Do going concern disclosures in the management report and audit report signal bankruptcy risk? Evidence from privately held firms

Abstract

This article provides evidence of the relations between disclosures in the management report of conditions that could challenge the continuance of operations, auditors' going concern reporting and the likelihood of bankruptcy for privately held firms in an environment characterized by low litigation risk. We conduct a matched case–control study using data for 125 firms filing for liquidation bankruptcy and 125 non‐bankrupt firms. The results show that disclosures in the management report and auditors' going concern modifications are positively associated with the likelihood of bankruptcy and that their predictive ability is incremental to the control factors. Despite the lower litigation pressure facing private Swedish firms, the informational value of going concern disclosures is comparable with those in litigious environments.

External audit in the function of providing assurance in the correctness of the assumptions about the going concern assumption

“…Model improvement has a particularly positive effect on type II error. Despite findings that there is a great revision in predicting the permanence of private Swedish firms, Alexeyeva and Sundgren (2021) have also seen a high error rate of Type II in their results. The authors believe that the consequences of a Type II error are less than the consequences of a Type I error due to fears of a potential self-fulfilling prophecy effect (Alexeyeva & Sundgren, 2021).…”

Is auditor financial decision-making affected by prior audit report information? A behavioral approach

“…Nelson and Tan [ 19 ] state that “given that much archival research addresses audit opinions, additional judgment and decision-making research on opinion modification can offer converging evidence and potentially explain puzzling archival results by capitalizing on the comparative advantages of the experimental approach, such as the use of controlled setting, manipulation of key constructs and randomization”. According to Carson [ 18 ] and Alexeyeva & Sundgren [ 50 ], studies that investigate what auditors are evaluating to determine the likelihood of a client failure represent a need for the existing literature.…”

Aligning disclosure requirements for managerial assessments of going concern risk: Initial evidence from New Zealand

“…First, several studies examine the informativeness of management commentary in predicting failure (Alexeyeva & Sundgren, 2022;Boo & Simnett, 2002;Tennyson et al, 1990). For example, Mayew et al (2015) find that a statement about a company's ability to continue as a going concern within the MD&A is predictive for up to 3 years for firms that later file for bankruptcy.…”

“…First, several studies examine the informativeness of management commentary in predicting failure (Alexeyeva & Sundgren, 2022; Boo & Simnett, 2002; Tennyson et al., 1990). For example, Mayew et al.…”