Predicting impending bankruptcy from auditor qualified opinions and audit firm changes

Abstract

Unlike prior research, we investigate the incremental explanatory power of both auditor qualified opinions and auditor changes beyond the information conveyed by traditional financial statement ratios in predicting bankruptcy. We find that qualified auditor opinion and auditor changes are both important in predicting impending bankruptcy and that auditor changes convey important information not reflected in auditor qualified opinions alone. In fact, we find compelling evidence that auditor changes provide incremental explanatory power in predicting impending firm failure beyond what is conveyed by auditor qualified opinions and traditional financial statement ratios considered jointly. Although the existing relevant literature provides no empirical evidence in this regard to our knowledge, this result is intuitive as one motivation for clients to change audit firms is to seek less conservative professional auditors as a strategic response to manifestation of the financial statement effects of bankruptcy.