Event Study: Audit Report Announcements

Event study methodology is widely used in researches dedicated to the impact of audit opinion on investors’ decisions. This methodology requires specification of date of audit opinion announcement, date when the information about type of audit opinion becomes available to public. This date is event and days (allowed to capture pre- and post- effects) around the date are ‘event window’ (Campbell et al. 1997). See illustration of Time Line:

Source: Campbell, J.Y., Lo, A.W. and MacKinlay, A.C. (1997). The Econometrics of Financial Markets. Princeton, NJ: Princeton University Press, p. 157.

I wrote about this kind of studies in audit area in one of my posts (click link) on February. The issue here is difficulty to identify correct date of event as this would influence the whole research. There are number of researchers who emphasized this issue, e.g. Craswell (1985), Martinez et al. (2004), Soltani (2000). Especially this problem arises when it is necessary to compare studies in different countries, i.e. jurisdictions.

In following paragraphs I want to discuss briefly the features on event identification process in different countries.

Anglo-Saxon system

The countries with a case law system are suggested here: USA, UK, Canada, Australia. I would consider two key relevant characteristics:

·        Work of stock exchange commissions (let us name ‘SEC’ all similar authorities) with financial/annual reports, e.g. US companies are obliged to file 10-K (which contains audited FS) within 90 days after fiscal year end and after filing 10-Ks almost immediately become available to public via US SEC site (see sec.gov)

·        Transparency, e.g. it is more common for US companies to announce audit opinions before the annual general meeting or 10-K filing date.

Reasonable methodic in date selection was used by Menon and Williams (2010). They chose earlier of:

(1)   10-K filing date;

(2)   Date of press release of financial statement and audit opinion.

Continental European (Roman) Legal tradition

Following could be outlined as features in relation to opinion announcements (based on example of France and Spain):

·        SEC do not make audited financial statement available to public as soon as possible (see below some peculiarities in Spain) with deadline of 90 days after fiscal year end;

·        Audited financial statement must be provided (France and Spain) to shareholders at least 15 days (or any other number of days prescribed by law to notify shareholders about AGM) before annual general meeting (AGM). At the same time reports are to be send to SEC and only after this they are to be published by SEC ;

·        Listed companies are reluctant to announce publicly audit opinions (Soltani 2000).

To solve this issue for French market Soltani (2000) defined and calculated results for following three event dates:

(1)   Date of audit opinion signature;

(2)   15 days before the AGM date (most precise as was mentioned by Soltani);

(3)   Average date between the (1) and (2)

Martinez et al. (2004) identified that law requires listed companies to file audited financial statements (FS) within Spanish SEC (which has to publish them aftermath) before the date of AGM announcement. So Martinez used the earlier of:

(1)   Date when Spanish SEC makes FS and audit reports available to public;

(2)   15 days before the AGM date.

Russian jurisdiction

Russian modern corporate laws also belong to continental legislation system with specifics of emerging market economy and socialistic overregulated past.

Following matters to be considered:

·        All open joint stock companies have to file their audited FS to Tax authorities within 90 days after year end, but Tax authorities must not release them to public (Accounting Law, ФЗ 129);

·        Audited FS must be distributed to shareholders at least 20 days before AGM (Open Joint Stock Companies Law, ФЗ 208);

·        Audited FS must be also included in the quarterly report of issuer (ежеквартальный отчет эмитента) for the first quarter, which must be issued not later than 45 days after 1^st Quarter end, i.e. 15^th of May,

·        Announcement about the issue of quarterly reports and AGM must be placed by companies on the state authorized news wire available to public via internet (State Provision about Disclosure Information by Issuers, Приказ ФСФР N 06-117/пз-н).

 So in selection correct event date it would be reasonable to consider the earlier of:

(1)   Announcement of 1^st Quarter report issue on statutory news wire;

(2)   20 days before the AGM date.

Conclusion

I hope above summary and considerations about Russia would help researchers involved in accounting/reporting area to do event studies. I am going to use these ideas in my coming dissertation and I would like my readers to share with me information about report release legislation in their countries.

References

Campbell, J.Y., Lo, A.W. and MacKinlay, A.C. (1997). The Econometrics of Financial Markets. Princeton, NJ: Princeton University Press.

Craswell, A. T. (1985) Studies of the information content of qualified audit reports, Journal of Business Finance and Accounting. No 12(1), pp. 93–115

Martinez, M., Martinez, A. and Benau, M. (2004). Reactions of the Spanish capital market to qualified audit reports. European Accounting Review. Vol. 13, No. 4, pp. 689-711.

Menon, K. and Williams D.D. (2010). Investor Reaction to Going Concern Audit Reports. The Accounting Review. Vol. 85, No. 6, pp. 2075-2105.

Soltani, B. (2000) Some empirical evidence to support the relationship between audit reports and stock prices – the French case. International Journal of Auditing. No 4, pp. 269–291.

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.