Auditor Conservatism: Evidence from Debt Capacity and Going Concern Reporting

• In Event: Auditors' Report Modifications

Abstract

Using changes in the value of a firm’s real estate as exogenous shocks to debt capacity, I find that auditors fail to fully account for a firm’s change in debt capacity when issuing a going concern opinion. Specifically, I find a positive association between the change in real estate value and Type I going concern reporting errors, indicating that more positive changes in the value of a firm’s real estate increase the likelihood auditors issue a going concern opinion to a distressed client that does not subsequently fail. This association is only present for Big4 firms, industry specialists, and audit firms with non-extreme tenure indicating these auditors are excessively conservative. The association is not present for important clients with high influence, suggesting that auditors consider more factors in their reporting as the cost of a Type I error increases. In additional analyses, I find no association between the change in real estate values and Type II going concern reporting errors, although the instances of Type II errors are limited.

Author

• Ryan T Dunn, Auburn University