The Impact of Crash Risk on Auditors’ Going Concern Opinion Decisions.

• In Event: Audit Risks, Audit Opinions, and Disclosures

Abstract

We examine whether clients’ crash risk impacts auditors’ going concern opinion (GCO) decisions. Unlike other non-financial market variables such as stock return and volatility, which measure financial distress and have been shown to be associated with the issuance of a GCO, recent research suggests that crash risk can proxy for the degree of “bad news hoarding” by managers. We posit that the heightened audit risk associated with withheld negative information likely makes auditors more conservative in their GCO decisions. Using a sample of distressed firms for the period 2001-2014, we find that a company’s current-year crash risk is positively associated with the auditor’s propensity to issue a GCO for that year. However, this association exists only in the post-2008 financial crisis period, suggesting that auditors have become sensitive to stock price crash risk in their GCO decisions after the crisis. In addition, we find that Type I errors (GCOs not followed by subsequent bankruptcy) increase when auditors incorporate the crash risk into their GCO decisions. We find no evidence that Type II errors (bankruptcies not preceded by GCOs) are associated with crash risk.

Authors

• Jagan Krishnan, Temple University

• Jayanthi Krishnan, Temple University

• Xin Zhao, Temple University