Do Clients Reward or Punish Audit Offices for Issuing Going Concern Modified Opinions

• In Event: Audit Opinions and Partner Identification

Abstract

This study examines the effect of the aggregated number of going concern opinions (GCOs) an office issues on its subsequent changes in market shares at the metro level. In theory, the number of GCOs issued each year at office level provides information about 1) an office’s willingness to tolerate clients in poor financial health under its current office acceptance and retention policies, and 2) an office’s tendency to avert legal and reputational risk by issuing GCOs. Those clients with incentives to “seek risk tolerance” will be attracted to an office with more GCOs, whereas those clients with incentives to “avoid GCO receipt” will be repelled from an office with more GCOs. Therefore, the impact of GCOs issued by an office on its market shares should depend upon the net effect of its clients’ (and potential clients’) managers’ incentives to “seek risk tolerance” versus to “avoid GCO receipt”.

Analyzing a large sample of U.S. audit offices from year 2000 to year 2017, we find that an office’s GCOs issuance is associated with a reduction in local market shares, more client dismissals, and fewer new client acquisitions in the subsequent year. This penalizing effect of office-level GCOs holds for only non-Big 4 offices, consistent with the notion that Big 4 clients on average are healthier and thereby do not make office affiliation decisions on the basis of offices’ GCO issuances. Additional analysis of auditor dismissal at the client level supplements the main results. Taken together, our results suggest that financially weak clients’ incentives to “avoid GCO receipt” dominate their incentives to “seek risk tolerance”, resulting in a reduction of market shares among non-Big 4 offices issuing more GCOs.

Authors

• Michael Ettredge, University of Kansas

• Xudong Li, Monmouth University

• Qiyang Lian, University of Kansas

• Lili Sun, University of North Texas