The relevance of quantifiable audit qualifications in the valuation of IPOs

Abstract

How useful are audit qualifications to financial statement users? We analyze a sample of 204 firms that went public at the Athens Stock Exchange over the period 1987-2002. For 149 of these firms, auditors report quantitative estimates of the amount by which assets are overstated and/or liabilities are understated in reported financial statements. We find that underwriters and their affiliated analysts do not incorporate the negative information provided by these qualifications into offer prices and earnings forecasts. Investors, however, appear to efficiently impound the negative implications of the audit qualifications into stock market prices within the first day of trading. The results suggest that underwriters tend to align their interests with the interests of their clients, the old stockholders, at the expense of the new stockholders. They also suggest that the practice of reporting quantifiable qualifications in audit reports is valuable to investors given that they are disclosed by an expert.

Audit pricing, quality of earnings and board independence: The case of the Athens stock exchange

“…Spathis (2003) found that most of the audit report qualifications in Greece are "subject to" (or "except for") opinions. While Caramanis and Spathis (2006) empirically demonstrate that audit qualifications in Greece are systematic in nature, Ghicas, Papadaki, Siougle, and Sougiannis (2008) provide evidence that audit qualifications are value relevant. Organizational complexity is expressed by the square root of the number of subsidiaries similar to Mitra, Hossain, and Deis (2007).…”

The Audit Reporting Debate: Seemingly Intractable Problems and Feasible Solutions

“…One of the reasons is an ongoing perception, especially among users and regulators, that there is still room for improving the form and content of the audit report. This perception is supported by academic research showing that although there is support that audit reports have information value for different groups of users such as investors (e.g., Chen and Church, 1996;Ghicas et al, 2008), loan officers (e.g., Guiral-Contreras et al, 2007;Schneider and Church, 2008) and financial and investment analysts (e.g., Dúrendez Gómez-Guillamón, 2003;O'Reilly et al, 2006), there is also evidence to the contrary (e.g., Wright and Robbie, 1996; Bartlett and Chandler, 1999;Pucheta Martínez et al, 2004), suggesting the presence of an information gap. 1 Furthermore, prior research provides ample evidence of an audit expectation gap, particularly in relation to auditor reporting, showing that there are significant perceptual differences between auditors and users as to the messages conveyed by the audit report (e.g., Innes et al, 1997;Gay et al, 1998;McEnroe and Martens, 2001).…”

The Value of Financial Statement Verification in Debt Financing: Evidence from Private U.S. Firms

“…7 In one of the few examples of related research, Teoh and Wong [1993] use earnings response coefficients to test, and find confirmatory evidence of, the joint hypothesis that larger auditors are associated with more credible financial reports and that investors respond more intensively to more credible reports. Ghicas et al [2007] examine the value of audit qualifications to financial statement users and find that investors impound this information, but underwriters and analysts do not. In addition, significant research, particularly experimental, investigates how management's accounting choices affect financial statement users' perceptions of the information.…”