Modeling the Audit Opinions Issued to Bankrupt Companies: A Two‐stage Empirical Analysis*

Abstract

Many observers are dissatisfied with the accounting profession's ability to warn the public of upcoming bankruptcy filings. Since regulators and users tend to treat an unmodified audit opinion as a "clean bill of health," they do not expect the business to fail in the near future. Research has shown that more often than not, auditors end up letting users down when it comes to predicting bankruptcy filings with audit opinions.Although auditors assert they are not responsible for predicting future events, it is very clear that their opinion decision is evaluated, at least in part, based on events that occur after the audit report date. The interesting and logical next step is to find out how companies exit bankruptcy. Do they liquidate or reorganize? Successful reorganization may, in the end, exonerate auditors and preserve their role as an early warning device. The opinion prediction model developed in the paper introduces a new bankruptcy resolution variable that proxies for the auditor's prognosis of the ultimate disposition of the soon-to-be-bankrupt company. Using a sample of bankruptcy filings between 1982 and 1992, we find that auditors do not seem to be able to predict filings or resolution. Our tests of bankruptcy resolution support what auditors have been arguing for years: that they are not clairvoyant with respect to a client's future. for their useful comments. Our paper also benefited from a workshop at the University of Miami. 507 508Modeling the Audit Opinions Issued to Bankrupt Companies

A Review Of Going Concern Prediction Studies: 1976 To Present

“…Two models ( [Dopuch et al, 1987]; [Menon and Schwartz, 1987]) were developed for application to any group of firms with SIC codes other than 6000-6999 (financial, insurance, and real estate firms). One model [Casterella et al, 2000] was developed for application to firms with SIC codes below 6000. The trend seems to be moving away from the development of focused models as most of the focused models were developed in 1995 and earlier.…”

Different Pathways that Suggest Whether Auditors’ Going Concern Opinions are Ethically Based

“…The main conclusion of the empirical research is that the larger the client, the smaller chance of receiving a warning signal (Behn et al, 2001;Geiger and Raghunandan, 2001;Mutchler et al, 1997). Others authors also conclude that auditors are less likely to modify the opinion for new clients and for those that have been clients for a long period of time (Casterella et al, 2000). Further, there is evidence that recent loss of audit clients appears to significantly moderate the willingness of auditors to disclose a warning signal (Vanstraelen, 2003).…”

The efficacy of liquidation and bankruptcy prediction models for assessing going concern

“…However, even though prior research have found bankruptcy prediction models to be useful for assessing going concern, other research indicate that a bankrupt company can be regarded as a going concern until the resolution of bankruptcy, and that company bankruptcy is less costly compared to company liquidation (Shultz, 1995;Alderson and Betker, 1996;Franks et al, 1996;Casterella et al, 2000). Indeed, Alderson and Betker (1996) show that the loss of going concern value forms the largest component of liquidation cost at 32 percent of corporate value.…”