MD&A Disclosure and the Firm's Ability to Continue as a Going Concern

Abstract

This paper explores the role of textual disclosures in the Management, Discussion, and Analysis (MD&A) section of a firm's SEC 10-K filing in predicting a firm's ability to continue as a going concern. Using a sample of firms that filed for bankruptcy between 1995 and 2012 to identify firms that cease as a going concern, we find that both management's opinion about going concern reported in the MD&A and the linguistic tone of the MD&A together provide significant explanatory power in predicting whether a firm will cease as a going concern. Moreover, the predictive ability of MD&A disclosure is incremental to financial ratios, market-based variables, and even the auditor's going concern opinion. We also find that the incremental predictive ability of MD&A disclosures extends to three years prior to bankruptcy.

Are going‐concern issues disclosed in audit reports associated with subsequent bankruptcy? Evidence from the United States

“…5 The fiscal yearends of the companies in our sample span the period from June 1, 1999, to May 31, 2016(i.e., Compustat fiscal years 1999to 2015. 5 The fiscal yearends of the companies in our sample span the period from June 1, 1999, to May 31, 2016(i.e., Compustat fiscal years 1999to 2015.…”

“…We use Audit Analytics, a U.S. audit market database, to identify companies with an initial going-concern modified report. 5 The fiscal yearends of the companies in our sample span the period from June 1, 1999, to May 31, 2016(i.e., Compustat fiscal years 1999to 2015.…”

“…To the extent auditors' reliance on financial factors is reflected in their choice of disclosures in additional paragraphs of GCOs, empirical evidence about such disclosures also provides indirect evidence about auditors' reliance on financial factors in arriving at going-concern-related decisions. Mayew, Sethuraman, and Venkatachalam (2015) argue that Management Discussion and Analysis (MD&A hereafter) disclosures have significant incremental information content over and above what can be discerned from financial ratios and market-based variables for GCOs.…”

The total cost of misclassification in credit scoring: A comparison of generalized linear models and generalized additive models

“…Generally, qualitative independent variables that are derived from the company's annual report, such as qualitative information, can affect significantly a company's probability of bankruptcy (e.g., Cecchini, Aytug, Koehler, & Pathak, 2010;Mayew, Sethuraman, & Venkatachalam, 2015;Shirata, Takeuchi, Ogino, & Watanabe, 2011) as well as its financial structure and profitability (Li, 2010;Loughran & McDonald, 2011). Generally, qualitative independent variables that are derived from the company's annual report, such as qualitative information, can affect significantly a company's probability of bankruptcy (e.g., Cecchini, Aytug, Koehler, & Pathak, 2010;Mayew, Sethuraman, & Venkatachalam, 2015;Shirata, Takeuchi, Ogino, & Watanabe, 2011) as well as its financial structure and profitability (Li, 2010;Loughran & McDonald, 2011).…”

“…Our empirical analysis is also limited by the source of our data, because the database we used does not provide information on all relevant qualitative independent variables. Generally, qualitative independent variables that are derived from the company's annual report, such as qualitative information, can affect significantly a company's probability of bankruptcy (e.g., Cecchini, Aytug, Koehler, & Pathak, 2010;Mayew, Sethuraman, & Venkatachalam, 2015;Shirata, Takeuchi, Ogino, & Watanabe, 2011) as well as its financial structure and profitability (Li, 2010;Loughran & McDonald, 2011). This suggests that using additional qualitative variables to predict the likelihood of bankruptcy should increase a model's validity.…”