Chen & Church AR 1996

THE ACCOUNTING REVIEWVol. 71. No. 1January 1996pp. 117-128

Going Concern Opinions andthe Market's Reaction to

Bankruptcy Filings

Kevin C. W. ChenRutgers University-New Brunswick

Bryan K. ChurchWilfrid Laurier University

ABSTRACT: This study investigates the association between going concernopinions and the market's reaction to bankruptcy filings. The results of prior studiesindicate that going concern opinions are useful in predicting bankruptcy and providesomeexplanatory power in predicting bankruptcy resolution. As such, going concernopinions may reduce the surprise associated with bankruptcy. Our results areconsistent with this assertion. Firms receiving going concern opinions experienceless negative excess returns in the period surrounding bankruptcy filings than thosereceiving unqualified opinions. These results hold after controlling forthe probabilityof bankruptcy, the market's reaction to news announcements occurring prior tobankruptcy, and changes in stock price prior to the issuance of the auditor's report.Overall, our results are consistent with going concern opinions having informationvalue.

Key Words: Going concern, Bankruptcy, Audit qualifications. Capital markets.

Data Availability: A list ofsampie firms is available from the authors upon request.All other data are available from public sources.

RI. INTRODUCTION

esearchers and practitioners alike contend that market participants are interested in theauditor's assessment of going concem, particularly in light ofthe increasing number ofbankruptcies occurring over the past decade.' Although the auditor is not responsible for

' See for example Connor (1986), Campbell and Mutchler (1988), Ellingsen et al. (1989), and Boritz (1991).

We acknowledge the helpful comments of Lucy Ackert, Duane Kennedy, Morley Lemon, Claude Pilote, BillSalatka, Katherine Schipper, Mark Zmijewski, two anonymous referees and workshop participants at Hong KongUniversity of Science and Technology, Rutgers University—Newark and University of Waterloo.

Submitted April 1994.Accepted July 1995.

117

118 The Accounting Review, January 1996

predicting bankruptcy and the issuance of a going concem opinion is by no means a predictionof bankruptcy (AICPA 1993, section 341.04),^ investors appear to expect the auditor to providethem with a warning of approaching financial failure. Indeed Altman (1982, 7) suggests thatfinancial-statement users often perceive the issuance of a going concem opinion as a predictionof bankruptcy.

Prior studies (e.g., Campbell and Mutchler 1988) suggest that the issuance of a going concemopinion may increase investors' assessments of the firm's probability of financial failure. Iffinancial failure subsequently occurs, therefore, the surprise associated with the failure eventwould differ between firms receiving a going concem opinion and those receiving an unqualifiedopinion. The purpose of this study is to examine the association between going concem opinionsand the market's reaction to bankruptcy filings.

Other studies (Clark and Weinstein 1983; Eberhart et al. 1990) show that bankruptcyannouncements produce a significant negative excess stock retum. The magnitude of decline inshare prices would be affected by the market's a priori assessment of a firm's probability ofbankmptcy as well as the expected resolution of bankruptcy. Previous studies report that goingconcem opinions are useful in predicting bankruptcy (Hopwood et al. 1989, 1994) and providesome explanatory power in predicting bankruptcy resolution (Kennedy and Shaw 1991). Hence,the presence of a going concem opinion may reduce the surprise associated with bankruptcyfilings. In this study, we test whether firms receiving going concem opinions experience lessnegative excess retums in the period surrounding bankruptcy filings than those receivingunqualified opinions.

Our results indicate that going concem opinions are useful in explaining the market's reactionto bankruptcy filings. After controlling for the probability of bankruptcy, the market's reactionto the media's disclosures of financial difficulties and the changes in stock price prior to theissuance ofthe auditor's report, we find that the unexpected drop in share prices is less negativefor firms that have received a going concem opinion as compared to those that have received anunqualified opinion. This finding is consistent with going concem opinions having informationvalue.^

The remainder of this paper is organized as follows. The selection of sample firms isdescribed in section II and the empirical results are presented in section III. The concludingremarks are provided in section IV.

II. SAMPLE SELECTION

Initially, we identify firms filing for bankruptcy court protection (i.e., Ch. 11 filings) usingthe F&S Index of Corporate Changes (1981 through 1988 editions). Firms satisfying thefollowing criteria are retained in the sample.

1. Financial data and the auditor's report are available from Compustat or microfiche.2. The annual report and 10-K filing dates are available forthe last set of financial statements

issued prior to bankruptcy filing from the SEC public reference room in Washington, D.C.

^ Strategic reporting considerations may affect whether the auditor issues a going concem opinion. Kida (1980) finds thatauditors are more likely to issue a going concem opinion if they have a strong belief that the client's creditors will sueif the client fails. In contrast, auditors are less likely to issue a going concern opinion if they have a strong belief thatthe opinion will hurt the client's relations with the auditor. Others (Mutchler 1984; Matsumura et al. 1994) suggest thatthe decision to issue a going concem opinion is affected by the auditor's belief about whether the opinion will be self-fulfilling.Other studies (e.g., Elliott 1982; Dodd et al. 1984; Dopuch et al. 1986; Fleak and Wilson 1994) examine the market'sreaction to the issuance of going concem opinions in order to assess infonnation value. The resulu of these studies areinconclusive (see Asare 1990 for a review).

Chen and Church—Going Concem Opinions and the Market's Reaction to Bankruptcy Filings 119

3. Retums data are available from the CRSP NYSEyASE and NASDAQ tapes for the periodstarting from 240 trading days (about one year) preceding the earlier of the 10-K or annualreport filing dates to one day after bankruptcy filing.

The resulting sample consists of 106 bankrupt firms. We classify these firms by the type ofthe audit report received in the fiscal year immediately prior to the bankruptcy filing. The resultsare summarized in table 1, which shows that 42 firms (40 percent ofthe 106 sample firms) haveuncertainties involving going concern.'* Eight other firms (seven percent) have uncertaintiesinvolving either asset realization or contingent liabilities. The remaining 56 firms (53 percent)received unqualified opinions.

We delete the eight firms receiving qualified opinions involving either asset realization orcontingent liabilities. These firms are excluded from the sample because the focus of this paperis on comparisons between firms receiving going concem opinions (GC) and those receivingunqualified opinions (UQ).^ The yearly breakdown of the resulting sample of 98 firms is asfollows: 1 in 1980,6in 1981,13 in 1982,13 in 1983,16in 1984,17 in 1985,9 in 1986,9 in 1987,and 14 in 1988.* At the time ofthe bankruptcy filing, 40 sample firms were listed on NYSE/ASEand 58 were listed on NASDAQ. Thirty-five two-digit SIC industries are represented in thesample, with no one industry providing more than 14 firms.

For the 98 sample firms, we identify the earlier of the annual report or 10-K filing date forthe last set of financial statements issued prior to bankruptcy. The earlier of the two dates is usedas a proxy for the date that the auditor's report becomes publicly available.

We define the bankruptcy filing date as the day before the date on which the Wall StreetJournal disclosed the bankruptcy filing, or the date on which the Wall Street Journal reported thatthe filing was imminent.^ For six firms that are not covered by the Wall Street Journal, we usethe date provided by the F&S Index of Corporate Changes. The bankruptcy filings occurred from11 to 281 trading days after the filing ofthe last set of financial statements (i.e., the earlier oftheannual report or 10-K filing date).

III. EMPIRICAL RESULTS

Univariate Tests

In this subsection, we present univariate tests to investigate excess retums occurring aroundthe date of bankruptcy filing. We compute excess retums occurring between day -10 and day+10(relative to the bankruptcy filing date) and we examine GC and UQ firms separately.

•* Ofthe 42 firms, 31 are first-time going concem opinions (i.e., a going concem opinion was not received in the precedingyear).

' Another reason for dropping the eight firms is that the sample size is too small to analyze separately and draw meaningfulconclusions. Although not reported, the results described throughout the paper are largely unchanged if the eight firmsare retained in the sample and included in the group of firms receiving going concem opinions. The nature ofuncertainties surrounding asset realization and contingent liability opinions, however, is quite different from thatsurrounding going concem opinions. Therefore, it is reasonable to exclude the eight firms from our sample.

' We do not identify firms filing for bankruptcy subsequent to 1988 because auditing standards changed, with changestaking effect January 1,1989. The primary change being that 'subject to' opinions are no longer allowed. Presently, auditreports may be modified for going concem (and other) uncertainties, through the use of an explanatory paragraphfollowing the opinion paragraph, but the opinions are no longer qualified.

•' For 16 out of 98 sample firms, the Wall Street Joumal reported that bankruptcy filing was inuninent a few days beforethe actual filing. For these fimis, the market's reaction, if any, should arise around the time of the media disclosure asopposed to the filing date.


TABLE 1

Sample Selection and Type of Opinion Received

Sample SelectionBankrupt firms on CRSP tapes 250Retums data not available around bankruptcy filing <110>Retums data not available 240 days prior to 10-K or annual report filing dates <11>10-K or annual report filing dates not available <10>Financial data and/or auditor's report not available <13>

Total firms 106

Type of opinion receivedUnqualified 56Going Concem 42AR/CL^ 3,Total firms 106

AR/CL indicates firms receiving qualified opinions involving asset realization or contingent liability uncertainties.

We calculate excess retums, ER, for each firm using a raw retum adjusted for size (see Hanet al. 1992, 70, n.8).* All firms on the CRSP data tapes (NYSE/ASE and NASDAQ) are dividedinto ten groups each year based on their market value of equity on the last day of the precedingyear. For each firm, we compute the difference between the retum of the firm and the retum ofthe portfolio of firms in the same decile. In order to combine excess retums for individual firmsin each group, we calculate average excess retums, AER.

Panel A of table 2 shows the AER over various trading days beginning 10 days beforebankruptcy filing and ending 10 days after. Panel A also shows the percentage of firmsexperiencing negative ER. All data are presented separately for GC and UQ firms. As can be seenfrom panel A of table 2, both groups of firms experience a drop in stock price in excess of 13percent on the day of bankruptcy filing (day 0), with the drop being smaller for the GC firms (13.84percent) than the UQ firms (17.04 percent). Both groups of firms also experience negative y4£/?on most days from -10 to -Hi: the AER is negative ten out of 12 days in each group. From days+2 to -HlO, ihe AERs become less negative and on many days ihe, AERs are positive. Further, thepercentage of firms experiencing negative ER is greatest on the day of bankruptcy filing. Betweenday -10 and day -I-IO, 48 to 76 percent of the GC firms experience negative ER, and 36 to 79percent of the UQ firms experience negative ER.

Next we compare the differences in daily AERs between GC and UQ firms. Both parametricand nonparametric tests are conducted because the AERs are not normally distributed. In theparametric r-tests, the standard deviations are computed cross-sectionally using individual firms'ERs. The cross-sectional standard deviations, instead of the time-series standard deviations

Fama and French (1992) show that, during the 1963-1990 period, no significant relation exists between average retumsand market beta, but a strong relation exists between size and average retums. These findings justify our use of size-adjusted excess retums.


TABLE 2

Excess Returns Around the Bankruptcy Filing Date

Trading Goingday

Panel A:

-10-9-8-7-6-5-4

-3-2-1

0

12

345678910

Panel B:

Mean

daily retums

-2.54-2.82-0.93-0.10-2.43

0.140.11

-1.32-0.83-5.10

-13.84-5.36-0.11

2.082.980.790.27

-1.214.44

-2.28-0.08

window returns

[-10,-21-12.57[-1,+\] -24.28[+2,+10] 2.19

concern"S.D.' "/

7.867.676.06

10.048.637.91

13.0210.3214.078.40

17.1624.7117.9314.1424.3116.1210.078.26

15.5710.5714.24

14.8520.5427.39

'o<O

67626448645055606274

76

5752

5252606464626769

81

8848

Unqualified^

Mean

-2.60-2.27-0.290.03

-1.36-2.53-2.11-3.290.09

-5.29-17.04-10.57

3.50-0.960.330.75

-3.002.24

-0.022.980.09

-14.94-32.29

3.70

S.D.'

1.9,110.879.427.398.24

10.799.84

10.8114.5117.0820.7922.6020.5913.5314.4516.5713.8113.5311.4313.3610.87

19.1022.1834.08

%<0

7057555563617066

68

6379

7036

5254595943455054

84

8945

MeanDiff.

0.06-0.55-0.64-0.13-1.07

2.672.221.97

-0.920.193.205.21

-3.613.042.650.043.27

-3.454.46

-5.26-0.17

2.378.011.51

t-value

0.04-0.30-0.41-0.07-0.62

1.410.930.91

-0.310.070.811.09

-0.911.060.590.011.28

-1.481.57

-2.00"-0.06

0.661.83''

-0.21

WilcoxonZ-value

0.25-0.47-0.75

0.900.040.761.060.520.39

-0.600.761.09

-1.81''0.710.410.181.07

-1.40-0.05-1.19-0.93

0.201.75''

-0.27

° The numbers of firms in the portfolio are 42 for trading days -10 through 3 and between 36 and 40 for the remainderof trading days.

•" The numbers of firms in the portfolio are 56 for trading days -10 through 3 and between 51 and 55 for the remainderof trading days.

' The cross-sectional standard deviations of individual firms' excess retums {ER) or window cumulative excess returns(WCER) are used to compute standard deviations for each group.

" Significance at the 0.05 level.

(based on past retums), are used in the r-tests because Morse and Shaw (1988) show that thestandard deviation of a firm's retums increases after bankruptcy filing.

The tnean differences between groups, the standard deviations of AERs, the r-values, and theWilcoxon z-values are reported in panel A of table 2. As can be seen, frotn day -10 to day -Hi, theAER of GC firms is greater (less negative on most days) than that of UQ firms seven out of twelve


days. The parametric atid notiparametric tests, however, itidicate that in general the differencesare insignificant at conventional levels.

Panel B of table 2 sutnmarizes the daily AERs of GC and UQ firms across three windowsiWCER): [-10, -2], [-1, +1], and [+2, +10]. We compute the WCER as the retum of a firm for thecumulation period less the retum of the same size decile portfolio for the cumulation period. Ascan be seen, in the [-1, +1] window, the GC firms experience less negative WCER than the UQfirms, and the difference is significant in both parametric and nonparametric tests.

To obtain additional insight, we calculate the cumulative excess retums {CER) each day fromday -10 to day +10. The CERs are measured as each group's average retum for the cumulationperiod less the retum ofthe same size decile portfolio for the cumulation period. We plot the CERsby group as well as the difference in CERs between the two groups (GC and UQ) in figure 1 overthe entire 21-day period. For both groups, the CERs, become increasingly negative through day+1. Thereafter, the CERs of GC firms increase slightly (becoming less negative), whereas theCERs of UQ firms flatten out. A comparison of the two groups (GC and UQ) indicates that GCfirms experience less negative CERs from day -5 onward.

The findings presented in this subsection provide evidence that GC firms experience lessnegative retums around bankruptcy filings than UQ firms.' This result suggests that the surpriseassociated with bankruptcy filings is smaller for GC firms than UQ firms.

' We consider whether this result could be caused by some firms having low share prices (see Dopuch et al. 1986). Forthe NYSE and ASE firms in our sample, we investigate share prices and find that GC firms generally have lower shareprices than UQ firms. The low-price effect would lead GC firms to have larger negative excess retums in the periodsurrounding bankmptcy filing; however, our findings suggest that GC firms have less negative excess retums in thisperiod. Hence, our results do not appear to be caused by a low-price effect.

FIGURE 1Cumulative Excess Returns {CERs) From Day -10 through +10 for the Going Concern

(GC) and Unqualified (UQ) Groups (Day 0 is the Bankruptcy Filing Date)

GC.UQ

.20.00% •

-40.00%


Regression Test

We perform a regression test to control for other factors that could explain the differencebetween the bankruptcy filitig date excess retums of going concem opinion firms and unqualifiedopinion firms. The nature ofthe auditor's report is included as an independent variable in this test:the variable (denoted GQ is one if a GC opinion is received and zero otherwise. We expect thecoefficient for this variable to have a positive sign. We investigate whether the GC variableprovides incremental explanatory power beyond that provided by the other independent vari-ables. We also conduct the regression test to provide insight into the effects of other variables onthe market's reaction to the bankruptcy filing.

As a starting point in identifying control variables, we consider factors that may affect themarket's a prion assessment ofthe probability of bankruptcy as well as the expected resolutionof bankruptcy. Investors can use financial ratios to form assessments of the probability ofbankruptcy (denoted BKPROB). Such assessments, in tum, may affect the surprise associatedwith bankruptcy filings. Empirically, we estimate BKPROB using Ohlson's (1980, 121) bank-ruptcy prediction model. We choose to use Ohlson's model because (1) a conditional logitapproach is employed which provides a probabilistic measure of financial failure, (2) the modelis estimated from a large sample of firms (105 failed firms and 2,058 non-failed firms) and itpredicts well and (3) differences in predictive ability between Ohlson's model and competingbankruptcy prediction models are not readily apparent (Foster 1986).

In addition to providing a composite measure ofthe probability of bankruptcy, BKPROB alsomay be useful in predicting the outcome of bankruptcy. The results of Kennedy and Shaw (1991)indicate that firms with higher BKPROB are more likely to liquidate than reorganize, whichsuggests that shareholders of firms with higher BKPROB receive less after bankruptcy proceed-ings than shareholders of firms with lower BKPROB.

The preceding discussion suggests that BKPROB may serve a dual role in explaining negativeexcess retums in the period surrounding bankruptcy. As an indicator of approaching bankruptcy,BKPROB may be positively correlated with excess retums (i.e., higher BKPROB is associatedwith less negative excess retums). As an indicator of the resolution of bankruptcy, BKPROB maybe negatively correlated with excess retums (i.e., higher BKPROB is associated with morenegative excess retums).

In addition, we control for the market's reaction to the media's disclosure of financialdifficulties (e.g., quarterly losses, suspension of dividends, default on debt, etc.) occurringsubsequent to the issuance of financial statements but prior to bankruptcy (denoted MKTNEWS).Such disclosures may affect the market's assessment of a firm's future prospects. We identifymedia disclosures for sample firms by reference to the Wall Street Journal Index. For eachdisclosure, we compute a window cumulative excess retum {WCER) for the three days surround-ing the disclosure. We sum up the WCERs for each firm to obtain a measure that reflects the overalleffect of the media's disclosure of financial difficulties.'"

Finally, we consider changes in stock price prior to the issuance of the auditor's report (denotedCH PRICE). The market may react to events that trigger financial demise, and in fact, such events mayunderlie the issuance of going concem opinions. However, we are interested in assessing whether the

'"A drawback of using MKTNEWS is that news announcements must be disclosed in the Wall Street Journal to be reflectedin this measure. Yet infonnation may be disseminated through other sources. Thus, we consider an altemative measure ofMKTNEWS, denoted MKTER. This variable is defmed as the compounded, cumulative excess retum from two days afterthe issuance of fmancial statements to two days prior to bankruptcy. The results are unaffected if MKTER is substitutedfor MKTNEWS.


opinions, as opposed to the underlying causal event(s), are associated with the market's reaction tobankruptcy filings. Hence, we use CHPRICE as a proxy to control for events occurring prior to theissuance ofthe auditor's report. We compute CHPRICE as the compounded, cumulative excess retumfrom day -240 to day -2 (where day 0 is the day that the auditor's report is issued).

For descriptive purposes, we test whether BKPROB, MKTNEWS, and CHPRICE aresignificantly different among firms receiving GC and UQ opinions. The results are presented inpanel A of table 3. The results show that the GC firms have a significantly higher probability ofbankruptcy {BKPROB) and a larger change in stock price prior to the issuance of the auditor'sreport {CHPRICE). By comparison, the market's reaction to the media's disclosure of financialdifficulties occurring subsequent to the issuance of financial statements but prior to bankruptcy{MKTNEWS) is not significantly different between the two groups.

The finding for BKPROB suggests that GC firms have a much worse financial profile thanUQ firms (see also McKeown et al. 1991). A weakened financial profile could very well be oneof the reasons that a GC opinion is issued. The finding for CHPRICE suggests that GC firmsexperience a greater decline in stock price in the year preceding the issuance ofthe auditor's reportthan UQ firms (see also Elliott 1982; Dodd et al. 1984). The presence of significant differencesbetween the two groups of firms suggests that we should control for such differences in our tests.

Next, we present a correlations matrix to examine associations between the variables ofinterest. In addition to the three control variables, the matrix includes the GC variable, which isof primary interest. The correlations matrix is presented in panel B of table 3.

We estimate the following regression model:

WCER.^^ = flo + «i ^^i + «2 BKPROB^ + a^ MKTNEWS^ + a^ CHPRICE^ + u^, (1)

where WCER^^, GC^, BKPROB.^, MKTNEWS,, and CHPRICE. are as defmed previously for the ithfirm; a^, a^, a^, a^ and a^ are the regression parameter estimates; and «; is a mean zero stochasticdisturbance term.'' We estimate the model for three different event windows: a three-day window(one day before bankmptcy to one day after), a five-day window (three days before bankruptcyto one day after) and a seven-day window (five days before bankruptcy to one day after). Wepresent the regression results in table 4, with the results of each event window presentedseparately in panels A, B and C.'^ Several findings are worth noting.

The coefficient ofthe GC variable is significant at p < 0.01 in each panel. This result indicatesthat GC opinions have incremental explanatory power beyond that provided by other independentvariables. The positive sign of the coefficient indicates that GC firms experience less negativeexcess retums (as compared to UQ firms).

The coefficient of the BKPROB variable is significant at p < 0.01 in each panel. The negativesign of the coefficient indicates that excess retums become more negative as the probability ofbankruptcy increases. The negative sign suggests that shareholders of firms with weaker financialprofiles are expected to receive less in bankruptcy proceedings (Kennedy and Shaw 1991), thusencountering greater sell-offs on bankruptcy filing dates.

"The independent variables in (1) could be those used by auditors in their decisions to issue GC opinions. Thus, (1) is partof arecursive regression system consisting of (1) and an equation with GC as a dependent variable and all other independentvariables appearing in (1) as independent variables. As shown by Johnston (1972,377-378), there is no bias in applyingordinary least squares estimation to (1) alone.

'̂ We perform two model checks to ensure the robustness ofthe regression results. First, we test for heteroskedasticity amongthe residuals and find that it is not a problem (see White 1980). Second, we examine the data to detennine the presence ofoutliers. Following the approach of Belsley et al. (1980), a few extreme observations are identified. We perform anotherset of regressions excluding these observations and find that the overall model results are improved: when the outliers areexcluded, the significance level of the coefficient of the GC variable is increased. Thus, the presence of extremeobservations tends to obscure the relation between GC opinions and excess retums occurring around bankruptcy.

Chen and Church—Going Concern Opinions and the Market's Reaction to Bankruptcy Filings 125

TABLE 3

Descriptive Statistics for the Independent Variables"

Panel A : mean statistics by group

Going concem (GC)

Unqualified (UQ)

/-test between UQand GC groups

(prob > 0

Panel B: correlation coefficients with

CHPRICE

MKTNEWS

GC

BKPROB

0.87

0.61

5.63(0.00)

-0.50

0.11

0.48

CHFRICE

-68.03

^7.02

-2.91(0.00)

-0.15

-0.28

MKTNEWS

-11.78

-15.00

0.63(0.27)

0.36 •

° Variable definitions:BKPROB = probability of bankruptcy, calculated from model 3 of Ohison (1980, 121);

CHPRICE = the size-adjusted cumulative excess return computed from 240 to two days prior to the filing of the lastannual report prior to bankruptcy;

MKTNEWS = the cumulation of three-day excess returns surrounding the media's disclosure of financial difficultiesoccurring subsequent to the filing ofthe last annual report but prior to bankruptcy; and

GC = one if the firm received a going concern opinion prior to bankruptcy and zero otherwise.

The coefficient ofthe CHPRICE variable is significant at p < 0.01 in each panel. The negativesign of the coefficient indicates that excess retums around the bankruptcy filing date are lessnegative for firms that experience a greater decline in stock price prior to the issuance of theauditor's report.

Lastly, the coefficient ofthe MKTNEWS variable is not significant at any conventional level,regardless of the length of the window. This result indicates that the market's reaction to themedia's disclosure of financial difficulties prior to bankruptcy is not associated with securityretums occurring around bankruptcy.'^

IV. CONCLUSIONS

In this paper, we investigate the association between going concem opinions (GC) and themarket's reaction to bankruptcy filings. After controlling for other variables such as the

"We also examine the effect ofthe probability of receiving a going concem opinion, (denoted GCPROB), on WCER. Wecompute GCPROB from model 1 of Chen and Church (1992,41). This variable is excluded from equation (1) becauseit is highly correlated with BKPROB (p = 0.77). The results, however, are unaffected if GCPROB is substituted forBKPROB. In addition, the size variable (measured as the natural logarithm of the market value of stock at the end ofthe year prior to bankruptcy) is not found to be significant in the regressions.


TABLE 4

Regression Results

Model: WCER., = OQ + «i GC. + a^ BKPROB., + a^ CHPRICE., + a^ MKTNEWS.

Panel A: Window for WCER one day before bankruptcy to one day after

coefficient(t-value)

Panel B: Window for


-0.21(-3.41)"

0.13(2.73)''

-0.33(-3.53)''

-0.18(-2.81)"

WCER three days before bankruptcy to one day after

-0.20(-2.87)"

0.14(2.65)"

-0.41(-3.81)"

-0.22(-2.95)"

Panel C: Window for WCER five days before bankruptcy to one day after


-0.32(-4.49)"

0.15(2.77)"

-0.28(-2.61)"

-0.24(-3.13)"

0.02(0.25)

-0.01(-0.15)

0.09(0.97)

0.129

0.138

0.145

Variable definitions:WCER = size-adjusted window cumulative excess retum;

GC = one if the firm received a going concern opinion prior to bankruptcy and zero otherwise;BKPROB = probability of bankruptcy, calculated from model 3 of Ohison (1980, 121);

CHPRICE = the size-adjusted cumulative excess retum computed from 240 to two days prior to the filing of the lastannual report prior to bankruptcy; and

MKTNEWS = the cumulation of three-day excess retums surrounding the media's disclosure of financial difficultiesoccurring subsequent to the filing of the last annual report but prior to bankruptcy.

" Significance at the 0.01 level.

probability of bankruptcy, the market's reaction to the media's disclosure of financial difficultiesprior to bankruptcy and changes in stock price prior to the issuance ofthe auditor's report, we findthat GC opinions are useful in explaining excess retums occurring around bankruptcy filings.Regression results indicate that GC firms experience less negative excess retums than other firmsin three-, five-, and seven-day windows surrounding bankruptcy filings.

Our findings may be considered in light of prior research on the usefulness of going concemopinions. Several studies have examined the information value of GC opinions by investigatingexcess retums occurring around the issuance of the auditor's report. The results of these studieshave been mixed. The results of the present study are consistent with GC opinions havinginformation value.

Our findings should be interpreted in light of potential limitations, which in tum point towardavenues for future research. First, common factors may underlie the issuance of a going concemopinion and the occurrence of bankruptcy. Audit qualification and bankruptcy filing are bothchoice variables. Both variables could be based in part on common factors which have been


omitted in our tests. Iti addition, the market may examine the financial information ofthe firm andassess a higher probability of bankruptcy for going concern firms, independent of the auditor.Although we attempt to identify the appropriate control variables in the regression test, it is stillpossible that our results could be confounded by omitted variables.

Second, our sample consists entirely of firms filing for bankruptcy. Obviously, the vastmajority of firms do not face bankruptcy proceedings. While a sample of bankrupt firms isnecessary for the present study, future research may investigate situations in which auditors issueGC opinions to firms that do not subsequently fail. A different methodology would be requiredfrom that used in the present study.

Finally, bankruptcy is not the only form of financial difficulty. Other forms of financialdifficulty include default on debt obligations and negotiation with creditors to resolve financialproblems. The association between going concem opinions and the market's reaction to thesealtemative forms of financial distress is an interesting issue that could be examined in futureresearch.

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