Market Reactions to Disclosure of Reportable Events

Abstract

This study investigates the information content of FRR No. 31 reportable events (SEC 1988) communicated by auditors to clients in the two fiscal years and interim period preceding auditor changes. Reportable events identify weaknesses in internal control and problems related to the reliability of management representations and/or financial statement reliability. We examine 1,264 auditor changes (with available stock price data) over the period 1993 to 1996, including 118 companies with reportable events. Our findings suggest that reportable events disclosed in Form 8-K filings of auditor changes are considered by investors to have information content. We find a −2.75 percent (−5.53 percent) cumulative abnormal return over a three-day (seven-day) announcement period surrounding the disclosure of reportable events in Form 8-K filings. The conclusion that reportable events offer useful information to investors is robust to alternative specifications of expected returns and to controls for other disclosures (resignations and disagreements) made when auditor changes occur. Further tests also highlight differential information content among the types of reportable events. Specifically, stock prices act as if investors find reportable events about reliability issues more informative than reportable events about internal control weaknesses.

Evidence on the Association between Financial Restatements and Auditor Resignations

“…Prior research indicates disagreements and reportable events are associated with problematic situations (Krishnan 2002;Krishnan and Krishnan 1997;DeFond et al 1993) and that investors respond to the disclosure of disagreements and reportable events (Griffin and Lont 2010;Whisenant et al 2003;Hackenbrack and Hogan 2002). Therefore, we include two additional control variables, DISAGREE and REPORTEVENT.…”

Reporting Internal Control Deficiencies in the Post‐Sarbanes‐Oxley Era: The Role of Auditors and Corporate Governance

“…Also, prior to SOX, disclosure of any internal control deficiencies were required around auditor changes (J. Krishnan, 2005; Whisenant et al ., 2003). 14 Thus, we predict a positive association for reporting of deficiencies and auditor changes 15…”

Do Investors Care about Auditor Dismissals and Resignations? What Drives the Response?

“…A related strand of the literature examines the response to mandated auditor change disclosures coincident with an auditor change. These papers show a negative response at the filing date when the auditor's letter is delayed ͑Krishnan 2002͒ and when an adverse disclosure such as a disagreement or reportable event ͑e.g., about reliability͒ accompanies the auditor change filing ͑Whisenant et al 2003;Beneish et al 2005͒. These papers also contend that it is the interaction of a resignation and a reportable event that mostly drives the negative announcement return, not the reportable disclosure per se ͑Whisenant et al 2003, note 6͒, and that investors find uninformative a resignation announcement absent a reportable event disclosure ͑Beneish et al 2005͒.…”

“…However, we do observe a small but significant response of Ϫ0.288 percent for all dismissals ͑but not timely dismissals͒ for event days Ϫ1 to 1 ͑column 1͒, possibly related to small companies ͑column 8͒ with prior litigation ͑column 16͒ or higher bankruptcy risk ͑column 18͒. Table 2 also shows no difference in mean excess return for an auditor change with or without a reportable event ͑columns 5 and 6͒, although in later analysis we do find, consistent with previous research ͑e.g., Whisenant et al 2003͒, that investors' response to an auditor change varies for specific kinds of reportable events, in particular, an auditor-client disagreement and a disclosure of nonreliance. Investors also act as if they condition their response on more fundamental factors.…”