Anticipation and Reaction to Going Concern Modified Audit Opinions by Sophisticated Investors

The purpose of this paper is to examine whether institutional investors: 1) anticipate a distressed firm's receipt of a first-time going concern modified audit opinion, and 2) react to a first-time going concern modified opinion by engaging in abnormal net selling of firm shares. Using a proprietary database of U.S. institutional investor trades, we find that institutional investors are net sellers of first-time going concern opinion firms beginning six months before the release of the report and remain net sellers through the subsequent three months. We also find that the severity of the reasons auditors modify their opinions is associated with increased trading activity, but only after the opinion is publicly available. Our results support the position that an auditor's going concern modified opinion is influential in the marketplace by documenting that institutional investors anticipate this price-relevant information and react through increased selling. The finding of increased net selling of firms with more severe reasons for report modifications provides evidence of the incremental informational value of the wording in the modified opinion