Do Auditors and Clients Respond to the Expected Self-Fulfilling Prophecy Effect of Going Concern Opinions?

Abstract

Prior auditor reporting literature posits a self-fulfilling prophecy (SFP) effect, whereby auditors’ going concern opinions (GCOs) increase the probability of subsequent failure for audit clients. This possibility of a causal SFP effect for GCOs has troubled companies, practitioners, and regulators for decades. Our study examines whether auditor and client decisions are sensitive to the expectation of an SFP effect. Data demonstrate significant engagement-specific variation in the expected SFP effect across distressed clients. We find evidence consistent with auditor reluctance to issue GCOs to distressed clients when such opinions are expected to increase the probability of subsequent failure. This association is lessened for larger auditors, consistent with their differential sensitivity to the expected costs of issuing clean opinions versus GCOs. We also find that the expected SFP effect is associated with management’s auditor switching and auditor selection decisions. These results inform practitioner and regulator concerns around the SFP effect and provide archival evidence that complements and extends prior analytical and experimental work.

Keywords

going concern opinion auditor independence self-fulfilling prophecy bankruptcy auditor reporting auditor switching and selection M41 M42

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