Societal Trust and Going Concern Assessments: Boon or Bane?
56 Pages Posted: 30 Jul 2018 Last revised: 10 Nov 2019
Date Written: November 8, 2019
Following the severe liquidity and credit problems that companies faced during the financial crisis of 2007-2008, there is heightened interest in reasons why auditors might not issue going-concern opinions (GCOs) to financially distressed clients who seem to warrant such opinions. We examine whether auditors in high societal trust countries exercise less caution, and consequently insufficient professional skepticism, when assessing the ability of entities to continue as a going concern. Using a large sample of observations across several countries, we find a lower incidence of GCOs in jurisdictions with high societal trust. Corroborating this result, we find that this effect varies predictably with cross-sectional variation in litigation risk, management turnover, and auditor turnover. We also find that high societal trust is associated with fewer GCO Type I misclassifications, but more GCO Type II misclassifications. We further investigate managements’ faithfulness in financial reporting and find that societal trust positively affects financial reporting quality only when a company is not in financial distress. This suggests that auditors do not adequately perceive that companies in high trust countries become less trustworthy as their financial condition deteriorates. Our study highlights how an informal control mechanism can have beneficial effects across multiple economic contexts while posing problems in the auditing context.
Keywords: Going-concern opinion, societal trust, professional skepticism, informal controls, formal controls, legal liability
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