Stock market reaction to auditor opinions – Italian evidence

Abstract

Purpose – The purpose of this paper is to examine investor reactions to auditor opinions containing qualifications or an emphasis of matter paragraph related to going concern uncertainty or financial distress. In particular, abnormal returns are analyzed around audit report dates. Design/methodology/approach – The event study methodology, focusing on a short event window, was used to determine whether there is an immediate market reaction to the audit report announcement, as might be expected assuming efficient stock markets. Findings – Overall, this analysis shows that the audit reports investigated have information content for investment decisions. In particular, the qualifications expressed in the audit report have a negative effect on stock prices. It is also shown that an unqualified opinion with an emphasis of matter paragraph regarding going concern uncertainty or financial distress has a positive effect on stock prices. These results also elucidate the distinction between different types of opinions in the Italian context. Research limitations/implications – This paper has attempted to limit the possible concurrent effects on stock prices using a short window event study methodology. However, the possibility that some other event may have occurred during this event window cannot be excluded. Among the policy implications coming from this research, it is argued that the authorities should regulate the public disclosure of audit reports, so that the information becomes available to the audited company and the other stakeholders on the same day, which, in theory, would be the day that the audit process concludes with the signing of the audit report. Originality/value – The findings of this paper show the relevance of audit reports, distinguishing the different impacts based on the types of audit opinions issued in a specific jurisdiction (qualified and unqualified with an emphasis of matter paragraph).

Anticipation and reaction to going‐concern modified audit opinions by sophisticated investors

“…In general, companies that are recipients of unexpected first‐time GCMO reports experience a statistically and economically significant negative stock price reaction (Blay & Geiger, ; Fleak & Wilson, ) that causes a shift in firm valuation from the income statement to the balance sheet (Blay et al, ). In sum, prior research supports the position that the GCMO opinion provides incremental information to the market from the auditor that is generally interpreted as a signal of potential business failure (Carson et al, ; Hopwood, McKeown, & Mutchler, ; Ianniello & Galloppo, ).…”

“…Professional standards indicate that a GCMO is not a prediction of failure. Nonetheless, it is a credible signal from the auditor regarding the financial condition of the company and the auditor's professional assessment of continued future viability that has the potential to provide price‐relevant information to the market (Blay, Geiger, & North, ; Carson et al, ; Fleak & Wilson, ; Ianniello & Galloppo, ; Menon & Williams, ; Renart & Barnes, ). Therefore, we examine trading around announcements of first‐time GCMOs to determine whether institutional investors in the US appear to anticipate this GCMO, and whether it provides additional information to these investors.…”

“…Prior research has found that an audit by independent external auditors increases the credibility of financial information produced and disseminated by company management (Duréndez Gómez‐Guillamón, ; Fan & Wong, ; Wallace, ), which then enables companies to reduce their overall cost of capital (Lennox & Pittman, ; Minnis, ). In addition, prior research finds that specific communications from external auditors directly affect both a company's cost of capital (Karjalainen, ; Ogneva, Subramanyam, & Raghunandan, ) and their equity price (Blay & Geiger, ; Fleak & Wilson, ; Ianniello & Galloppo, ; Kausar, Taffler, & Tan, ; Menon & Williams, ).…”

Company Management’s and Auditor’s Reporting on Going Concern: Discussion of the Current International Regulatory Framework

“…Prior research regarding the informative value of going concern auditor"s reports shows mixed results (e.g. Abad, Sánchez-Ballesta, & Yagüe, 2017;Amin et al, 2014;Blay et al, 2011;Feldmann & Read, 2013;Fischer, Marsh, & Brown, 2016;Ianniello & Galloppo, 2015;Kausar & Lennox, 2017;Kausar, Taffler, & Tan, 2017;Mock et al, 2013;O"Reilly, 2009), mostly measured based on market reaction or an experiment among financial statements users.…”

Auditor Reporting and Corporate Debt Structure

“…A majority of studies examines the impact that audit opinions have in the stock market. Prior studies show that qualified audit reports decrease earnings response coefficients as well as increase information asymmetry in the stock market and firms' cost of equity (Choi and Jeter, 1992;Menon and Williams, 2010;Ianniello et al, 2015;Amin et al, 2014;Abad et al, 2017). Some studies assess the impact that audit opinions have in the debt market.…”