Do going concern opinions provide incremental information to predict corporate defaults?
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Do going concern opinions provide incremental information to predict corporate defaults? Elizabeth Gutierrez 1 & Jake Krupa 2 & Miguel Minutti-Meza 2
& Maria
Vulcheva 3
# Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract Investors, regulators, and academics question the usefulness of going concern opinions (GCOs). We assess whether GCOs provide incremental information, relative to other predictors of corporate default. Our measure of incremental information is the additional predictive power that GCOs give to a default model. Using data from 1996 to 2015, initially we find no difference in predictive power between GCOs alone and a default model that includes financial ratios. However, there is an imperfect overlap between GCOs and other predictors. We show that GCOs increase the predictive power of several models that include ratios, market variables, probability of default estimates, and credit ratings. Using a model that includes ratios and market variables, GCOs increase the number of predicted defaults by 4.4%, without increasing Type II errors. Our findings suggest that GCOs summarize a complex set of conditions not captured by other predictors of default. Keywords Going concern opinions . Predictive accuracy . Type I and II errors . Audit
quality
1 Introduction In this study, we assess whether going concern opinions (GCOs) provide incremental information, relative to other predictors of corporate default. Our empirical measure of incremental information is the additional predictive power that GCOs give to a statistical model of default. The standard auditor’s opinion gives a pass/fail statement regarding a company’s compliance with Generally Accepted Accounting Principles
* Miguel Minutti-Meza [email protected]
1
School of Economy and Business, Universidad de Chile, Santiago, Chile
2
University of Miami, Coral Gables, FL, USA
3
Florida International University, Miami, FL, USA
E. Gutierrez et al.
(GAAP), but it does not provide much company-specific information. The GCO is a notable exception, in that it warns investors when a company is in financial distress.1 Diverse stakeholders, including debt and equity investors, auditing regulators, accounting standard setters, and academics view auditors’ GCOs and default prediction as important issues. For instance, GCOs receive considerable attention from the business press. A keyword search of terms related to GCOs in ProQuest retrieved 1526 press articles published in the period from 2000 to 2018, including 177 articles during the peak of the financial crisis (2008 and 2009).2 The public scrutiny of the auditor’s responsibility to issue a GCO increases after failures of high-profile businesses and during periods of economic downturn. In the aftermath of the dot-com bubble and during deliberations for the Sarbanes-Oxley Act of 2002, Weiss Ratings Inc. submitted to the United States Senate a report showing that auditors only issued GCOs for 42% of the 228 publicly traded companies that filed for bankruptcy protection in
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