The Auditor's Going‐Concern Disclosure as a Self‐Fulfilling Prophecy: A Discrete‐Time Survival Analysis*

Abstract

The question of how an auditor's going-concern disclosure affects a client's future operations has long troubled the auditing profession. In an attempt to provide further understanding of this issue, we introduce Discrete-Time Survival Analysis (DTSA) to examine the aftermath of 23 1 first-time going-concern disclosures on clients' subsequent continuance. DTSA represents a significant refinement over traditional ordinary least squares (OLS) and logistic (LOGIT) regression in that it provides not only a probability estimate, but also an estimate of the timing of the event occurrence. The addition of this extra dimension (event timing) aids decision makers by providing more complete information about event probabilities.Consistent with the "self-fulfilling prophecy effect," the risk profiles developed from DTSA indicate that the first year subsequent to the initial going-concern disclosure was the most dangerous in terms of risk of bankruptcy. However, after the first year, the incidence of bankruptcy decreases significantly. Thus, DTSA is able to provide a richer perspective on this perplexing issue than previously considered.

The Relation between Auditor Switching and Self-fulfilling Prophecy Effect: The Bivariate Probit Model

“…They found no evidence of the self-fulfilling prophecy effect. Louwers et al (1999) found no proof of it either. However, Nogler (1995), using a sample of 157 American companies that received IGCQs from [1983][1984][1985][1986][1987][1988][1989][1990], found that 33% of them were bankrupt later and 30% experienced an organizational restructure such as mergers, liquidation, or dissolution, supporting the idea of the self-fulfilling prophecy effect.…”

“…First, does the self-fulfilling prophecy effect exist? The evidence has been inconsistent Taffler, 1992, 2001;George et al, 1996;Guiral, 2011;Louwers et al, 1999;Mutchler, 1984;Tucker and Matsumura, 1998;). Disclosed IGCQs accompany complex and unobservable factors.…”

The Initial Going-concern of Delisting Firms: An Application of Proportional Hazard Model

“…effect of self-fulfilling prophecy may exist. Louwers (1999) indicated that the IGCO opinion accelerates business failure and thus has impacts on current and potential investors, creditors, suppliers, and customers. Previous studies test the self-fulfilling prophecy by the percentage approach, calculating the ratio of bankrupt IGCO firms to the total IGCO firms.…”

“…On the other hand, in a sample of 157 American IGCO firms during the years of 1983 to 1990, Nogler (1995) finds a 33% sample declares bankruptcy after the first year of IGCO issued and supports the effect of self-fulfilling prophecy. In addition, in a sample of 210 IGCO American firms during the years of 1984 to 1991, Louwers (1999) states that 38 (18%) firms are bankrupt after the first year of IGCO issued, 17 (8%) firms after the second year. If applying the DTSA (discrete time survival analysis) modeling, it is 27% after the first year and 18% after the second year, which are similar to a 24% after the first year in the study of Citron and Taffer (1992) for a British IGCO sample.…”

“…Actually after the disclosure of IGCO, financial impacts to corporate operations do not occur immediately but generally prolong to the future. Focusing on only one or two years after an adverse IGCO issued and when bankruptcy probability may not increase yet and impacts of future periods are ignored, result bias may occur in empirical inferences (Louwers et al, 1999). Therefore, after the disclosure of IGCO firms, for any point in time during the survival period, bankruptcy probability should be evaluated carefully.…”