Do corporate payouts signal going-concern risk for auditors? Evidence from audit reports for companies in financial distress

Jian Cao (), Thomas R. Kubick () and Adi N. S. Masli ()
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Jian Cao: Florida Atlantic University
Thomas R. Kubick: University of Kansas
Adi N. S. Masli: University of Kansas

Review of Quantitative Finance and Accounting, 2017, vol. 49, issue 3, No 2, 599-631

Abstract: Abstract We examine the association between payout policy changes and going-concern decisions for financially distressed clients. Extant auditing standards indicate that payout reductions, which offer a prospect of short-term cash relief, can potentially mitigate going-concern uncertainty, whereas economic theory suggests payout decreases (increases) convey mixed but mostly negative (positive) signals about a company’s future financial status. We find that, compared with a bankruptcy prediction model over short (not to exceed 1 year) and long (2–3 years) horizons, auditors seem to significantly underreact to payout decreases (i.e., negative signals) but react appropriately to payout increases (i.e., positive signals) in their going-concern decisions. Moreover, auditors are three times more likely to make Type II misclassification errors in payout-decreasing firms than in payout-increasing and no-change firms. We also find that auditors take longer to determine the appropriate opinion for clients with payout changes, especially for those who cut their payouts. Overall, our findings suggest that auditors respond differently to positive and negative signals about companies’ future prospects, reflecting the mixed nature of payout decreases relative to payout increases and the professional standards’ emphasis on the prospect of short-term cash relief from payout reductions.

Keywords: Audit reports; Dividends; Going-concern; Stock repurchases; Payout policy (search for similar items in EconPapers)
JEL-codes: G18 G35 M42 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (4)

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DOI: 10.1007/s11156-016-0602-0

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