% of the publicly traded companies implemented the two-phase models for going concern auditors’ opinions. We utilize a hand-collected dataset of 143 GCOs of publicly traded companies for the years 2007-2013. We examine the stockholders’ and bondholders’ reactions to GCOs preceded by early warnings of uncertainty (GCUs) compared to companies where the GCO disclosure tracks a “clean” opinion. The findings indicate that the equity and debt market reacts to GCUs in a negative and economically significant fashion. In addition, we find that GCUs reduce the negative market reaction to GCOs. This finding indicates that GCU announcements improve the timing and quality of the financial statement disclosure.

Keywords: Going-concern Uncertainty; International Auditing Standards; International Auditing Practices; Audit opinions; Disclaimer of opinion; Financial condition; Short-term market reaction

JEL Classification: M41, M42, G14, G24