The Reputation Effect of Going Concern Reporting Errors

• In Event: Continental Breakfast & Research and Education Forum
  In Paper Session: Table 6: Demand for Audits / Audit Quality

Abstract

Accounting theory posits that management seeks to signal high financial reporting quality by retaining an external audit firm with a reputation for high audit quality. This paper directly tests whether an incumbent audit firm’s reputation for false negative (Type II) going concern reporting errors is associated with subsequent audit firm switching activity. Documented results provide no evidence of such a relationship. This paper further investigates Type II going concern reporting errors and documents that the vast majority of such observations have a very low predicted probability of receiving a going concern opinion from an audit firm in the same tier as their incumbent audit firm. That is, they are of a nature that financial statement users would not reasonably expect an alternate audit firm to issue a going concern opinion in the same circumstances. While it is theoretically possible for an audit firm to differentiate according to going concern reporting accuracy, it does not appear that a major United States audit firm has done so in a meaningful way over the past decade.

Author

• Nathan R Berglund, Mississippi State University