K.U.Leuven - Departement toegepaste economische wetenschappen
DTEW Research Report 9955 pages:1-44
This study provides evidence on the relationship between audit report type and subsequent business termination in an environment where firms are closely held and the audit environment is non-litigious. The results show that an endogenous relationship exists between bankruptcy and audit report type, and between voluntary liquidation and audit report type. A non-clean opinion is typically given to firms with financial difficulties, which in turn become more severe after the receipt of a non-clean audit opinion. We find evidence that, even without a litigation deterrent in Belgium, financial performance has a similar impact on audit report type as in litigious environments, that is, the worse the financial condition the higher the likelihood of receiving a non-clean audit report. We also find that the self-fulfilling prophecy holds for bankruptcy, that is that a non-clean audit report triggers bankruptcy. Our paper investigated the relationship between audit report type and business termination for various types of business terminations including bankruptcy, voluntary liquidation and merger. The results reveal significant differences across the forementioned types of business terminations. One difference is that the self-fulfilling prophecy only holds when the audited firm has no decision power as to termination of is operations, that is for bankruptcy. It does not hold for voluntary liquidation nor merger. Another important difference relates to business termination through merger. No significant difference in performance exists between surviving and merging firms and no endogenous relationship exists between mergers and audit report type. For merging firms audit report qualifications are triggered by the weakness of the auditee's internal control system and not by substandard financial performance. Finally, our study provides some evidence on quality differentiation between Big Six and non Big Six auditors in the Belgian audit market. When financial difficulties are obvious, as is the case when a company is about to go bankrupt, both Big Six and non big Six auditors are as competent and/or independent to assess and report going concern problems. However, when financial difficulties are less apparent, as is the case for firms which are about to go into liquidation, our results indicate that Big Six auditors are more likely to issue a qualified audit opinion.