Audit Opinion and Share Prices

How often have you heard (working as auditor) or told (being client) “what is the value in all your audit procedure”?

Actually, there is the value of audited company at the stake! To keep our clients from such comments, we can now offer scientific dispute :)

Nowadays I am busy with preparation of my research proposal in the audit area. I have reviewed and read sufficient number of research articles dedicated to subject of relationship between share price and audit opinion announcement effect.

It is interesting that while working in audit firm I was not aware that there were lots of researches in this area. Of course, my colleagues and I assumed that audit opinions are able to communicate additional valuable information to investors, public, and regulatory authorities, but I could not imagine that topic is rather popular among researchers in economics and statistics.

So, the main questions which researchers ask: “Is there any information content in audit opinion announcement for investors?”; “Do audit opinions really influence share prices?”. The researches in this area started in 1970-s and still are carried out. There are different research methods are applied: event study statistics with models, sociological interviews, modeling situation based on group of investors.

Based on what I have already read I can say that the results are controversial.

Number of studies (pls. see Firth (1978); Dopuch et al (1986); Chen et al. (2000); Menon and Williams (2010)) present sufficient evidence that share prices significantly decrease after announcement of qualified (modified) opinions as oppose to non-modified. Chen et al. (2000) illustrated his research with interesting figure showing distribution of share returns as a result of reaction on clean and modified audit opinion (MAO) in Shanghai Stock Exchange.

No very much need in comment. MAO announcement effect is rather negative and significant on event date.

On the other hand there are number of researches that do not prove hypothesis that investor reaction towards audit opinion is statistically significant. Studies are carried out by Chow and Rice[different results for API and types of qulafications] (1982); Martinez et al (2004); Ogneva and Subramanyam (2007); Al-Thuneibat and Nedal (2008)). Probably figure provided by Al-Thuneibat who tested same idea in Jordan market describes behavior of return in this case.

As seen from the figure above behavior of returns on shares of companies’ which have received qualified audit opinions is rather controversial and does not maintains single pattern.

Conclusion

Finally, I personally think that statistical research depend on quality of data you get and appropriateness of method applied. For example, in event study researches it is important to pick up right date. Moreover, attitude of investors towards audit opinion varies from country to country depending on development of markets, institutes, legal relations and culture. Probably cross country research needed to be carried out based on the unified elaborated methodology by group of scientists. So, I would not be much creative if I say: “further researches to be carried out in this area” ;)

Articles mentioned in post:

Ali A. Al-Thuneibat, Basheer Ahmad Khamees, Nedal A. Al-Fayoumi, (2007) "The effect of qualified auditors' opinions on share prices: evidence from Jordan", Managerial Auditing Journal, Vol. 23 Iss: 1, pp.84 - 101

Chen, C.J.P., Su, X. and Zhao, R. (2000), “An emerging market’s reaction to initial modified audit opinions: evidence from the Shanghai Stock Exchange”, Contemporary Accounting Research, Vol. 17, pp. 429-55.

Chow, C. W., and S, J, Rice. 1982. Qualified audit opinions and share prices — An investigation. Auditing: A Journal of Practice and Theory 1 (Wmter): 35-53.

Dopuch, N., R. Holthausen, and R. Leftwich. 1986. Abnormal stock returns associated with media disclosures of “subject to” qualified audit opinions. Journal of Accounting and Economics 8 _June_: 93–117.

Firth, M, A. (1978). Qualified audit reports: Their impact on investment decisions. Accounting Review 53 (3): 642-50.

Martinez, M., Martinez, A. and Benau, M. (2004), “Reactions of the Spanish capital market to qualified audit reports”, European Accounting Review, Vol. 13, pp. 689-711

Menon, Krishnagopal; Williams, David D (2010). Investor Reaction to Going Concern Audit Reports. Accounting Review, Nov2010, Vol. 85 Issue 6, p2075-2105, 31p

Ogneva, M., and K. R. Subramanyam. 2007. Does the stock market under-react to going concern opinions? The evidence from the U. S. and Australia. Journal of Accounting and Economics 43 _July_: 439–452.