Anomalous Price Reaction and Differential Stockholder Response to Going-Concern Audit Opinions and Withdrawals

Abstract

We explore the medium-term market reaction to going-concern modified audit opinions and their withdrawal for a large sample of firms from 1994 to 2002. Results show asymmetric market response to these accounting system disclosures. The market underreacts to going-concern opinions, resulting in a subsequent downward drift of around -16% over the one-year period subsequent to the going-concern opinion, but fully anticipates their withdrawal. This post-going-concern announcement drift is distinct from other established anomalies; however, it is limited to those going-concern cases with negative earnings surprise. Nonetheless, adjusting for transactions costs, the opportunity to earn profits by trading on this anomaly is limited and risky. Analysis of stockholder trading activities reveals that institutions reduce their holdings in such stocks on a timely basis in contrast to retail investors. Our results are original, and indicate that auditors are providing clear messages to financial statement users in the going-concern context but their information content is not being fully impounded by the market on a timely basis.

Keywords: Market anomalies, Investor Biases, Limits to arbitrage, Going-concern

JEL Classification: G14, G23, M41, M49