When are going concern audit opinions more informative? An analysis of auditor reasons and ex post accuracy

Purpose: We examine the content of auditors’ going concern opinions (GCOs) to investigate how the market reacts to particular explanations and to the overall number of reasons presented by auditors. We investigate whether the market reacts differentially to explanatory paragraphs alluding to specific financial concerns emphasized in the finance literature: reductions in expected future cash flows, difficulties with short-term liquidity and violations of debt covenants. Finally, we examine whether GCOs that are ex-post accurate, as indicated by a subsequent bankruptcy, are accompanied by more negative reactions. Design/methodology/approach: We regress cumulative abnormal returns on the number of reasons cited by auditors and indicator variables for whether auditors cited concerns pertaining to future cash flows, debt covenant violations or short-term cash holdings. We include an indicator for subsequent bankruptcy and control variables. Findings: The market reaction to GCOs is significantly more negative when auditors offer more reasons or specifically cite a decrease in expected future cashflows or a violation of debt covenants and when GCOs are ex-post accurate. Research limitations/implications: The results indicate that auditors’ explanations for GCOs contain incremental information content that is useful to investors. Practical implications: We find that more detailed GCO reports are more informative to investors, supporting the need for regulations requiring auditors to provide detailed justifications when issuing GCOs. Originality/value: This study is the first to examine how the number of reasons given by auditors affects market reactions to GCOs and to specifically examine how investors react to GCOs that cite violations of debt covenants or reductions in future cash flows as justifications for the GCO.