When Auditors Say 'No', Does the Market Listen?
European Accounting Review
58 Pages Posted: 18 May 2014 Last revised: 11 Mar 2019
Date Written: March 1, 2019
Abstract
Previous research on whether the market responds to auditors’ opinions has provided mixed results. We revisit this issue in China, where the stock market is dominated by individual investors who are more likely to neglect value-relevant information. In addition, China permits modified audit opinions (MAOs) on violations of accounting standards or disclosure rules (GAAP/DISC MAOs), which are subtler in valuation implications than going concern opinions (GCOs) and are more likely to be mispriced. The Chinese stock market thus gives us the best chance of detecting MAO mispricing. We find that, ceteris paribus, MAO recipients underperform in the future and have higher incidence of other outcomes that are adverse to investors, and the market reacts negatively to MAOs during the short window around MAO disclosure. Importantly, MAO disclosure is not followed by negative long-term stock returns, suggesting that stock price adjustments to MAOs are speedy and unbiased. These findings hold for both GCOs and GAAP/DISC MAOs. Together, our findings support the informativeness of audit opinions and cast doubt on the argument that investors inefficiently price audit opinions due to information processing bias.
Keywords: audit modifications; information content; capital market efficiency
JEL Classification: G14; M42
Suggested Citation: Suggested Citation