Evidence on Risk Changes Around Audit Qualification and Qualification Withdrawal Announcements

Neil L. Fargher and Michael S. Wilkins

Journal of Business Finance & Accounting, 1998, vol. 25, issue 7‐8, 829-847

Abstract: Qualifications to an audit report may provide the basis for an auditor's claim that the user was warned about an unusual risk. If audit qualifications highlight changes in firm risk that are material, then the announcement of a qualification should be associated with an increase in the risk of the affected firm. In this paper, we test this proposition. Our initial tests do not detect a shift in systematic risk around qualification announcements; however, subsequent analysis shows that firms announcing recurring material uncertainties have higher levels of systematic risk than firms announcing initial qualifications. Furthermore, we document a significant decrease in systematic risk for firms publicly announcing qualification withdrawals. These results are consistent with announcements of qualification withdrawals providing more timely information to capital market participants than announcements of qualification issuances, which are more likely to have been pre‐empted by alternative sources of information. Our findings also indicate that unsystematic, or firm‐specific, risk changes significantly around qualification and withdrawal announcement dates. Although systematic risk is of primary importance to investors, information regarding company‐specific risk may assist other outside users (i.e., lenders, regulators, employees, rating agencies, etc.) in evaluating a given firm's ability to satisfy its existing contracts. In total, this paper provides evidence that may be useful to many external parties regarding the association between the material uncertainties that are highlighted in audit reports and changes in firm risk.

Date: 1998
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