Description
This paper aims to examine the effect that the recent financial crisis had on auditor
conservatism in the form of increased going-concern opinions.
Accounting Research Journal
The effect of financial crisis on auditor conservatism: US evidence
J oseph Beams Yun-Chia Yan
Article information:
To cite this document:
J oseph Beams Yun-Chia Yan , (2015),"The effect of financial crisis on auditor conservatism: US
evidence", Accounting Research J ournal, Vol. 28 Iss 2 pp. 160 - 171
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The effect of fnancial crisis on
auditor conservatism:
US evidence
Joseph Beams
Department of Accounting, University of New Orleans, New Orleans,
Louisiana, USA, and
Yun-Chia Yan
Department of Accounting and MIS, University of Texas at Brownsville,
Brownsville, Texas, USA
Abstract
Purpose – This paper aims to examine the effect that the recent fnancial crisis had on auditor
conservatism in the form of increased going-concern opinions.
Design/methodology/approach – This study uses a sample of US’ distressed frms from 2005 to
2011 to test the change in going-concern opinions issued. This paper uses a logistic regression model to
control for other predictors of going-concern opinions to determine when the fnancial crisis led to an
increase in auditor conservatism.
Findings – The authors fnd that auditors became more conservative in the form of issuing higher
levels of going-concern opinions even after controlling for other predictors of going-concern opinions.
This increased conservatism was present in both Big 4 and non-Big 4 accounting frms. The increased
conservatism quickly returned to normal levels when the fnancial crisis eased.
Originality/value – These fndings add to the literature on the effects of environmental changes on
audit opinions. Additionally, this study fnds a difference in the timing of the reaction by large and small
accounting frms, but, overall, it fnds consistency in that both increased conservatismduring the crisis
and quickly returned to normal afterward.
Keywords Conservatism, Financial crisis, Auditor, Going-concern
Paper type Research paper
1. Introduction
The recent fnancial crisis and recession had a devastating effect on families and
businesses around the world. The survival of many businesses was threatened by slow
sales and tight lending. According to The National Bureau of Economic Research (2010),
the recent recession in the USAoffcially started in December 2007 and ended in June of
2009. It lasted 18 months which makes it the longest US recession in more than 60 years.
Although the recession offcially ended in June 2009, many areas of the economy showed
little recovery in that year.
The exact time that a recession starts or ends is not known at the time it happens.
There are usually some signs that business is slowing down, followed by speculation
that a country may be falling into a recessionary time, but the offcial beginning and
ending must be calculated after the fact, once data can be collected and analyzed.
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1030-9616.htm
ARJ
28,2
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Received21 June 2013
Revised16 May2014
Accepted5 June 2014
Accounting Research Journal
Vol. 28 No. 2, 2015
pp. 160-171
©Emerald Group Publishing Limited
1030-9616
DOI 10.1108/ARJ-06-2013-0033
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Some companies could not survive the economic downturn and were either taken
over by other companies or fell into bankruptcy. When an auditor foresees a high
likelihood of bankruptcy, he gives the company a going-concern modifed audit opinion.
It does not matter if the higher likelihood of bankruptcy is the result of an economic
downturn or more frm-specifc factors. Previous studies have suggested that auditors
may get overly cautious during times of heightened public scrutiny.
This study looks at the effects of the recent fnancial crisis on auditors’ going-concern
audit opinions. We fnd that not only did the number of distressed companies and the
number of going-concern opinions increase during the fnancial crisis but also auditors
became more conservative toward distressed companies in the form of issuing a higher
percentage of going-concern opinions to those companies. Even for the same level of
fnancial ratios and bankruptcy predictors, auditors increased their likelihood of issuing
going-concern opinions. This increased conservatism was very evident in 2008, but the
level of conservatism had returned to normal by 2010.
The remainder of this paper is organized as follows. Section 2 provides a review of
prior literature and the development of research questions. Section 3 describes the
sample and the methodology used to test these questions. The results of the tests are
presented in section 4, and section 5 provides a conclusion.
2. Prior literature and hypothesis development
Prior studies have looked at the causes of going-concern modifed audit opinions.
According to Statement on Auditing Standards No. 59 (AICPA, 1988):
The auditor has a responsibility to evaluate whether there is substantial doubt about the
entity’s ability to continue as a going concern for a reasonable period of time, not to exceed one
year beyond the date of the fnancial statements being audited […].
However, under international standards, the time period to be considered for a
going-concern modifcation must be a minimum of 12 months rather than the “not to
exceed one year” required by the US standard (Carson et al., 2013).
If the auditors perceive a high likelihood of frm failure, they issue a going-concern
modifed audit opinion. An auditor’s doubt about a frm’s ability to continue must
include all relevant factors. The auditor considers both the frmand the environment, as
well as management’s plans to overcome its expected diffculties.
The going-concern modifed audit opinion is intended to warn users of fnancial
statements of the risks that a company is facing. A company receiving a going-concern
modifed audit opinion can have diffculty raising capital from new investors or
creditors. This limitation on the availability of capital can make a company’s failure
even more likely. Receiving a going-concern opinion can anger the company’s
management and may create hardship that would otherwise not have existed. When
auditors issue a going-concern modifed audit opinion, their clients are more likely to
switch to another audit frm (Lennox, 2000; Carcello and Neal, 2003; Carey et al., 2008;
Carson et al., 2013). This provides an incentive for the audit frm to resist issuing a
going-concern opinion. The decision to give a company a going-concern opinion is not
taken lightly.
However, investors are less surprised by a frm’s bankruptcy if the frmhas received
a going-concern opinion frst (Chen and Church, 1996). Feldmann and Read (2010) fnd
that over 40 per cent of the frms that fle bankruptcy do not receive a going-concern
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modifed audit opinion prior to fling bankruptcy. Not issuing a going-concern modifed
opinion can lead to litigation against the auditors. Auditors must weigh the risks of
assigning a going-concern audit opinion too early and possibly losing a client’s business
against the risk of a client going bankrupt and the audit frm facing litigation because
they did not provide a warning to the public in the form of a going-concern modifed
audit opinion.
During times of recession, all companies have a harder time surviving. The banking
crisis that accompanied the 2007 recession left many banks applying much tighter
lending requirements. In an environment of declining sales, many companies needed
additional fnancing; however, banks were reluctant to lend to all but the strongest
customers. That left some companies without the necessary cash they needed to survive.
These factors affect an entitie’s ability to survive and must be considered by auditors
when accessing whether to issue a going-concern modifed audit opinion.
An increased likelihood of company failures during the recession period could be due
to greater diffculty of obtaining fnancing during this period. While the strongest
clients could still obtain fnancing, less stable companies often could not. Auditors
consider the ability of the audit client to obtain fnancing as part of the going-concern
assessment. Prior research has found that future fnancing reduces the probability of
receiving a going-concern audit opinion (Defond et al., 2002; Mutchler et al., 1997).
Auditors must consider all relevant factors when assessing a going-concern modifed
audit opinion. Bankruptcy prediction models have been developed for use in predicting
the likelihood of a company declaring bankruptcy. As a going-concern opinion is
intended to warn of a high likelihood of a frm failure, the use of these bankruptcy
prediction models has been tested for their correlation with going-concern audit
opinions. One of these models uses a Z-score to measure the degree of a company’s
fnancial distress and the likelihood of bankruptcy (Zmijewski, 1984). The Z-score uses
a combination of return on assets, fnancial leverage and liquidity. The Z-score has been
found to be positively associated with receiving a going-concern audit opinion (Carcello
and Neal, 2000).
2.1 Changes in conservatism
The audit opinion is an opinion and therefore has a degree of subjectivity to it. Prior
studies have found that auditor conservatism changes resulting from changes in the
auditing environment (Geiger and Raghunandan, 2002; Geiger et al., 2005; Fargher and
Jiang, 2008; Feldmann and Read, 2010).
Geiger and Raghunandan (2002) fnd that reduced legal pressure because of changes
in laws during the 1990s led to a lower incidence of going-concern opinions for
distressed frms in the late 1990s. Geiger et al. (2005) fnd that auditors were more likely
to issue going-concern opinions after December 2001 than previously due to the changes
in attitudes resulting from publicity from major corporate scandals and the passage of
the Sarbanes–Oxley Act.
Fargher and Jiang (2008) also fnd that auditors were more likely to issue
going-concern opinions after 2002 than in the prior period. They fnd that the auditors’
increased conservatismled not only to a small decrease in the level of company failures
that were not preceded by going-concern audit opinions but also to an increase in
going-concern opinions for companies that did not fail.
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Feldmann and Read (2010) fnd that going-concern modifed opinions increased after
2002 and led to a lower incidence of bankrupt frms that did not receive a going-concern
opinion previously. However, they also fnd that the change was only temporary and the
conservatism soon returned to normal levels.
When the economy slows signifcantly, businesses face additional challenges. The
number of going-concern opinions is expected to increase because the number of
bankruptcies also increases. The number of distressed companies increased during the
2007-2009 fnancial crisis and therefore, we expect auditors to have increased the
number of going-concern opinions during the same period. However, do audit frms
increase their conservatism or even overcompensate during these times? This study
attempts to answer the following research questions:
RQ1. Did the relative proportion of going-concern opinions for distressed
companies increase during the fnancial crisis?
RQ2. After controlling for other predictors of going-concern opinions, did the
relative likelihood of receiving a going-concern opinion increase during the
fnancial crisis?
3. Sample and methodology
3.1 Sample selection
Consistent with prior going-concern studies (Carcello and Neal, 2000; Geiger and
Raghunandan, 2002; Geiger et al., 2005; Feldmann and Read, 2010), we create a sample
of all fnancially distressed US frms listed on Compustat for the years 2005-2011. We
defne fnancially distressed frms as those with negative earnings or negative operating
cash fows as defned in DeFond et al. (2002). We remove companies in the fnancial
industries (SIC: 60-69) due to their unique reporting requirements. Firms with a prior
year going-concern opinion are inherently more likely to have a current year
going-concern opinion. Therefore, consistent with prior studies (DeFond et al., 2002; Li,
2009), we ensure that only frst-time going-concern opinions are included by removing
frms that had a prior year going-concern opinion. The resulting sample has 9,240
frm-year observations. Consistent with prior research, we winsorize the continuous
variables used in the analysis at the 1 and 99 per cent levels.
3.2 Methodology
To test RQ1, we separate the frms by year to look at the number of distressed frms and
the level of going-concern opinions per year. We examine the percentage of
going-concern opinions between the years and conduct a t-test on the pre-crisis years
versus the crisis years. We defne the pre-crisis years as 2005-2006 and the crisis years
as 2008-2009. The recession offcially started at the end of 2007, so we do not include
2007 with either group.
We next separate the frms into two groups based on whether they had a Big 4
accounting frmconduct their external audit. This allows us to examine howthe level of
going-concern opinions for each group changed during and after the fnancial crisis.
To test whether auditors became more conservative during the fnancial crisis, we
use a logistic regression model. The dependent variable in the model is a dichotomous
variable that represents the audit opinion. The audit opinion is either a going-concern
opinion or not a going-concern opinion. The variable of interest is CRISIS. The CRISIS
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variable is coded as a 1 if the observation was from the 2008-2009 crisis years and is
coded 0 for all other years. We expect the crisis years to have a higher incidence of
going-concern opinions, and therefore, we predict the CRISIS variable will be positive
and signifcant.
Observations from the 2005-2006 pre-crisis period are compared to the crisis and
post-crisis periods. The post-crisis years are defned as 2010-2011. The POSTCRISIS
variable is either a 0 or 1 depending on whether the observation is from the 2010-2011
post-crisis years. We do not predict a signifcant difference between this period and the
pre-crisis period. Because the recession started in 2007, the year 2007 is not included in
either group, and therefore, the 2007 observations are omitted from the fnal analysis.
Also, frms that did not contain the variables for the analysis were omitted. This resulted
in a sample of 7,210 frm-year observations for the regression analysis.
Because the bankruptcy prediction model Z-score (Zmijewski, 1984) correlates with
going-concern modifed audit opinions, we include a variable to measure Z-score in the
model (Carcello and Neal, 2000).
We also include an interaction termin the model for the interaction of Z-score with the
crisis period. In the non-crisis years, this interaction termwill have the value of 0, as the
CRISIS variable will be zero. During the crisis years, it will be identical to Z-score.
Therefore, this variable will indicate whether auditors weigh the variables included in
the Z-score more or less heavily during the crisis years than other years.
3.3 Going-concern control variables
Due to the increased diffculty in obtaining loans during the crisis period, we control for
a frm’s ability to obtain external fnancing. Consistent with prior research, we control
for this by including a variable for future fnancing which represents whether the frm
had a newissuance of equity or debt over the subsequent fscal year (Defond et al., 2002;
Mutchler et al., 1997).
Previous research on going-concern opinions have found a variety of frm-specifc
variables associated with a higher likelihood of receiving a going-concern audit opinion.
Prior research has found that going-concern opinions are associated with longer audit
reporting delays (Raghunandan and Rama, 1995; Carcello et al., 1996; Ettredge et al.,
2006). To control for this relationship, we include a variable to measure the days from
the fscal year-end to the date of the audit report.
Generally, smaller frms have been found to have a higher likelihood of receiving a
going-concern audit opinion (Carcello and Neal, 2000; Behn et al., 2001; Geiger et al.,
2005; Knechel and Vanstraelen, 2007; Feldmann and Read, 2010). One-year stock market
return and liquid investments have been found to be negatively associated with
receiving a going-concern opinion. Higher stock volatility and leverage (defned as total
liabilities divided by total assets) have been found to be positively associated with
going-concern opinions (DeFond et al., 2002). Different industries can also have an effect
on going-concern opinions (Krishnan, 2005).
The size of an audit frm has been tested for a relationship to going-concern audit
opinions. The results have been mixed. Some have suggested that Big 4 audit frms are
more likely to issue a going-concern audit opinion. The size of audit frms is usually
separated into two groups, Big 4 and non-Big 4. Behn et al. (2001) found a positive
relationship between Big 4 audit frms and going-concern opinions. Other researchers
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(Geiger et al., 2005; Feldmann and Read, 2010; Knechel and Vanstraelen, 2007) have not
found such a relationship.
We include all of these variables from the prior research to control for other factors
impacting going-concern opinions. The following model is used to test RQ2 :
GC ? ?
0
? ?
1
* CRISIS ? ?
2
* POSTCRISIS ? ?
3
* Z * CRISIS
? ?
4
* LNTA ? ?
5
* Z ? SCORE ? ?
6
* BIG4 ? ?
7
* VOLATILITY
? ?
8
* RETURN ? ?
9
* INVESTMENTS ? ?
10
*LEV
? ?
11
* AUDELAY ? ?
12
* FUTUREFINANCE ? ?
13
* IND ? ?
Where:
GC ?going concern, 1 if audit opinion is frst-time going concern,
0 otherwise;
CRISIS ?1 if crisis period (2008 and 2009), else 0;
Postcrisis ?1 if post-crisis period (2010 and 2011), else 0;
Z * CRISIS ?Interaction term for Z-SCORE and CRISIS;
LNTA ?Natural log of total assets (in millions of dollars);
Z-SCORE ?Z-score from Zmijewski’s (1984) model;
BIG4 ?indicator variable that takes a value of 1 if audited by a Big
4 accounting frm, otherwise zero;
VOLATILITY ? standard deviation of annual stock returns in recent three
years;
RETURN ?one-year common stock return;
INVESTMENTS ? short- and long-term investment securities (including cash
and cash equivalents) defated by total assets (TA);
LEV ?total liabilities over total assets;
AUDELAY ?the number of calendar days fromfscal year-end to the date
of the auditor’s report;
FUTUREFINANCE ?an indicator variable that takes the value of 1 if the frm has
a new issuance of equity or debt over the subsequent fscal
year; and
IND ?industry dummy variables as defned in Krishnan (2005).
4. Results
The data in our sample include all non-fnancial distressed companies in the sample
years. Distressed companies are defned as having either negative earnings or negative
cash fows. Table I shows the total number of distressed companies for each year and the
number of going-concern opinions for each year. The total number of going-concern
opinions for all frmyears is 820 (8.87 per cent) out of the total sample of 9,240 frm-year
observations. Prior to 2010, the number of distressed frms ranged from a low of 1,224
frms in 2007 to a high of 1,649 frms in 2009.
Table I also shows that the total number of distressed frms decreased in 2010 and
2011 compared to that in all the previous years in the sample. This is likely a
combination of the weaker frms exiting the market during the fnancial crisis and the
surviving frms beginning to recover. These years also have the lowest levels of
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going-concern opinions. Our sample starts with the 2005 year which was only shortly after
the heightenedgoing-concernopinions fromthe Enronera andthe passage of the Sarbanes–
OxleyAct (Geiger et al., 2005; Fargher andJiang, 2008; FeldmannandRead, 2010). Therefore,
the heightened conservatism of auditors may not have fully returned to normal until 2006
and then it began to rise again in 2007 with the onset of the recent crisis.
The sample only contains distressed frms that have negative earnings or operating
cash fows. The number of distressed frms is expected to increase during a fnancial
crisis. Likewise, with more distressed frms, one would expect more going-concern
opinions to be issued. However, should this lead to a higher percentage of distressed
frms receiving going-concern opinions?
Figure 1 shows the increase in the percentage of going-concern opinions out of total
distressed frms. In the years leading up to the recession (2005-2006), the going-concern
opinions range from 8.90 to 6.71 per cent of distressed frms. The recession offcially
started in December of 2007. The percentage of going-concern opinions for the
distressed companies was 8.58 per cent in that year, and the following two years
(2008-2009) sawdramatic increases in the percentage of distressed companies receiving
going-concern opinions with 12.63 per cent in 2008 and 11.52 per cent in 2009.
To answer RQ1, that the relative proportion of going-concern opinions for distressed
companies increases during the fnancial crisis, we conducted a t-test on the proportion
of going-concern opinions in the years before the fnancial crisis versus the years of the
fnancial crisis. Table II, shows the results of the t-test. The years before the crisis are
defned as 2005 and 2006, and the years during the crisis are defned as 2008 and 2009.
The mean proportion of going-concern opinions from 2005 to 2006 is 0.0785, and the
Table I.
Number of distressed
frms and going-
concern opinions by
year
Year Total frms
a
GC opinions
b
2005 1,371 122
2006 1,252 84
2007 1,224 105
2008 1393 176
2009 1,649 190
2010 1,198 73
2011 1,153 70
Total 9,240 820
Notes:
a
Total number of distressed frms per year;
b
number of going-concern opinions for distressed
frms
8.90%
6.71%
8.58%
12.63%
11.52%
6.09% 6.07%
0%
2%
4%
6%
8%
10%
12%
14%
2005 2006 2007 2008 2009 2010 2011
Time period
P
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a
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Figure 1.
Percentage of
distressed companies
receiving
going-concern
opinions
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mean proportion of going-concern opinions from 2008 to 2009 is 0.1203. This difference
is signifcant at p ? 0.0001. This confrms RQ1 that a higher proportion of distressed
frms received going-concern opinions during the fnancial crisis.
After the fnancial crisis, the percentage of going-concern opinions returned to 6.09
and 6.07 per cent in 2010 and 2011, respectively. This is consistent with the fndings of
Feldmann and Read (2010) that the elevated percentage of going-concern opinions
decreases quickly after the crisis has passed.
Table III separates the frms into two groups based on whether they are audited by a
Big 4 accounting frm. The results show that overall Big 4 accounting frms issued
going-concern opinions to 6.51 per cent of the fnancially distressed frms they audited,
while the non-Big 4 frms issued going-concern opinions to 11.50 per cent of the
fnancially distressed frms they audited. Table III also shows a breakdown of
going-concern opinions by year between Big 4 and non-Big 4 auditing frms.
Figure 2 shows that, in every year, the non-Big 4 frms had a higher percentage of
going-concern opinions. However, in 2009, during the fnancial crisis, the percentages
betweenthe groups became closer. By2010, the differences became more pronouncedagain.
The percentage of going-concern opinions increased for both groups during the fnancial
crisis, indicating that it is not an issue specifc only to big or small auditing frms.
For the non-Big 4 frms, the percentage of going-concern opinions increased sooner,
but also decreased sooner after the crisis. The Big 4 frms did not show an increase in
going-concern percentages until 2008. The non-Big 4 frms reached a peak of 15.85 per
cent in 2008 and then began to come down. The Big 4 frms did not reach their peak of
Table II.
Comparison of
proportion of going-
concern opinions.
Before fnancial crisis
(2005-2006) vs during
fnancial crisis
(2008-2009)
Variable
Pre-fnancial crisis
(2005-2006)
Means (n ?2,623)
During fnancial
crisis
(2008-2009)
Means
(n ?3,042)
Difference
in means t-value
p-value
(Two-tailed)
Going-concern
opinions 0.0785 0.1203 0.042 5.216 0.0001
Table III.
Going-concern
opinions by auditor
type and year. Big 4
vs non-Big 4
(N ?9,240)
Year
Big 4
a
Non-Big 4
b
#Firms
c
#GC
d
(%) #Firms
e
#GC
f
(%)
2005 727 45 6.19 644 77 11.96
2006 618 27 4.37 634 57 8.99
2007 590 26 4.41 634 79 12.46
2008 781 79 10.12 612 97 15.85
2009 804 85 10.57 845 105 12.43
2010 679 24 3.53 519 49 9.44
2011 657 30 4.57 496 40 8.06
Total 4,856 316 6.51 4384 504 11.50
Notes:
a
Audited by a Big 4 auditing frm;
b
audited by a non-Big 4 auditing frm;
c
total number of
distressed frms audited by Big 4 frms;
d
number of going-concern opinions from Big 4 frms;
e
total
number of distressed frms audited by non-Big 4 frms;
f
number of going-concern opinions from
non-Big 4 frms
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10.57 per cent for going-concern opinions until 2009 before dramatically declining to
3.53 per cent in 2010.
A partial explanation of this difference is the number of frms from the non-Big 4
group that met the defnition of distressed. In 2008, there were 612 distressed frms in
this group and 97 of them received a going-concern audit opinion. By 2009, there were
845 distressed frms in this group but only 105 of them received a going-concern audit
opinion. The difference between the two groups may also be infuenced by a difference
in clientele between the types of audit frms.
To test RQ2, we use a logistic regression model. Table IV shows the results of the
logistic regression. The variable of interest is CRISIS. The variable for CRISIS had the
expected sign and is signifcant at the p ? 0.001 level. The signifcance of the CRISIS
variable, even after controlling for the other bankruptcy prediction variables, indicates
that auditors became more inclined to issue going-concern audit opinions during the
crisis. The regression indicates that auditors were more likely to issue going-concern
opinions during the crisis for the same levels of the bankruptcy prediction criteria[1].
The variable for POSTCRISIS was not signifcant which was expected. This
suggests that the increased conservatism declined toward normal levels after the crisis
had passed. Auditors became more conservative at the height of the fnancial crisis but
returned to normal levels afterward.
The interaction term for the interaction of Z-SCORE and CRISIS is signifcant at the
p ? 0.001 level. Because the CRISIS variable is either 0 or 1, the interaction term Z *
Crisis has a value of zero for all non-crisis years and is equal to Z-SCORE for the crisis
years. Z-SCORE is signifcant and has a positive coeffcient in the model; however, the
coeffcient on the interaction variable is ?0.079. There was no predicted sign for the
interaction term, but the negative coeffcient means that the Z-score is less infuential to
the going-concern decision during the crisis years than in the non-crisis years. This may
seem counter-intuitive due to the importance of going-concern opinions during crisis
years, but this does not mean auditors are not looking more closely at the companies.
Clearly, the overall level of going-concern opinions does increase during crisis years.
As Z-score is a summary number, the negative coeffcient on the interaction term
may indicate that, in times of turmoil, auditors must dig deeper. Other factors or
frm-specifc items may have greater predictive value during periods of fnancial crisis.
This study did not test all possible interactions. It is possible that other factors may be
more or less important to the going-concern decision during crisis years. Further
research on additional interaction items may help shed light on these issues.
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
2005 2006 2007 2008 2009 2010 2011
Time period
P
e
r
c
e
n
t
a
g
e
Big 4 Non Big 4
Figure 2.
Comparison of
change in
going-concern
percentage for Big 4
vs Non-Big 4 Firms
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The variables for size (LNTA), Z-score (Z-SCORE), short- and long-term investments
(INVESTMENTS), leverage (LEV), audit delay (AUDELAY) and future fnancing
availability (FUTUREFINANCE) all had the predicted sign and were signifcant. The
variable for stock return (RETURN) was only marginally signifcant. The variable for
Big 4 auditing frm was marginally signifcant.
5. Conclusion
This paper examined the relationship between the recent fnancial crisis and auditor
conservatism. The fnancial crisis and the recession that started in December 2007 led to
Table IV.
Logistic regression
testing effect of
fnancial crisis years
on auditor going-
concern opinions
(N?7,210)
Variables Predicted sign Coeffcient p-value
Intercept ? ?1.854 0.000***
CRISIS ? 0.637 0.000***
POSTCRISIS ? ?0.120 0.368
Z * CRISIS ? ?0.079 0.000***
LNTA ? ?0.239 0.000***
Z-SCORE ? 0.026 0.000***
BIG4 ? 0.215 0.062*
VOLATILITY ? 0.000 0.165
RETURN ? ?0.009 0.066*
INVESTMENTS ? ?0.579 0.004***
LEV ? 0.183 0.007***
AUDELAY ? 0.005 0.000***
FUTUREFINANCE ? ?0.276 0.007***
IND Controlled
Model Chi-square 309.84
R
2
9.9%
N 7,210
Notes: Model:
GC ? ?
0
? ?
1
* CRISIS ? ?
2
* POSTCRISIS ? ?
3
* Z * CRISIS ? ?
4
* LNTA
? ?
5
* Z ? SCORE ? ?
6
* BIG4 ? ?
7
* VOLATILITY ? ?
8
* RETURN
? ?
9
* INVESTMENTS ? ?
10
*LEV ? ?
11
* AUDELAY
? ?
12
* FUTUREFINANCE ? ?
13
* IND ? ?
The variables are defned as follows: GC ?Going concern, 1 if audit opinion is frst-time going concern,
0 otherwise; CRISIS ?1 if crisis period (2008 and 2009), else 0; POSTCRISIS ?1 if post-crisis period
(2010 and 2011), else 0; Z * CRISIS ? Interaction term for Z-score and Crisis; LNTA ? Natural log of
total assets (in millions of dollars); Z-SCORE ? Z-score from Zmijewski’s (1984) model; BIG4 ?
Indicator variable that takes a value of 1 if audited by a Big 4 accounting frm, otherwise zero;
VOLATILITY ? Standard deviation of annual stock returns in recent three years; RETURN ?
One-year common stock return; INVESTMENTS ? Short- and long-term investment securities
(including cash and cash equivalents) defated by total assets (TA); LEV ?Total liabilities over total
assets; AUDELAY ? The number of calendar days from fscal year-end to the date of the auditor’s
report; FUTUREFINANCE ? An indicator variable that takes the value of 1 if the frm has a new
issuance of equity or debt over the subsequent fscal year; IND?Industry dummy variables as defned
in Krishnan (2005); *** and *denote signifcance at the 0.01 and 0.10 levels, respectively; p-values are
one-tailed if direction is predicted, otherwise two-tailed
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increased numbers of fnancially distressed frms. The greater number of fnancially
distressed frms also resulted in a greater number of going-concern opinions. Not only
did the number of going-concern opinions increase but also the percentage of fnancially
distressed frms receiving going-concern opinions increased. The increase in percentage
of going-concern opinions was not driven by the size of auditing frmas it holds true for
Big 4 accounting frms and non-Big 4 accounting frms.
Our regression results show that even after controlling for other predictors of
going-concern opinions, auditors were more likely to issue going-concern opinions
during the fnancial crisis. By 2010, the fnancial crisis had eased and the level of
going-concern opinions quickly dropped to pre-crisis levels not seen since before the
passage of the Sarbanes–Oxley Act. This indicates that the increased conservatismthat
auditors displayed during the crisis did not continue after the crisis ended.
Note
1. As the variables “CRISIS” and “POSTCRISIS” are being compared to the pre-crisis years
(2005-2006), a positive coeffcient for CRISIS or POSTCRISIS indicates that the probability of
receiving a going-concern opinion is higher relative to the pre-crisis period.
References
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Standards No. 59, The Auditor’s Consideration of an Entity’s Ability to Continue as a
Going-Concern, AICPA, New York, NY.
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Carcello, J., Hermanson, D. and Huss, F. (1996), “Inappropriate audit partner behavior: views of
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Carey, P.J., Geiger, M.A. and O’Connell, B.T. (2008), “Costs associated with
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Carson, E., Fargher, N., Geiger, M., Lennox, C., Raghunandan, K. and Willekens, M. (2013), “Audit
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independence? Evidence from going concern audit opinions”, Journal of Accounting
Research, Vol. 40 No. 4, pp. 1247-1274.
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pp. 55-77.
Feldmann, D. and Read, W. (2010), “Auditor conservatism after Enron”, Auditing: A Journal of
Practice & Theory, Vol. 29 No. 1, pp. 267-278.
Geiger, M. and Raghunandan, K. (2002), “Going concern opinions in the ‘new’ legal environment”,
Accounting Horizons, Vol. 16 No. 1, pp. 17-26.
Geiger, M., Raghunandan, K. and Rama, D. (2005), “Recent changes in the association between
bankruptcies and prior audit opinions”, Auditing: A Journal of Practice & Theory, Vol. 24
No. 1, pp. 21-35.
Knechel, R. andVanstraelen, A. (2007), “The relationshipbetweenauditor tenure andaudit quality
implied by going concern opinions”, Auditing: AJournal of Practice &Theory, Vol. 26 No. 1,
pp. 113-131.
Krishnan, J. (2005), “Audit committee fnancial expertise and internal control: an empirical
analysis”, The Accounting Review, Vol. 80 No. 2, pp. 649-675.
Lennox, C. (2000), “Going-concern opinions in failing companies: auditor dependence and opinion
shopping”, SSRN Working Paper Series.
Li, C. (2009), “Does client importance affect auditor independence at the offce level? Empirical
evidence from going-concern opinions”, Contemporary Accounting Research, Vol. 26 No. 1,
pp. 201-230.
Mutchler, J., Hopwood, W. and McKeown, J. (1997), “The infuence of contrary information and
mitigating factors in audit opinion decisions on bankrupt companies”, Journal of
Accounting Research, Vol. 35 No. 2, pp. 295-310.
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and after SAS No. 59”, Auditing: A Journal of Practice & Theory , Vol. 14 No. 1, pp. 50-63.
The National Bureau of Economic Research (2010), “Business Cycle Dating Committee, National
Bureau of Economic Research”, available at: www.nber.org/cycles/sept2010.html
Zmijewski, M. (1984), “Methodological issues related to the estimation of fnancial distress
prediction models”, Journal of Accounting Research, Vol. 22 No. 1, pp. 59-82.
About the authors
Joseph Beams is an Associate Professor of Accounting at the University of NewOrleans. He holds
the Oil and Gas Professorship in Accounting. He conducts research in fnancial accounting and
taxation. He has published in a variety of academic and professional journals, including Journal of
Business Ethics, Accounting Horizons, Journal of Accountancy, Accounting and the Public Interest,
as well as other academic and professional journals. Joseph Beams is the corresponding author
and can be contacted at: [email protected]
Yun-Chia Yan (Anderson) is currently an Assistant Professor at the University of Texas at
Brownsville, USA. His research is in the areas of auditing, fnancial reporting, capital markets and
AIS. His articles have been published in various journals, including Asia-Pacifc Journal of
Accounting and Economics (forthcoming), Accounting and the Public Interest (forthcoming),
Journal of Forensic and Investigative Accounting, International Journal of Banking and Finance,
Journal of Accounting and Finance andIssues in Information Systems.
For instructions on how to order reprints of this article, please visit our website:
www.emeraldgrouppublishing.com/licensing/reprints.htm
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doc_469336782.pdf
This paper aims to examine the effect that the recent financial crisis had on auditor
conservatism in the form of increased going-concern opinions.
Accounting Research Journal
The effect of financial crisis on auditor conservatism: US evidence
J oseph Beams Yun-Chia Yan
Article information:
To cite this document:
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evidence", Accounting Research J ournal, Vol. 28 Iss 2 pp. 160 - 171
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The effect of fnancial crisis on
auditor conservatism:
US evidence
Joseph Beams
Department of Accounting, University of New Orleans, New Orleans,
Louisiana, USA, and
Yun-Chia Yan
Department of Accounting and MIS, University of Texas at Brownsville,
Brownsville, Texas, USA
Abstract
Purpose – This paper aims to examine the effect that the recent fnancial crisis had on auditor
conservatism in the form of increased going-concern opinions.
Design/methodology/approach – This study uses a sample of US’ distressed frms from 2005 to
2011 to test the change in going-concern opinions issued. This paper uses a logistic regression model to
control for other predictors of going-concern opinions to determine when the fnancial crisis led to an
increase in auditor conservatism.
Findings – The authors fnd that auditors became more conservative in the form of issuing higher
levels of going-concern opinions even after controlling for other predictors of going-concern opinions.
This increased conservatism was present in both Big 4 and non-Big 4 accounting frms. The increased
conservatism quickly returned to normal levels when the fnancial crisis eased.
Originality/value – These fndings add to the literature on the effects of environmental changes on
audit opinions. Additionally, this study fnds a difference in the timing of the reaction by large and small
accounting frms, but, overall, it fnds consistency in that both increased conservatismduring the crisis
and quickly returned to normal afterward.
Keywords Conservatism, Financial crisis, Auditor, Going-concern
Paper type Research paper
1. Introduction
The recent fnancial crisis and recession had a devastating effect on families and
businesses around the world. The survival of many businesses was threatened by slow
sales and tight lending. According to The National Bureau of Economic Research (2010),
the recent recession in the USAoffcially started in December 2007 and ended in June of
2009. It lasted 18 months which makes it the longest US recession in more than 60 years.
Although the recession offcially ended in June 2009, many areas of the economy showed
little recovery in that year.
The exact time that a recession starts or ends is not known at the time it happens.
There are usually some signs that business is slowing down, followed by speculation
that a country may be falling into a recessionary time, but the offcial beginning and
ending must be calculated after the fact, once data can be collected and analyzed.
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1030-9616.htm
ARJ
28,2
160
Received21 June 2013
Revised16 May2014
Accepted5 June 2014
Accounting Research Journal
Vol. 28 No. 2, 2015
pp. 160-171
©Emerald Group Publishing Limited
1030-9616
DOI 10.1108/ARJ-06-2013-0033
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Some companies could not survive the economic downturn and were either taken
over by other companies or fell into bankruptcy. When an auditor foresees a high
likelihood of bankruptcy, he gives the company a going-concern modifed audit opinion.
It does not matter if the higher likelihood of bankruptcy is the result of an economic
downturn or more frm-specifc factors. Previous studies have suggested that auditors
may get overly cautious during times of heightened public scrutiny.
This study looks at the effects of the recent fnancial crisis on auditors’ going-concern
audit opinions. We fnd that not only did the number of distressed companies and the
number of going-concern opinions increase during the fnancial crisis but also auditors
became more conservative toward distressed companies in the form of issuing a higher
percentage of going-concern opinions to those companies. Even for the same level of
fnancial ratios and bankruptcy predictors, auditors increased their likelihood of issuing
going-concern opinions. This increased conservatism was very evident in 2008, but the
level of conservatism had returned to normal by 2010.
The remainder of this paper is organized as follows. Section 2 provides a review of
prior literature and the development of research questions. Section 3 describes the
sample and the methodology used to test these questions. The results of the tests are
presented in section 4, and section 5 provides a conclusion.
2. Prior literature and hypothesis development
Prior studies have looked at the causes of going-concern modifed audit opinions.
According to Statement on Auditing Standards No. 59 (AICPA, 1988):
The auditor has a responsibility to evaluate whether there is substantial doubt about the
entity’s ability to continue as a going concern for a reasonable period of time, not to exceed one
year beyond the date of the fnancial statements being audited […].
However, under international standards, the time period to be considered for a
going-concern modifcation must be a minimum of 12 months rather than the “not to
exceed one year” required by the US standard (Carson et al., 2013).
If the auditors perceive a high likelihood of frm failure, they issue a going-concern
modifed audit opinion. An auditor’s doubt about a frm’s ability to continue must
include all relevant factors. The auditor considers both the frmand the environment, as
well as management’s plans to overcome its expected diffculties.
The going-concern modifed audit opinion is intended to warn users of fnancial
statements of the risks that a company is facing. A company receiving a going-concern
modifed audit opinion can have diffculty raising capital from new investors or
creditors. This limitation on the availability of capital can make a company’s failure
even more likely. Receiving a going-concern opinion can anger the company’s
management and may create hardship that would otherwise not have existed. When
auditors issue a going-concern modifed audit opinion, their clients are more likely to
switch to another audit frm (Lennox, 2000; Carcello and Neal, 2003; Carey et al., 2008;
Carson et al., 2013). This provides an incentive for the audit frm to resist issuing a
going-concern opinion. The decision to give a company a going-concern opinion is not
taken lightly.
However, investors are less surprised by a frm’s bankruptcy if the frmhas received
a going-concern opinion frst (Chen and Church, 1996). Feldmann and Read (2010) fnd
that over 40 per cent of the frms that fle bankruptcy do not receive a going-concern
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modifed audit opinion prior to fling bankruptcy. Not issuing a going-concern modifed
opinion can lead to litigation against the auditors. Auditors must weigh the risks of
assigning a going-concern audit opinion too early and possibly losing a client’s business
against the risk of a client going bankrupt and the audit frm facing litigation because
they did not provide a warning to the public in the form of a going-concern modifed
audit opinion.
During times of recession, all companies have a harder time surviving. The banking
crisis that accompanied the 2007 recession left many banks applying much tighter
lending requirements. In an environment of declining sales, many companies needed
additional fnancing; however, banks were reluctant to lend to all but the strongest
customers. That left some companies without the necessary cash they needed to survive.
These factors affect an entitie’s ability to survive and must be considered by auditors
when accessing whether to issue a going-concern modifed audit opinion.
An increased likelihood of company failures during the recession period could be due
to greater diffculty of obtaining fnancing during this period. While the strongest
clients could still obtain fnancing, less stable companies often could not. Auditors
consider the ability of the audit client to obtain fnancing as part of the going-concern
assessment. Prior research has found that future fnancing reduces the probability of
receiving a going-concern audit opinion (Defond et al., 2002; Mutchler et al., 1997).
Auditors must consider all relevant factors when assessing a going-concern modifed
audit opinion. Bankruptcy prediction models have been developed for use in predicting
the likelihood of a company declaring bankruptcy. As a going-concern opinion is
intended to warn of a high likelihood of a frm failure, the use of these bankruptcy
prediction models has been tested for their correlation with going-concern audit
opinions. One of these models uses a Z-score to measure the degree of a company’s
fnancial distress and the likelihood of bankruptcy (Zmijewski, 1984). The Z-score uses
a combination of return on assets, fnancial leverage and liquidity. The Z-score has been
found to be positively associated with receiving a going-concern audit opinion (Carcello
and Neal, 2000).
2.1 Changes in conservatism
The audit opinion is an opinion and therefore has a degree of subjectivity to it. Prior
studies have found that auditor conservatism changes resulting from changes in the
auditing environment (Geiger and Raghunandan, 2002; Geiger et al., 2005; Fargher and
Jiang, 2008; Feldmann and Read, 2010).
Geiger and Raghunandan (2002) fnd that reduced legal pressure because of changes
in laws during the 1990s led to a lower incidence of going-concern opinions for
distressed frms in the late 1990s. Geiger et al. (2005) fnd that auditors were more likely
to issue going-concern opinions after December 2001 than previously due to the changes
in attitudes resulting from publicity from major corporate scandals and the passage of
the Sarbanes–Oxley Act.
Fargher and Jiang (2008) also fnd that auditors were more likely to issue
going-concern opinions after 2002 than in the prior period. They fnd that the auditors’
increased conservatismled not only to a small decrease in the level of company failures
that were not preceded by going-concern audit opinions but also to an increase in
going-concern opinions for companies that did not fail.
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Feldmann and Read (2010) fnd that going-concern modifed opinions increased after
2002 and led to a lower incidence of bankrupt frms that did not receive a going-concern
opinion previously. However, they also fnd that the change was only temporary and the
conservatism soon returned to normal levels.
When the economy slows signifcantly, businesses face additional challenges. The
number of going-concern opinions is expected to increase because the number of
bankruptcies also increases. The number of distressed companies increased during the
2007-2009 fnancial crisis and therefore, we expect auditors to have increased the
number of going-concern opinions during the same period. However, do audit frms
increase their conservatism or even overcompensate during these times? This study
attempts to answer the following research questions:
RQ1. Did the relative proportion of going-concern opinions for distressed
companies increase during the fnancial crisis?
RQ2. After controlling for other predictors of going-concern opinions, did the
relative likelihood of receiving a going-concern opinion increase during the
fnancial crisis?
3. Sample and methodology
3.1 Sample selection
Consistent with prior going-concern studies (Carcello and Neal, 2000; Geiger and
Raghunandan, 2002; Geiger et al., 2005; Feldmann and Read, 2010), we create a sample
of all fnancially distressed US frms listed on Compustat for the years 2005-2011. We
defne fnancially distressed frms as those with negative earnings or negative operating
cash fows as defned in DeFond et al. (2002). We remove companies in the fnancial
industries (SIC: 60-69) due to their unique reporting requirements. Firms with a prior
year going-concern opinion are inherently more likely to have a current year
going-concern opinion. Therefore, consistent with prior studies (DeFond et al., 2002; Li,
2009), we ensure that only frst-time going-concern opinions are included by removing
frms that had a prior year going-concern opinion. The resulting sample has 9,240
frm-year observations. Consistent with prior research, we winsorize the continuous
variables used in the analysis at the 1 and 99 per cent levels.
3.2 Methodology
To test RQ1, we separate the frms by year to look at the number of distressed frms and
the level of going-concern opinions per year. We examine the percentage of
going-concern opinions between the years and conduct a t-test on the pre-crisis years
versus the crisis years. We defne the pre-crisis years as 2005-2006 and the crisis years
as 2008-2009. The recession offcially started at the end of 2007, so we do not include
2007 with either group.
We next separate the frms into two groups based on whether they had a Big 4
accounting frmconduct their external audit. This allows us to examine howthe level of
going-concern opinions for each group changed during and after the fnancial crisis.
To test whether auditors became more conservative during the fnancial crisis, we
use a logistic regression model. The dependent variable in the model is a dichotomous
variable that represents the audit opinion. The audit opinion is either a going-concern
opinion or not a going-concern opinion. The variable of interest is CRISIS. The CRISIS
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variable is coded as a 1 if the observation was from the 2008-2009 crisis years and is
coded 0 for all other years. We expect the crisis years to have a higher incidence of
going-concern opinions, and therefore, we predict the CRISIS variable will be positive
and signifcant.
Observations from the 2005-2006 pre-crisis period are compared to the crisis and
post-crisis periods. The post-crisis years are defned as 2010-2011. The POSTCRISIS
variable is either a 0 or 1 depending on whether the observation is from the 2010-2011
post-crisis years. We do not predict a signifcant difference between this period and the
pre-crisis period. Because the recession started in 2007, the year 2007 is not included in
either group, and therefore, the 2007 observations are omitted from the fnal analysis.
Also, frms that did not contain the variables for the analysis were omitted. This resulted
in a sample of 7,210 frm-year observations for the regression analysis.
Because the bankruptcy prediction model Z-score (Zmijewski, 1984) correlates with
going-concern modifed audit opinions, we include a variable to measure Z-score in the
model (Carcello and Neal, 2000).
We also include an interaction termin the model for the interaction of Z-score with the
crisis period. In the non-crisis years, this interaction termwill have the value of 0, as the
CRISIS variable will be zero. During the crisis years, it will be identical to Z-score.
Therefore, this variable will indicate whether auditors weigh the variables included in
the Z-score more or less heavily during the crisis years than other years.
3.3 Going-concern control variables
Due to the increased diffculty in obtaining loans during the crisis period, we control for
a frm’s ability to obtain external fnancing. Consistent with prior research, we control
for this by including a variable for future fnancing which represents whether the frm
had a newissuance of equity or debt over the subsequent fscal year (Defond et al., 2002;
Mutchler et al., 1997).
Previous research on going-concern opinions have found a variety of frm-specifc
variables associated with a higher likelihood of receiving a going-concern audit opinion.
Prior research has found that going-concern opinions are associated with longer audit
reporting delays (Raghunandan and Rama, 1995; Carcello et al., 1996; Ettredge et al.,
2006). To control for this relationship, we include a variable to measure the days from
the fscal year-end to the date of the audit report.
Generally, smaller frms have been found to have a higher likelihood of receiving a
going-concern audit opinion (Carcello and Neal, 2000; Behn et al., 2001; Geiger et al.,
2005; Knechel and Vanstraelen, 2007; Feldmann and Read, 2010). One-year stock market
return and liquid investments have been found to be negatively associated with
receiving a going-concern opinion. Higher stock volatility and leverage (defned as total
liabilities divided by total assets) have been found to be positively associated with
going-concern opinions (DeFond et al., 2002). Different industries can also have an effect
on going-concern opinions (Krishnan, 2005).
The size of an audit frm has been tested for a relationship to going-concern audit
opinions. The results have been mixed. Some have suggested that Big 4 audit frms are
more likely to issue a going-concern audit opinion. The size of audit frms is usually
separated into two groups, Big 4 and non-Big 4. Behn et al. (2001) found a positive
relationship between Big 4 audit frms and going-concern opinions. Other researchers
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(Geiger et al., 2005; Feldmann and Read, 2010; Knechel and Vanstraelen, 2007) have not
found such a relationship.
We include all of these variables from the prior research to control for other factors
impacting going-concern opinions. The following model is used to test RQ2 :
GC ? ?
0
? ?
1
* CRISIS ? ?
2
* POSTCRISIS ? ?
3
* Z * CRISIS
? ?
4
* LNTA ? ?
5
* Z ? SCORE ? ?
6
* BIG4 ? ?
7
* VOLATILITY
? ?
8
* RETURN ? ?
9
* INVESTMENTS ? ?
10
*LEV
? ?
11
* AUDELAY ? ?
12
* FUTUREFINANCE ? ?
13
* IND ? ?
Where:
GC ?going concern, 1 if audit opinion is frst-time going concern,
0 otherwise;
CRISIS ?1 if crisis period (2008 and 2009), else 0;
Postcrisis ?1 if post-crisis period (2010 and 2011), else 0;
Z * CRISIS ?Interaction term for Z-SCORE and CRISIS;
LNTA ?Natural log of total assets (in millions of dollars);
Z-SCORE ?Z-score from Zmijewski’s (1984) model;
BIG4 ?indicator variable that takes a value of 1 if audited by a Big
4 accounting frm, otherwise zero;
VOLATILITY ? standard deviation of annual stock returns in recent three
years;
RETURN ?one-year common stock return;
INVESTMENTS ? short- and long-term investment securities (including cash
and cash equivalents) defated by total assets (TA);
LEV ?total liabilities over total assets;
AUDELAY ?the number of calendar days fromfscal year-end to the date
of the auditor’s report;
FUTUREFINANCE ?an indicator variable that takes the value of 1 if the frm has
a new issuance of equity or debt over the subsequent fscal
year; and
IND ?industry dummy variables as defned in Krishnan (2005).
4. Results
The data in our sample include all non-fnancial distressed companies in the sample
years. Distressed companies are defned as having either negative earnings or negative
cash fows. Table I shows the total number of distressed companies for each year and the
number of going-concern opinions for each year. The total number of going-concern
opinions for all frmyears is 820 (8.87 per cent) out of the total sample of 9,240 frm-year
observations. Prior to 2010, the number of distressed frms ranged from a low of 1,224
frms in 2007 to a high of 1,649 frms in 2009.
Table I also shows that the total number of distressed frms decreased in 2010 and
2011 compared to that in all the previous years in the sample. This is likely a
combination of the weaker frms exiting the market during the fnancial crisis and the
surviving frms beginning to recover. These years also have the lowest levels of
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going-concern opinions. Our sample starts with the 2005 year which was only shortly after
the heightenedgoing-concernopinions fromthe Enronera andthe passage of the Sarbanes–
OxleyAct (Geiger et al., 2005; Fargher andJiang, 2008; FeldmannandRead, 2010). Therefore,
the heightened conservatism of auditors may not have fully returned to normal until 2006
and then it began to rise again in 2007 with the onset of the recent crisis.
The sample only contains distressed frms that have negative earnings or operating
cash fows. The number of distressed frms is expected to increase during a fnancial
crisis. Likewise, with more distressed frms, one would expect more going-concern
opinions to be issued. However, should this lead to a higher percentage of distressed
frms receiving going-concern opinions?
Figure 1 shows the increase in the percentage of going-concern opinions out of total
distressed frms. In the years leading up to the recession (2005-2006), the going-concern
opinions range from 8.90 to 6.71 per cent of distressed frms. The recession offcially
started in December of 2007. The percentage of going-concern opinions for the
distressed companies was 8.58 per cent in that year, and the following two years
(2008-2009) sawdramatic increases in the percentage of distressed companies receiving
going-concern opinions with 12.63 per cent in 2008 and 11.52 per cent in 2009.
To answer RQ1, that the relative proportion of going-concern opinions for distressed
companies increases during the fnancial crisis, we conducted a t-test on the proportion
of going-concern opinions in the years before the fnancial crisis versus the years of the
fnancial crisis. Table II, shows the results of the t-test. The years before the crisis are
defned as 2005 and 2006, and the years during the crisis are defned as 2008 and 2009.
The mean proportion of going-concern opinions from 2005 to 2006 is 0.0785, and the
Table I.
Number of distressed
frms and going-
concern opinions by
year
Year Total frms
a
GC opinions
b
2005 1,371 122
2006 1,252 84
2007 1,224 105
2008 1393 176
2009 1,649 190
2010 1,198 73
2011 1,153 70
Total 9,240 820
Notes:
a
Total number of distressed frms per year;
b
number of going-concern opinions for distressed
frms
8.90%
6.71%
8.58%
12.63%
11.52%
6.09% 6.07%
0%
2%
4%
6%
8%
10%
12%
14%
2005 2006 2007 2008 2009 2010 2011
Time period
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Figure 1.
Percentage of
distressed companies
receiving
going-concern
opinions
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mean proportion of going-concern opinions from 2008 to 2009 is 0.1203. This difference
is signifcant at p ? 0.0001. This confrms RQ1 that a higher proportion of distressed
frms received going-concern opinions during the fnancial crisis.
After the fnancial crisis, the percentage of going-concern opinions returned to 6.09
and 6.07 per cent in 2010 and 2011, respectively. This is consistent with the fndings of
Feldmann and Read (2010) that the elevated percentage of going-concern opinions
decreases quickly after the crisis has passed.
Table III separates the frms into two groups based on whether they are audited by a
Big 4 accounting frm. The results show that overall Big 4 accounting frms issued
going-concern opinions to 6.51 per cent of the fnancially distressed frms they audited,
while the non-Big 4 frms issued going-concern opinions to 11.50 per cent of the
fnancially distressed frms they audited. Table III also shows a breakdown of
going-concern opinions by year between Big 4 and non-Big 4 auditing frms.
Figure 2 shows that, in every year, the non-Big 4 frms had a higher percentage of
going-concern opinions. However, in 2009, during the fnancial crisis, the percentages
betweenthe groups became closer. By2010, the differences became more pronouncedagain.
The percentage of going-concern opinions increased for both groups during the fnancial
crisis, indicating that it is not an issue specifc only to big or small auditing frms.
For the non-Big 4 frms, the percentage of going-concern opinions increased sooner,
but also decreased sooner after the crisis. The Big 4 frms did not show an increase in
going-concern percentages until 2008. The non-Big 4 frms reached a peak of 15.85 per
cent in 2008 and then began to come down. The Big 4 frms did not reach their peak of
Table II.
Comparison of
proportion of going-
concern opinions.
Before fnancial crisis
(2005-2006) vs during
fnancial crisis
(2008-2009)
Variable
Pre-fnancial crisis
(2005-2006)
Means (n ?2,623)
During fnancial
crisis
(2008-2009)
Means
(n ?3,042)
Difference
in means t-value
p-value
(Two-tailed)
Going-concern
opinions 0.0785 0.1203 0.042 5.216 0.0001
Table III.
Going-concern
opinions by auditor
type and year. Big 4
vs non-Big 4
(N ?9,240)
Year
Big 4
a
Non-Big 4
b
#Firms
c
#GC
d
(%) #Firms
e
#GC
f
(%)
2005 727 45 6.19 644 77 11.96
2006 618 27 4.37 634 57 8.99
2007 590 26 4.41 634 79 12.46
2008 781 79 10.12 612 97 15.85
2009 804 85 10.57 845 105 12.43
2010 679 24 3.53 519 49 9.44
2011 657 30 4.57 496 40 8.06
Total 4,856 316 6.51 4384 504 11.50
Notes:
a
Audited by a Big 4 auditing frm;
b
audited by a non-Big 4 auditing frm;
c
total number of
distressed frms audited by Big 4 frms;
d
number of going-concern opinions from Big 4 frms;
e
total
number of distressed frms audited by non-Big 4 frms;
f
number of going-concern opinions from
non-Big 4 frms
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10.57 per cent for going-concern opinions until 2009 before dramatically declining to
3.53 per cent in 2010.
A partial explanation of this difference is the number of frms from the non-Big 4
group that met the defnition of distressed. In 2008, there were 612 distressed frms in
this group and 97 of them received a going-concern audit opinion. By 2009, there were
845 distressed frms in this group but only 105 of them received a going-concern audit
opinion. The difference between the two groups may also be infuenced by a difference
in clientele between the types of audit frms.
To test RQ2, we use a logistic regression model. Table IV shows the results of the
logistic regression. The variable of interest is CRISIS. The variable for CRISIS had the
expected sign and is signifcant at the p ? 0.001 level. The signifcance of the CRISIS
variable, even after controlling for the other bankruptcy prediction variables, indicates
that auditors became more inclined to issue going-concern audit opinions during the
crisis. The regression indicates that auditors were more likely to issue going-concern
opinions during the crisis for the same levels of the bankruptcy prediction criteria[1].
The variable for POSTCRISIS was not signifcant which was expected. This
suggests that the increased conservatism declined toward normal levels after the crisis
had passed. Auditors became more conservative at the height of the fnancial crisis but
returned to normal levels afterward.
The interaction term for the interaction of Z-SCORE and CRISIS is signifcant at the
p ? 0.001 level. Because the CRISIS variable is either 0 or 1, the interaction term Z *
Crisis has a value of zero for all non-crisis years and is equal to Z-SCORE for the crisis
years. Z-SCORE is signifcant and has a positive coeffcient in the model; however, the
coeffcient on the interaction variable is ?0.079. There was no predicted sign for the
interaction term, but the negative coeffcient means that the Z-score is less infuential to
the going-concern decision during the crisis years than in the non-crisis years. This may
seem counter-intuitive due to the importance of going-concern opinions during crisis
years, but this does not mean auditors are not looking more closely at the companies.
Clearly, the overall level of going-concern opinions does increase during crisis years.
As Z-score is a summary number, the negative coeffcient on the interaction term
may indicate that, in times of turmoil, auditors must dig deeper. Other factors or
frm-specifc items may have greater predictive value during periods of fnancial crisis.
This study did not test all possible interactions. It is possible that other factors may be
more or less important to the going-concern decision during crisis years. Further
research on additional interaction items may help shed light on these issues.
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
2005 2006 2007 2008 2009 2010 2011
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Big 4 Non Big 4
Figure 2.
Comparison of
change in
going-concern
percentage for Big 4
vs Non-Big 4 Firms
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The variables for size (LNTA), Z-score (Z-SCORE), short- and long-term investments
(INVESTMENTS), leverage (LEV), audit delay (AUDELAY) and future fnancing
availability (FUTUREFINANCE) all had the predicted sign and were signifcant. The
variable for stock return (RETURN) was only marginally signifcant. The variable for
Big 4 auditing frm was marginally signifcant.
5. Conclusion
This paper examined the relationship between the recent fnancial crisis and auditor
conservatism. The fnancial crisis and the recession that started in December 2007 led to
Table IV.
Logistic regression
testing effect of
fnancial crisis years
on auditor going-
concern opinions
(N?7,210)
Variables Predicted sign Coeffcient p-value
Intercept ? ?1.854 0.000***
CRISIS ? 0.637 0.000***
POSTCRISIS ? ?0.120 0.368
Z * CRISIS ? ?0.079 0.000***
LNTA ? ?0.239 0.000***
Z-SCORE ? 0.026 0.000***
BIG4 ? 0.215 0.062*
VOLATILITY ? 0.000 0.165
RETURN ? ?0.009 0.066*
INVESTMENTS ? ?0.579 0.004***
LEV ? 0.183 0.007***
AUDELAY ? 0.005 0.000***
FUTUREFINANCE ? ?0.276 0.007***
IND Controlled
Model Chi-square 309.84
R
2
9.9%
N 7,210
Notes: Model:
GC ? ?
0
? ?
1
* CRISIS ? ?
2
* POSTCRISIS ? ?
3
* Z * CRISIS ? ?
4
* LNTA
? ?
5
* Z ? SCORE ? ?
6
* BIG4 ? ?
7
* VOLATILITY ? ?
8
* RETURN
? ?
9
* INVESTMENTS ? ?
10
*LEV ? ?
11
* AUDELAY
? ?
12
* FUTUREFINANCE ? ?
13
* IND ? ?
The variables are defned as follows: GC ?Going concern, 1 if audit opinion is frst-time going concern,
0 otherwise; CRISIS ?1 if crisis period (2008 and 2009), else 0; POSTCRISIS ?1 if post-crisis period
(2010 and 2011), else 0; Z * CRISIS ? Interaction term for Z-score and Crisis; LNTA ? Natural log of
total assets (in millions of dollars); Z-SCORE ? Z-score from Zmijewski’s (1984) model; BIG4 ?
Indicator variable that takes a value of 1 if audited by a Big 4 accounting frm, otherwise zero;
VOLATILITY ? Standard deviation of annual stock returns in recent three years; RETURN ?
One-year common stock return; INVESTMENTS ? Short- and long-term investment securities
(including cash and cash equivalents) defated by total assets (TA); LEV ?Total liabilities over total
assets; AUDELAY ? The number of calendar days from fscal year-end to the date of the auditor’s
report; FUTUREFINANCE ? An indicator variable that takes the value of 1 if the frm has a new
issuance of equity or debt over the subsequent fscal year; IND?Industry dummy variables as defned
in Krishnan (2005); *** and *denote signifcance at the 0.01 and 0.10 levels, respectively; p-values are
one-tailed if direction is predicted, otherwise two-tailed
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increased numbers of fnancially distressed frms. The greater number of fnancially
distressed frms also resulted in a greater number of going-concern opinions. Not only
did the number of going-concern opinions increase but also the percentage of fnancially
distressed frms receiving going-concern opinions increased. The increase in percentage
of going-concern opinions was not driven by the size of auditing frmas it holds true for
Big 4 accounting frms and non-Big 4 accounting frms.
Our regression results show that even after controlling for other predictors of
going-concern opinions, auditors were more likely to issue going-concern opinions
during the fnancial crisis. By 2010, the fnancial crisis had eased and the level of
going-concern opinions quickly dropped to pre-crisis levels not seen since before the
passage of the Sarbanes–Oxley Act. This indicates that the increased conservatismthat
auditors displayed during the crisis did not continue after the crisis ended.
Note
1. As the variables “CRISIS” and “POSTCRISIS” are being compared to the pre-crisis years
(2005-2006), a positive coeffcient for CRISIS or POSTCRISIS indicates that the probability of
receiving a going-concern opinion is higher relative to the pre-crisis period.
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About the authors
Joseph Beams is an Associate Professor of Accounting at the University of NewOrleans. He holds
the Oil and Gas Professorship in Accounting. He conducts research in fnancial accounting and
taxation. He has published in a variety of academic and professional journals, including Journal of
Business Ethics, Accounting Horizons, Journal of Accountancy, Accounting and the Public Interest,
as well as other academic and professional journals. Joseph Beams is the corresponding author
and can be contacted at: [email protected]
Yun-Chia Yan (Anderson) is currently an Assistant Professor at the University of Texas at
Brownsville, USA. His research is in the areas of auditing, fnancial reporting, capital markets and
AIS. His articles have been published in various journals, including Asia-Pacifc Journal of
Accounting and Economics (forthcoming), Accounting and the Public Interest (forthcoming),
Journal of Forensic and Investigative Accounting, International Journal of Banking and Finance,
Journal of Accounting and Finance andIssues in Information Systems.
For instructions on how to order reprints of this article, please visit our website:
www.emeraldgrouppublishing.com/licensing/reprints.htm
Or contact us for further details: [email protected]
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