Who's Afraid of the Auditor? Differential Market Reaction to Bad and Good News

We explore the differential market reaction to the unambiguous bad news and good news signals provided by the going-concern audit opinion and its withdrawal for 845 firms from 1994 to 2002. Results show asymmetric market response to these news events. The market underreacts to such bad news disclosures, resulting in a downward drift of around -16% over the one-year period subsequent to the going-concern opinion, but treats good news consistent with theory. This post-going-concern announcement drift is also distinct from other established anomalies; however, we find no such evidence for going-concern cases with positive earnings surprise. Adjusting for transactions costs, the opportunity to earn profits by trading on this anomaly is limited and highly risky. Additional analyses of stockholder trading activities reveal that institutional investors reduce their holdings in such stocks on a timely basis in contrast to retail investors. Our results indicate that despite clear adverse signals about the firm's continuing financial viability being conveyed by the auditor to investors, this information is not being fully impounded by the market on a timely basis, in contrast to the good news conveyed by going-concern withdrawals. Our findings add to the existing literature calling into question the ability of the market to rationally price stocks in the case of acute public-domain bad news disclosures, as opposed to good news releases