Who's Afraid of the Auditor? Differential Market Reaction to Bad and Good News

48 Pages Posted: 6 Mar 2005

See all articles by Asad Kausar

Asad Kausar

American University - Kogod School of Business; Nanyang Technological University (NTU); Nanyang Technological University

Richard Taffler

Manchester Business School

Christine E.L. Tan

City University of New York - Baruch College

Date Written: March 14, 2005


We explore the differential market reaction to the unambiguous bad news and good news signals provided by the going-concern audit opinion and its withdrawal for 845 firms from 1994 to 2002. Results show asymmetric market response to these news events. The market underreacts to such bad news disclosures, resulting in a downward drift of around -16% over the one-year period subsequent to the going-concern opinion, but treats good news consistent with theory. This post-going-concern announcement drift is also distinct from other established anomalies; however, we find no such evidence for going-concern cases with positive earnings surprise. Adjusting for transactions costs, the opportunity to earn profits by trading on this anomaly is limited and highly risky. Additional analyses of stockholder trading activities reveal that institutional investors reduce their holdings in such stocks on a timely basis in contrast to retail investors. Our results indicate that despite clear adverse signals about the firm's continuing financial viability being conveyed by the auditor to investors, this information is not being fully impounded by the market on a timely basis, in contrast to the good news conveyed by going-concern withdrawals. Our findings add to the existing literature calling into question the ability of the market to rationally price stocks in the case of acute public-domain bad news disclosures, as opposed to good news releases.

Keywords: Market underreaction, going-concern, behavioral finance, limits to arbitrage

JEL Classification: G14, M40, M41

Suggested Citation

Kausar, Asad and Taffler, Richard J. and Tan, Christine, Who's Afraid of the Auditor? Differential Market Reaction to Bad and Good News (March 14, 2005). Available at SSRN: https://ssrn.com/abstract=676584 or http://dx.doi.org/10.2139/ssrn.676584

Asad Kausar

American University - Kogod School of Business ( email )

4400 Massachusetts Avenue NW
Washington, DC 20816-8044
United States

Nanyang Technological University (NTU) ( email )

S3 B2-A28 Nanyang Avenue
Singapore, 639798

Nanyang Technological University ( email )

Nanyang Business School
Singapore, 639798

Richard J. Taffler

Manchester Business School ( email )

Crawford House
Oxford Road
Manchester M13 9PL
United Kingdom

Christine Tan (Contact Author)

City University of New York - Baruch College ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States
646-312-3206 (Phone)
646-312-3161 (Fax)

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