Regulatory sanction risk and going-concern reporting practices: evidence for privately held firms

Abstract

We study the temporal evolution of going-concern reporting from 2004 to 2013 and test whether sanction risk is related to the likelihood of a going-concern opinion using samples of privately held firms. In 2009, the Supervisory Board of Public Accountants (SBPA) in Sweden started to issue significantly more going-concern-related disciplinary sanctions, and we test whether and how auditors at different audit firms adjust their reporting practices (Type I and Type II errors) in response to the increased sanction risk. Our findings reveal that auditors are more likely to issue going-concern opinions to bankrupt and non-bankrupt firms when the sanction risk is higher, suggesting that sanction risk is positively associated with conservatism in auditors' reporting. Furthermore, we find that auditors at Big 4 firms alter their reporting to conservative more than non-Top 7 firms when sanction risk increases. Finally, results on the informativeness of going-concern opinions indicate that a going-concern opinion increases the bankruptcy probability during both the lower and higher sanction risk periods, but the impact is higher under the higher sanction risk period.

Effects of the 2014 European reform on audit activity, the audit outcome and the audit market: the auditors’ view

“…Auditors believe that inspections and the risk of sanctions are critical mechanisms to ensure the correct adoption of regulatory provisions and, eventually, to enhance audit quality. This conclusion aligns with previous studies that find a positive correlation between the inspection process and audit quality (Li et al , 2020; Sundgren and Svänstrom, 2022; Blann et al , 2022; Lamoreaux et al , 2023). As one interviewee points out:…”

“…Empirical evidence shows that audit quality improves as a result of the inspection process (Lesage et al , 2016; Westermann et al , 2019; Blann et al , 2022). Sanctions, reputational risks, client loss and litigation risks associated with inspections that identify audit deficiencies (Christensen et al , 2022) can explain increased auditors’ conservatism (Sundgren and Svänstrom, 2022), effort and diligence (Li et al , 2020) when conducting their audit tasks. This leads to the deterrence of low-quality audits when there is an increase in oversight enforcement (Lamoreaux et al , 2023).…”