Table 6 presents the results of estimating equation (5). These results indicate that, in spite of a small sample size, the model performs reasonably well in predicting GCAR withdrawal with a pseudo R-square of 20%. The results provide some evidence that the return of institutional investors during the fiscal year subsequent to the initial GCAR opinion (IO_INCREASE) increases the probability of GCAR withdrawal as the coefficient is positive and significant (p < 10%). Our analysis of marginal effects shows that the likelihood of GCAR withdrawal increases from 42.6% to 51.4% when institutional ownership in a firm increases in the year subsequent to the initial GCAR.
Robustness Tests
We conduct a number of additional untabulated tests to determine if our results are due to alternative explanations, variable measurement specifications, or sample restrictions. Many of these have been footnoted throughout the text. We performed two additional untabulated tests on smaller samples explicitly controlling for analyst coverage and reasons cited for GCARs, respectively and found that our results were robust to the potentially correlated omitted variables. Regarding reasons cited for GCARs, Menon and Williams (2010) document that investors react more adversely to GCARs that cite financing problems compared to those citing problems associated with poor financial performance, operations, or other issues. As such, we include a control variable taking the value of one if the GCAR cites financing problems, and zero otherwise. We find that the financing problem indicator variable is not significant in our test of
short-window abnormal returns and abnormal volume.20 Furthermore, when this variable is included, we find that coefficients for the variable of interest (FIRSTGC*IO_FLIGHT) continue to be significant across the tests for both market response variables at the previously reported levels.
In addition to alternative explanations, we investigate whether our results are robust to alternative specifications for our variables. Specifically, we reperform our analyses of
IO_FLIGHT for an unranked continuous measure, an indicator variable taking that value of one for decreases in institutional ownership, and a categorical variable at three levels (high flight, low flight, and no flight). Additionally, we use an alternative proxy of the market’s uncertainty regarding the value of the firm’s equity by examining the long-window change in standard deviation of returns over the year surrounding the 10-K announcement window. Lastly, we investigate whether our results are due to sample restrictions. Specifically, our results could be a product of the number of institutional owners at the beginning of the period over which the change is measured. As such, we further restrict our sample to only those firms which have at least five institutional owners during the fourth quarter prior to fiscal year-end (Q-4).
Furthermore, we test whether our results will hold after restricting our sample to those firms which fiscal year-end coincides with a calendar quarter-end to ensure our measurement of institutional flight maps directly to the fiscal year of the audit opinion. All inferences in the paper remain qualitatively unchanged throughout these additional tests.
20 We also performed similar analyses with the remaining categories of problems Menon and Williams (2010)
identified as being present in GCARs (poor financial performance, operating problems, and other). We find that operating problems have a positive and significant coefficient (p-value < 5%) in our analysis of the change in standard deviation of returns suggesting operating problems lead to increased uncertainty about a firm. We also find that inclusion of the poor financial performance indicator leads to issues of multicollinearity due to its inclusion in 85% of GCARs. Our variable of interest (FIRSTGC*IO_FLIGHT) remains significant in all regressions.
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IV. Conclusion
Questions remain regarding the informativeness of going concern reporting, in part, because auditors’ expertise lies in providing assurance services not in assessing the going concern status of firms. Menon and Williams (2010) document significant negative short- window abnormal returns in the days around the GCAR announcement and conclude that first- time GCARs reveal value relevant bad news to equity investors. We first extend this study by testing the incremental market reaction around the annual report announcement of firms that receive a first-time GCAR modification, relative to similarly stressed firms where the auditor did not determine that a GCAR modification was warranted. We find that, on average, the auditor’s decision to issue a GCAR is associated with an incremental five-day size-adjusted abnormal return of -5.6% and a 1.1% increase in market-adjusted share turnover relative to similarly distressed firms.
Second, we extend prior research on the determinants and usefulness of GCAR modifications by recognizing that the GCAR in isolation is a noisy signal and examining the impact of other sophisticated parties in discerning the severity of the signal. We draw on prior literature which describes institutional investors as active market participants with greater resources and information relative to retail investors (Lakonishok, et al., 1992; Gompers and Metrick, 2001; Puckett and Yan, 2011). We find that controlling for other known determinants of GCAR issuance, an increase in institutional flight during the fiscal year significantly increases the likelihood of the auditor issuing a GCAR. In a supplemental analysis, we find that among firms receiving a first-time GCAR opinion, an increase in institutional ownership in the subsequent fiscal year significantly increases the probability of GCAR withdrawal. These results
suggest these sophisticated parties, auditors and institutional investors, may knowingly or not be making similar assessments of firms’ going concern status.
More importantly, our primary research question is whether equity markets use institutional investors’ aggregate trading behavior to interpret the severity of the private information contained in the auditors’ noisy GCAR signal. We expect that the market is searching for cues as to the severity of a firm’s financial stress. In doing so, market participants will look to sophisticated institutional investors for a signal of the information contained in the auditors’ report. We find that the magnitude of the incremental negative abnormal return and incremental market-adjusted turnover associated with a first-time GCAR depends upon the level of institutional flight in the preceding year.
Collectively, our results contribute to the literature by demonstrating that the auditor’s decision to issue a GCAR, as well as investors’ interpretation of that decision, are not independent actions. We provide large-sample evidence that the auditor’s first-time GCAR modification provides incremental information to investors beyond other information released at the annual report date. Furthermore, our results suggest that the market considers the past trading behavior of another informed and sophisticated set of investors in making its assessment of the GCAR’s information content, and that behavior of institutions is more useful than changes in the firm’s equity prices. In all, these findings suggest that the market benefits from the synergy between the decisions of both auditors and sophisticated institutional investors.