Upload
others
View
6
Download
0
Embed Size (px)
Citation preview
The influence of modified audit opinion on the
stock market and cost of debt: U.S. evidence
Student name: Carmen Necula
Student number: 10622756
Supervisor: Dr. Alexandros Sikalidis
MSc Accountancy and Control, Accountancy Track
Faculty of Economics and Business
Academic year: 2013-2014
June 22, 2014
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
2
Abstract
This study examines the impact of the announcement of a modified audit opinion on the market,
more specifically on the stock returns and on the cost of debt, and the way it is perceived by the
investors and creditors. The sample contains publicly held companies from U.S. with collected
data from 2012, that had a continuous auditing, excluding those from the financial and real estate
sector. The main focus was on the cumulative abnormal return and the interest rate for the
analysis of stock market and respectively the cost of debt. Contrary to the majority of previous
studies, the results suggest that there is no significant influence of a modified audit opinion over
the stock returns and the cost of debt, since the investors and creditors do not perceive this
information as value relevant for their decisions. However, the results may be biased by other
concurrent information, by the methodology approach or the sample might not be representative
for this research.
Key words: modified audit opinion, stock market, cost of debt, abnormal return, interest rate,
U.S., information content, value relevance
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
3
Contents
1. Introduction ......................................................................................................................................... 4
1.1Background .......................................................................................................................................... 4
1.2 Research question ................................................................................................................................ 6
1.3 Motivation ........................................................................................................................................... 7
2. Literature review and hypotheses development ............................................................................... 8
2.1 Theoretical background ...................................................................................................................... 9
2.1.1 Auditor opinion ............................................................................................................................. 9
2.1.2 Stock market ............................................................................................................................... 10
2.1.3. Cost of debt ................................................................................................................................ 11
2.2 Literature review ............................................................................................................................... 12
2.3 Hypotheses development ................................................................................................................... 16
2.3.1 Hypothesis I ................................................................................................................................ 16
2.3.2 Hypothesis II ............................................................................................................................... 17
3. Research methodology ...................................................................................................................... 18
3.1 Sample selection ................................................................................................................................ 18
3.2 Variables measurement ..................................................................................................................... 20
3.2.1. Dependent variables .................................................................................................................. 20
3.2.2 Independent variables ................................................................................................................ 21
3.2.3 Control variables ........................................................................................................................ 21
3.3 Regression models ............................................................................................................................. 22
4. Results................................................................................................................................................. 24
4.. The stock market reaction over the announcement of a modified audit opinion ................................ 24
4.2 The effect of modified audit opinion on the cost of debt .................................................................... 30
5. Limitations ......................................................................................................................................... 35
6. Summary and conclusion .................................................................................................................. 36
References .................................................................................................................................................. 38
Appendices ................................................................................................................................................. 41
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
4
1. Introduction
1.1 Background
Nowadays, many companies are disclosing the audit report either voluntarily for improving their
relationship with their stakeholders, or because they are required to do that, in order to give a fair
assurance over the financial statements. The audit report is not always in the auditee‟s favor,
because the auditor may find some inconsistencies that can affect the real image of the company.
Depending on their significance, these are included in the explanatory notes to an unqualified
audit opinion. No matter the type of the auditor‟s opinion is, this brings new information into the
stock market attention. This can lead to some changes in stock prices so the value relevance of
the auditor‟s opinion could be an important aspect that deserves to be analysed. Another aspect
about this, is the information decision usefulness, more precisely, the way in which the auditor‟s
opinion influences the investors‟ decision making process, about buying, selling or holding
stocks within a specific company. Another category of users that could make use of the audit
report is represented by the creditors, who have to be aware of the financial position of a
company when deciding to give them credits.
The relationship between stock market and auditor‟s opinions has been studied by other
authors too, using different samples and analyzing specific aspects of this topic. One of them is
the going concern opinion, as part of a modified audit opinion.
For instance, Ogneva and Subramanyam (2007) examines the returns following disclosure
of going concern opinions using a sample of U.S. and Australian firms, but they didn‟t find any
pricing anomaly related to going concern opinion in either of these countries. This can be
interpreted as the lack of under-reactions of the stock market following the disclosure of a going
concern opinion.
Different results related to this topic, are emphasized in Taffler et al. (2004), which found
a highly significant adverse price reaction over 1 year period, after a going concern modified
audit report, between -24% and -31%, based on expected return benchmark used. They did find
significant market under-reaction associated with a going concern opinion in U.K., but this
conclusion is consistent with irrational investor behavior.
The information content is analyzed in Frederick Jones (1996), where the U.S. sample is
used to prove that the independent auditor‟s going concern evaluation provides information to
investors and supports the requirement of disclosing those uncertainties within the audit report.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
5
Another interesting study about the information content of auditor‟s opinion is Dodd et al.
(1984) because they exclude the adverse opinion from their sample, containing New York Stock
Exchange firms. In their analysis, they took into consideration only qualified opinions and
disclaimer of opinion and the results suggest that audit opinions have little impact on the value of
common stock, but this doesn‟t mean they are less important.
One of the few studies that focused on the difference between the unqualified and the
qualified opinions is Chen et al. (2000). The conclusion stated in this paper is that there is a
negative association between MAOs and cumulative abnormal returns. Furthermore, they found
no difference between market reaction to qualified opinions and market reaction to unqualified
opinions with explanatory notes.
The cost of capital with its both cost of debt and cost of equity, has been in the main
attention of many researchers from many years, as well.
One recent paper where the debt contracting has been the main focus is Chen et al (2012).
The authors have examined the effect of qualified audit opinions on private debt contracts,
proving that there is an association: “a qualified audit opinion is associated with an average
increase of 18 basis points in the interest rate of loan facilities issued in the year following a
QAO.”1 This have consequences in the future too, as they observed the interest rate effects of a
QAO persist for three years, even after a clean audit report.
There are also studies that have made an analysis on the audit status of companies and the
influence of it on the cost of debt. A relevant study in this concern is Kim et al (2007), based on
privately held Korean companies, that are not required to get an external audit, but some of them
are voluntarily doing it. They found that those firms with an external audit, pay a significantly
lower interest rate on their debt as opposed to firms without an external audit. This is also
supported by the fact that a change in a company‟s audit status from no audit to external audit
(either voluntarily or mandatory) leads to significant savings in the cost of borrowing.
The relationship between accounting, disclosure quality and debt contracting is another
main topic for a large number of papers. Bharath et al (2004) has examined the commercial bank
loan contracts of publicly traded US firms and it has emphasized that “poor accounting quality
1 Chen, Peter F.; Tenho, Shaohua; Ma, Zhiming; Stice, Derrald E, 2012. Qualified audit opinions and debt contracting. The 3rd International
Conference of The Japanese Accounting Review, Kyoto, Japan, p. 6
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
6
reflects limited information about borrowers‟future operating cash flows”2. This is translated by
higher risks, which encourage the bank to increase their loan transaction cost in order to
compensate for the information risk. Since the accounting quality is closely related to a quality
audit report, I expect that a poor audit quality have similar effects on the interest rate.
These expectations are met in Karjalainen (2011), which examined a large sample of
private Finnish firms in order to emphasize the value relevance of the audit quality in debt
pricing. Their findings indicate that Big 4 audits correspond with a decreased cost of debt, and
that for firms with modified audit reports this is higher than for firms with a clean audit report.
Regarding the level of disclosure, Jere et al (2005) and Sengupta (1998) both have proved
there is an inverse relationship between interest cost of issuing debt and the quality of corporate
disclosure. Considering this, I assume that a high quality audit report will provide significant
information for the creditors, and their decision making process will be more accurate and the
level of riskiness decreases significantly.
Considering there is no much evidence of the difference between the effects of both clean
and modified audit opinions on the stock market reaction in the US market, I think my research
will bring a significant contribution into the literature and also a societal one, offering a better
overview over the auditor‟s opinion. As respects the cost of debt, there is a significant
contribution as well, since this is the first study to analyse the modified audit opinion influence
on cost of debt for U.S firms.
1.2 Research question
In my study, I want to focus on the effects of the auditor‟s opinion on the stock market and on the
cost of debt, considering the unqualified or clean opinion and the modified audit opinion. Some
other purposes related to this research question are investigating the value relevance of the
auditor‟s opinion and the usefulness of information disclosed within the audit report, for the
investors when, making their decisions.
Based on the above discussion this study examines the following research questions:
- How does the auditor‟s opinion over the financial statements influence the stock market?
- What is the effect of the auditor‟s opinion on the cost of debt?
2 Bharath, S.T., Sunder, J., Sunder, S., 2008. Accounting quality and debt contracting. The Accounting Review 83 (1), 1–28
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
7
1.3 Motivation
The main aim of this research is to bring into investors‟ and creditors‟ attention important
information, given the changes that may happen on the stock market when different types of audit
opinions are disclosed. The reason for focusing on these two categories of users, is that I consider
them the most important for a company in order to keep their business profitable. Investors can
significantly increase the profitability and creditors can help the companies make investments
that have future important benefits. Furthermore, considering that debt financing is the
predominant form of external financing for publicly traded firms in U.S. (Sengupta 1998), I
assume my sample will be relevant for analysing the influence of a modified audit opinion.
In this study, I will take a different approach from prior literature, which has primarily
focused on the stock market reaction by analyzing either the unqualified and qualified opinions or
the going concern opinions of auditors. There are few studies which actually highlight the
differences between types of opinions and the way they are perceived by investors and creditors,
which encouraged me to focus on two types of opinions: the unqualified opinion and the
modified audit opinion. The reason I chose these two types of opinions, is that the modified audit
opinion can be viewed as a bad news and the unqualified opinion as a good news so they can be
considered being opposite. The interesting part here is to analyze if the stock market reaction on
auditor‟s opinion differs after disclosing one type of opinion or another and in which way.
Regarding the approach for analyzing the effect on the cost of debt, I did not find many
studies regarding its relationship with the modified audit opinion, so I consider it would be
interesting to show whether the effect of disclosing such an opinion is similar with those from
Karjalainen (2011), already mentioned in the Background. Furthermore, I will also consider the
BIG4 variable in my model in order to emphasize the influence of auditor‟s rank on the cost of
debt, and the value relevance of audits to creditors.
This research will contribute to prior literature in a significant way, because it will bring
into the reader‟s attention the differences in the market reaction following those types of opinions
and the changes regarding the debt contracting. Also, through answering the research questions,
the value relevance of the auditor‟s opinion and the usefulness of the information provided will
be clearly emphasized.
Taking into consideration the previous papers, which are not aligned with the same
conclusion regarding the effect of the audit opinion over the stock market, I think extending the
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
8
analysis to another more recent period - 2012 - and using as sample firms listed on U.S. market,
will bring another contribution, from a scientific point of view. The paper will analyze recent data
from U.S. which, although it has been analyzed before, there have been found contradictory
results of the going concern opinion.
The stock market reaction to an auditor‟s opinion is important for both the company and
for its stakeholders. This study could bring into stakeholders‟ attention that there are some other
factors that can influence the reaction of stock market, besides auditor‟s opinion, so they should
analyze other determinants too, when making their decisions.
The cost of debt is another important aspect for every company since loans are one of the
way to get external financing. The extent to which a modified audit opinion could influence the
cost of debt, would increase the accuracy in decision making of the lenders when evaluating debt
covenants and the financial statements of a specific firm.
The rest of the paper is organized as it follows: section 2 reviews prior literature regarding
the audit opinion and its influence on the market, provide some theoretical background for the
most important concepts, and present the hypotheses of this research; section 3 develops the
methodology used for this study and the empirical models; section 4 describes the reports and
analyzes the results of the regression models; section 5 contains the limitations of the analysis;
and finally, section 6 presents the summary and the conclusion of this study.
2. Literature review and hypotheses development
The structure of this chapter is as it follows:
I will first provide some theoretical concepts that are most important to know for
understanding the relationships for the analysis;
Then I will present some key papers that have studied important aspects related to the
research questions and I will rely on their results to find an easier way to my own
findings;
The final section will describe the hypotheses I want to develop in this study.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
9
2.1 Theoretical background
In my research, I will focus on two types of auditor‟s opinion: the unqualified opinion, which is
the best opinion a company can receive, and the modified audit opinion, which can be
unfavorable for the company, depending on the importance of the explanatory notes included in
the report. The purpose of this comparison is to better highlight the differences between the two
types of auditor‟s opinions and between their effects on the stock market returns and cost of debt.
2.1.1 Auditor opinion
The auditor‟s report is known as a primary means of communication between the auditor and the
stakeholders of the audited entity, according to IAASB. The users of audited financial statements
rely on the audit report and they consider it meaningful for their decision making process. But,
since the global financial crisis began, the users are increasingly asking for more inside
information to be included within the audit report, for a better transparency.
One of the most important part of the audit report is the auditor‟s opinion because it
represents the assurance over the financial statements. The audit opinions can be classified as it
follows: unqualified opinion, modified unqualified opinion, qualified opinion, adverse opinion
and disclaimer opinion.
The unqualified opinion, also known as a clean opinion, states that the financial
statements are representing in a fair and accurate way the view of the business,
according to the accounting principles.
The modified unqualified opinion, also known as the standard auditor‟s report
with explanatory notes is used when the auditor wants to bring some specific
information into users‟ attention which may affect their decision making process.
A very known opinion in this case is the going concern report, which states that
the auditor has great doubts about the ability of the company to remain in
business.
A qualified opinion contains some misstatements detected by the auditor,
considered to be material but not pervasive.
For an adverse opinion, the auditor has found enough evidence to prove that the
misstatements are material and pervasive.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
10
The disclaimer opinion states that the auditor didn‟t find sufficient evidence over
the financial statements and is unable to complete the audit mission.
I chose to focus on two types, more precisely, on the unqualified opinion and the modified
unqualified opinion, because first of all, they are the most common among companies and
secondly, because I consider they bring different information that could matter in a way or
another for the constituencies. This means that it‟s expected to get different results with respect to
the effects of their disclosure on the stock returns and cost of debt.
2.1.2 Stock market
In order to better understand the relationship I want to analyze, I will provide an explanation for
stock market concept.
The stock market, also known as the equity market, is the market in which shares of
publicly held companies are issued and traded through exchanges, giving investors a part of
ownership and allowing them to participate in the achievements of the companies they own
shares, but they are also exposed to the risk of losing money if the company suffers losses. By
stock market reaction we can understand the changes that are happening in the market, through
the movement in the price, volume or returns of stocks.
There have been studies, as mentioned in the Background, that proved the stock market
underreacts following the going concern audit opinion disclosure. For instance, Taffler et al.
(2007) is one of the papers that brings into discussion this anomalous market behavior, consisting
in firms that are underperforming various return benchmarks. This is caused by “denying the bad
news conveyed by a going concern audit opinion and trading at prices inconsistent with
underlying value”3, which is explained by the existence of irrational or naïve investors. This fact
is inconsistent with the market efficiency concept, which states that prices fully reflect all the
publicly available information. The measurement procedure for this under-reaction of stock
market is represented by the difference between returns when the investors take into
consideration the going concern audit opinion and the returns when investors are ignoring this
disclosure.
3Taffler, R.J., Lu, J., Kausar, A., 2004. In denial? Stock market underreaction to going-concern audit report disclosures. Journal of Accounting
and Economics 38, 263–285
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
11
The question that comes next is whether there are possible over-reactions of the stock
market and the answer could be affirmative as well. One representative study on this topic is
Schaub (2006), which explains this concept as the phenomenon through which investors initially
compound the true impact of new information on the firm, in this case the disclosure of going
concern opinion, determining stock prices go too low following bad news or too high, based on
good news. This concept of overreaction is also against the stock market efficiency, as long as the
investment is not profitable. The results show that greater initial price reactions are followed by
larger stock price adjustments, which is consistent with the over-reaction hypothesis.
The aspect I want to emphasize here, is that the stock market efficiency is only a theory
which can hardly be applied in an imperfect economic environment and that stakeholders should
expect anomalies to happen.
2.1.3. Cost of debt
Capital is a fundamental element of a company for its business survival and for a high turnover.
There are two major ways to raise money for a company: debt financing and equity financing, but
the predominant one among companies is the debt financing.
Jensen and Meckling (1976) provides an important theoretical background over the cost
of debt and its particular aspects, like the incentive effects associated with highly leveraged firms,
the monitoring costs and the bankruptcy and reorganization costs.
For the incentives, they explain that creditors would not borrow a company for an amount
much higher than the entrepreneur‟s investment, because the latter tends to engage in activities
with a high profitability but a low probability of success, since he will benefit of most of the
gains if the things turn out well, and if not, the creditors will bear the most of the costs.
In order to limit this managerial behaviour, the creditors could ask for covenants with
provisions that impose constraints on management‟s decisions, including limitations of the
riskiness of the investment project. All the costs associated with these type of covenants are the
monitoring costs.
In case of bankruptcy or litigation the cost of debt increases, because there is much more
risk involved for the lenders and they will pay for fixed claims for a price inversely related to the
probability of the incurrence of these costs to probability of bankruptcy.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
12
According to Sengupta (1998) there are two alternative measures of cost of debt:
- the yield to maturity on new debt issues, and
- the total interest cost of new debt issues
In my study, I will consider the cost of debt as the interest rate, determined as the interest
expense scaled by total liabilities.
2.2 Literature review
The subject of this paper is a difficult and controversial one, because there were different findings
that came out of related studies regarding the effect of audit opinion over the stock market, as I
have already mentioned in the Background. Regarding the connection with the cost of debt, this
is quite a new topic since there were few studies that focused on it, as far as I documented.
One important study that outlines the stock market reaction to a going concern opinion is
Herbohn et al. (2007), which focuses on the information content of the audit report, but also
investigates the stock market anomaly following the going concern opinion, using Australian
firms. The authors state that a going concern opinion of an audit report “is a significantly
unambiguous „badnews‟ event for stock market participants and an adverse stock market reaction
is expected.”4. But this expectation wasn‟t proved through their study, because they did find that
the stock market has a significant negative reaction in the pre-event period rather than the post-
event period. They explain this by Australian markets being well informed, so the announcement
of a going concern opinion is a culmination of multiple prior events, and disclosing it doesn‟t
actually give additional information to the market. I consider this study a interesting one, as long
as the results are not consistent with the ones expected at the beginning.
The going concern opinion has also been analyzed from another point of view,
specifically the ability to predict the bankruptcy, as stated in Chen and Church (1996). This can
show a significant level of information usefulness for investors, who didn‟t know about the real
situation of the company where they own shares. The authors found that, as opposed to receiving
unqualified opinions, firms that receive going concern opinions “experience less negative excess
returns in the period surrounding bankruptcy filings”5. They focused only on one financial
4Herbohn, K., V. Ragunathan& R. Garsden (2007). The horse has bolted: revisiting the market reaction to going concern modifications of audit
reports, Accounting and Finance, 47:3, 473–493 5 Chen, K.C., & Church B.K. (1996). Going concern opinions and the market’s reaction to bankruptcy filings. The Accounting Review, Vol. 71
(1), pp. 117-128.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
13
difficulty occurring after disclosing a going concern opinion, in order to prove the value
information, but there are others too, like quarterly losses, suspension of dividends, default on
debt etc.
Another view over information usefulness of the going concern opinions is given by
Dennis O‟Reilly (2010), which shows the importance of disclosure for valuing company‟s stocks
by investors. What makes this study more interesting is the fact of being the first one that uses an
experimental approach for reaching the findings. More precisely, U.S. financial analysts were
required to participate by email at two stock price estimates of a financial distressed company,
one before and one after including the auditor‟s opinion. The author found significant stock price
reductions, after receiving a going concern opinion, and the usefulness of the auditor‟s opinion is
proved to be “greater when it provides a signal that differs from that which the market is
expecting”6. It will be interesting to see whether a qualitative research like this one is consistent
with my conclusion, also based on the US sample.
Chen et al. (2000) focused on the differences between the qualified and unqualified
opinions, by analyzing the valuation effect of modified audit opinions (MAOs), in the Chinese
stock market. The environment here has some specific characteristics, which differ from the ones
in U.S.. Some of them are related to the Chinese investors, who are not experienced in using
financial information, others to Chinese auditors who usually disclose an unqualified opinion
with explanatory notes instead of a qualified opinion, and other characteristics are related to the
regulators, who are more strict and more offended in case of GAAP violations. By analyzing
different forms and contents of modified audit opinions, the authors want to emphasize the role of
the auditor in the market. They found that in an emerging market like the Chinese one, MAOs are
negatively associated with the returns but there is no difference observed between the qualified
opinion and the unqualified opinion with explanatory notes. Furthermore, investors don‟t react
negatively until the second year after disclosure.
Allen et al. (2011) focused on the auditor‟s going concern opinion as a communication of
risk investors are exposed to. This leads to a substantial shift in the structure of the market
valuation for firms financially distressed and more importantly, “the results hold even after
6 Dennis M. O'Reilly, (2010) Do investors perceive the going-concern opinion as useful for pricing stocks?, Managerial Auditing Journal, Vol. 25
Iss: 1, pp.4 - 16
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
14
controlling for several other measures of financial distress”7. The analysis is conducted with
firms that are receiving for the first time the going concern opinion, which as opposed to the
other firms, have a greater valuation weight of the book value of equity. The authors succeed to
prove the value relevance of this type of opinion, as long as it brings up to investors the potential
risk of abandonment or adaption of firm assets.
As I noticed, there are many studies developed on one specific modifed report meaning
the going concern opinion, but less on the modified audit opinion as a whole, under all its
circumstances, as stated in Syou-Ching et al. (2009):
- going concern consideration
- change in the application of accounting principles for financial reporting as required under law
- change in the application of accounting principles for financial reporting on a voluntary basis
- uncertainty of events that may have significant impact on the future financial condition of the
firm
- the adoption of another auditor‟s audit report for the current year audit.
The reason for which the going concern opinion has got more attention from researchers
could be that the information provided is much more relvant for investors as opposed to the one
given by other issues, which may not influence in the same way the investment decisions. This
assumption is proved by Syou-Ching et al. (2009) which mentioned that “of the five
circumstances mentioned above, the one based on the going concern consideration had the
highest significant impact on stock prices”8. In their research, the authors have adopted Ohlson‟s
model for investigating the information content of MAO, in order to control for concurrent
information that could bring significant biases to the analysis, since they consider the event
approach a “validity trap”.
As Firth (1978) states, investors react differently to the various types of audit
qualification, meaning the type of audit opinion gives different information, and that the price
reactions occurred in the expected direction, immediately after releasing the audit reports. This is
an important study, that appears as reference for many recent articles, and that‟s one more reason
7Allen D. Blay, Marshall A. Geiger, David S. North (2011) The Auditor's Going-Concern Opinion as a Communication of Risk. A Journal of
Practice & Theory: May 2011, Vol. 30, No. 2, pp. 77-102. 8 Syou-Ching Lai, Cecilia Lin, Hung-Chih Li, Frederick H. Wu (2009). The Information Contents of Modified Unqualified Audit Opinions under
the Control of Concurrent Information: The Case of Taiwan, Journal of Accounting and Corporate Governance, Volume 6 Number 1, June 2009
pp.31-56
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
15
to mention it, for proving the differences between the two types of audit opinions I chose to
analyze.
One of the main articles I have relied on in my research is Chen et al (2012), that came
with significant findings regarding the audit opinion influence on the debt costing. They have
focused only on the qualified audit opinion, which is associated with decreased use of
performance pricing provisions in debt contracts. They also bring into discussion the importance
of the quality accounting information, with an inverse relationship: the higher the quality is, the
lower the cost of monitoring the borrower, supported by lenders, which leads to a lower interest
rate demanded by them. Since the qualified audit opinion is giving outside investors a signal over
the financial statement quality as being lower than a clean opinion, this will determine lenders to
rely less on the financial statement numbers, and make use of other monitoring mechanisms, that
imply higher costs.
Another study I have considered in my research is Karjalainen (2011), which has
emphasized that both audit quality and the auditor‟s opinion is perceived as value relevant
sources of information in debt pricing. The author has also identified a mixed evidence in the
prior literature regarding the extent to which the auditor opinion can affect stock prices and cost
of debt. This can be explained by the methodological problems as “identifying the first day of
trade on the audit report information”9 and also the “difficulty of isolating the market reaction to
the information content of the auditor‟s opinion from the reaction to other concurrent
information”10
.
The relationship between the auditor choice and debt pricing, was analysed in Pittman and
Fortin (2004), and later in 2007, the authors extended their research from publicly to private
traded companies. In the first paper, they have defined the cost of debt as the interest rate on the
debt of the firm, calculated as the interest expense for the year divided by the average short and
long term debt during the year. But in the second one, they used as a dependent variable the yield
spread as “the difference in basis points between the at-issue yield to maturity on the corporate
bond and that of a U.S. treasury bond issued on the same date with comparable maturity”11
.
9 Karjalainen, J. (2011), Audit Quality and Cost of Debt Capital for Private Firms: Evidence from Finland. International Journal of Auditing, 15: 88–108 10 Manuel Cano-Rodríguez (2010). Big Auditors, Private Firms and Accounting Conservatism: Spanish Evidence, European Accounting Review,
19:1, 131-159 11 Fortin, S. and Pittman, J. A. (2007), The Role of Auditor Choice in Debt Pricing in Private Firms. Contemporary Accounting Research, 24:
859–896
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
16
As opposed to their first research, they were unable to support the value relevance of
BIG4 audits in pricing bond issues. They concluded that the auditor characteristics are irrelevant
to the debt-contracting process for the private firms: “neither the presence of BIG4 auditor nor
auditor tenure explains debt pricing12
”.
One recent article that got my attention is Armitage and Marston (2014) which focuses on
the views of finance directors about the link between disclosure and the cost of capital, using a
qualitative methodology, through conducting 16 semi-structured confidential interviews. The
main question was whether greater disclosure to a rating agency or bank would affect the cost of
a bond issue or a bank loan. In most of the cases the answer was affirmative: nine of the
interviewees said that providing more information would increase the availability of debt or
reduce the cost of debt, one said it would have no effect and the rest of six were not sure.
Considering these views, I assume that providing an external audit, would have the same effect,
since this could be one way of increasing the corporate disclosure, especially when the auditor is
from Big4.
2.3 Hypotheses development
In order to provide a clear answer for each of the two research questions of my study, I will
develop two separate hypotheses that will be explained later in this section. The link between
them is the modified audit opinion, which remains the aim of the research along the whole study,
since I want to emphasize the differences from a clean opinion.
2.3.1 Hypothesis I
The first effect of a modified audit opinion I want to measure is the one on the stock
market, by analysing the daily returns based on stock prices.
As I noticed in previous studies, Chen and Church (1996) and Allen et al. (2011), the
going concern opinion is seen as a bad news because it announces financial difficulties of the
company, but the question is whether the unqualified opinion is considered by investors a good
news, which could encourage them to buy the specific stocks.
12 Fortin, S. and Pittman, J. A. (2007), The Role of Auditor Choice in Debt Pricing in Private Firms. Contemporary Accounting Research, 24:
859–896
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
17
The Chen et al. (2000) paper has a similar purpose, more precisely, analyzing if this type
of information provided through disclosing a modified audit opinion can be evaluated by
investors in a proper and timely way. According to Chen et al. (2000) there are differences
between the qualified opinion and unqualified opinion but these may not be observed by the
investors. The authors refer to one article from news to emphasize the “difference between the
two types of opinions as lawful but unreasonable (unqualified with explanations) versus unlawful
(qualified opinions)”13
. One problem here would be that some of the auditors are choosing an
unqualified opinion with explanatory notes – referred to as the modified audit opinion – instead
of a qualified opinion in order to keep their clients and in the same time conforming with auditing
standards. This assertions is made for the Chinese environment, which has an emerging market.
Based on this, the first hypothesis is as it follows:
H1: Ceteris paribus, the announcement of modified audit opinions is negatively
associated with market returns.
2.3.2 Hypothesis II
Another important effect of the auditor‟s opinion over the market that worths to be analysed is
the change in the cost of debt. This relationship between auditing and cost of debt has not been
studied by too many researchers, as most of the papers are focusing on the connection with the
accounting quality given by the way of disclosing the information to the market, as already
mentioned in the Literature review.
The qualified audit opinion has been proved to have a negative reaction among creditors,
which implicitly lead to a higher cost of debt, according to Chen et al (2012). Pittman and Fortin
(2004) examines the impact of auditor choice on debt pricing and concludes that the services
provided by Big 4 Auditors leads to enhancing the credibility of financial statements, which
reduces the debt monitoring costs.
Another factor besides the auditor choice is the auditor opinion, as the main subject of this
study. So I found it interesting to research on this relationship. The interest rate is the variable
that need to be analysed in order to figure out the direction towards it moves, when the auditor‟s
13 CHEN, C. J. P., SU, X. and ZHAO, R. (2000), An Emerging Market's Reaction to Initial Modified Audit Opinions: Evidence from the Shanghai
Stock Exchange. Contemporary Accounting Research, 17: 429–455
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
18
opinion is unqualified or modified. Considering that both auditor‟s choice and auditor‟s opinion
represent a direct influence over the audit quality, I expect that when the auditor opinion is
modified - there are some issues in providing a fair image of the financial statements that need to
be explained in the notes - the interest rate used by the company to pay its current debts,
increases.
That being said, the second hypothesis is stated as it follows:
H2: Ceteris paribus, there is a negative relationship between the modified audit opinions
and cost of debt.
These two hypotheses show, in my opinion, the most important aspects of the relationship
between auditor‟s opinion and the market, and also the differences between the two types of audit
opinions I want to analyze. By supporting the hypotheses, a significant contribution will be
brought to the prior literature, considering that there is little evidence of a comparison between
opinions.
3. Research methodology
For this study, I will develop a quantitative methodology using statistical models to
understand the assumptions stated in the hypotheses. The sample I used for examining the
variables is extracted from firms that were continuously audited for the 2011 and 2012.
In order to give have a clear image about the methodology, I will separately present it for
the two hypotheses, when there is the case.
Later in this chapter, I will present the steps for the selecting the sample, I will give an
overview over the variables used and their measurement and finally the empirical models will be
explained.
3.1 Sample selection
In order to keep the consistency in my study, I will use the same sample for proving both
hypotheses, with the focus on the audit opinion, which is present in both empirical models as an
independent variable.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
19
The sample is based on the changes happened in 2012, for US companies. Since there are
few papers that analyse the recent period, I consider this study will bring a big contribution to the
literature. However, I took into consideration the previous year as well, in order to select only the
companies that were continuously audited and to identify the companies that first disclosed a
modified audit opinion. Moreover the changes in earnings are also computed based on the
difference between those two years. More about the measurement of each variable is provided
later in this section.
Regarding the statistical procedure, I got data from Audit Analytics and I selected only
the observations that met some of the mandatory conditions, like having a valid date for the audit
opinion, which is represented by the “Signature date of opinion” variable. Other important
variables that I collected from this database, refer to the identifiers for the auditors and companies
selected. Since I first started collecting data from this databases, taking into considerations the
restrictions above mentioned, I got for the initial sample 14,659 firm year observations for 2012
and 2011, out of which only 6192 refer to the focus year of this study, 2012.
I used Compustat database for collecting financial and accounting data like assets,
liabilities, net income, equity and cash flow from operating activities. Besides these, the codes for
the auditor and auditor opinion are also available in Compustat, which give a more detailed
information regarding the type of opinion, since there are all included.
In order to assure the consistency in the selection of companies, I have used only the
company identifiers of the firms obtained from Audit Analytics, and after this, the sample was
reduced to 3,921. But in order to assure the validity of the research, I have applied some other
restrictions, regarding the following:
- the stock ownership code 0 for publicly traded companies
- the SIC codes excludes the 6 category for the financial and real estate sector
- the GIC industry code was also restricted, by eliminating the financial area (the category 40)
- the unaudited companies were excluded, since the focus of this study is given by the auditor
opinion
- the status of the company has to be active, since I am looking at the impact over the stock
market
After applying the restrictions afore-mentioned and after excluding those observations
with missing data regarding the financial variables like interest expense, cash flow from
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
20
operating activities, liabilities, common shares outstanding and others, the sample was reduced to
663 firm observations for both years, but only 332 for 2012.
Next step in the sample selection, was to collect data from CRSP regarding the daily stock
data for each of the companies identified before. After removing the missing values among
observations and after merging all data from the 3 databases, there were left 287 firm
observations of 2012. Because of the limited number of observations, the final sample, has only
the codes 1 and 4, for the auditor opinion variable, where 1 is for a clean opinion and 4 is for a
modified audit opinion. Considering this, the only difference that can be analysed here is the one
between these two types of opinion.
As stated in prior studies like Jones (1996) and Herbohn et al. (2007), it is important to
consider only the first time going concern audit reports, because this is the best way to analyze
the information content of the disclosure. For successive going concern audit reports, the
usefulness of the announcement is reduced, because the market is already aware of the real
situation of the firm from previous years. This will make necessary the examination of previous
audit report for each firm. Because is quite difficult to follow the historical data for each
company, I will implement this restriction only by considering the previous year in order to get a
more accurate data. Since the going concern is one cause for a modified audit opinion, I will
consider the same approach as in the papers mentioned above by determining the companies that
first have a modified audit opinion, considering the previous year as well.
3.2 Variables measurement
In this section I will explain the measurement of each variable (more in Appendix no. 1),
dependent and independent, as well as the rationale behind the control variables included, and for
this I will separately consider the two hypotheses.
3.2.1. Dependent variables
In order to reflect the real impact of disclosing the auditor opinion for the investors, so basically
the influence on the stock prices, the most used proxy is the cumulative abnormal returns, which
is the dependent variable for the first hypothesis.
For calculating this, the abnormal returns around the announcement date of the audit
opinion, will be determined. To reflect the immediate effect of disclosing the audit opinion, I
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
21
considered the abnormal returns one day before and one day after the event, given by the date of
disclosing the audit opinion. The abnormal return is determined after running a regression where
the return of the firm i on day t is the dependent variable, explained by the market return on the
day t. The period taken into consideration is from day (-120) to day (-30) as in Chen et al (2000).
The reason for choosing this period is to control for the effect of other external factors that could
increase the noise in the model.
Another aim of this study is to show the impact of auditor opinion over the cost of debt, as
stated in the second hypothesis, and for this I will use another dependent variable, the interest
rate, measured as the interest expense divided by the average short and long term debt (total
liabilites).
3.2.2 Independent variables
For the first hypotheses, one of the independent variables is given by the ΔEPS which reflects the
change in earnings per share (EPS2012 – EPS2011) scaled by the beginning price at day (−1).
Another independent variable is given by the interaction term OP*ΔEPS, where the OP takes
value of 1 if there is a modified audit opinion and 0 otherwise.
For the second hypothesis, I included as independent variables the leverage (LEV) as the
book value of total short- and long-term debt deflated by firm market value, the cash flow (CF)
from operations scaled by total assets, and the assets structure (ASSET_STR) measured as the
total property, plant and equipment scaled by total assets.
3.2.3 Control variables
In order to mitigate the effects of other factors on the dependent variables, I will consider some
control variables.
For the first and second hypothesis related to the influence of auditor opinion over the
stock market, I will use the following control variables:
Firstly, I used a dummy variable for the audit opinion (OP) which takes the value 1 for a
modified audit opinion and zero otherwise. The focus of this study is on the modified audit
opinion so this is the reason why I will control the regression by this variable.
Secondly, I added the dummy variable DIV, which equals 1 for the modified audit
opinions followed by a decrease in dividends between 2012 and 2011.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
22
Finally, I included a dummy control variable REPEAT which takes the value 1 for the
firms that have a modified audit opinion in the previous year as well, and 0 otherwise. This helps
to better reflect the impact of a new information for the investors and over the stock prices.
For the second hypothesis, regarding the relationship between audit opinions and cost of
debt I took into consideration some other control variables.
Firstly, the same dummy variable OP is for expressing the modified audit opinion, when it
takes the value of 1, and 0 otherwise.
Secondly, I included a dummy variable to control for firms that have an auditor from
one of the Big 4 audit firms (BIG4), which takes the value of 1 if this is the case, and 0 otherwise.
It has been proved that services provided by Big4 auditors give a plus of credibility among
creditors.
Thirdly, the negative book equity dummy indicates if the book value of equity is negative,
which is an important indicator for the creditors when considering to lend or no a specific
company.
3.3 Regression models
For the first hypothesis I used an event-study methodology in order to investigate stock market
reaction to the auditor‟s opinion, based on U.S. listed firms.
The descriptive data will be divided in two periods: the pre-event period and the post-
event period, where the event in this research is the disclosure of the auditor‟s opinion. In order to
better emphasize the effect of auditor opinion I think it is better to analyse the immediate changes
in the stock prices because in this way, the chances of other events‟ influences decrease
significantly.
In order to estimate the daily abnormal returns, I will use the model developed in Chen et
al. (2000) paper which is using the following formula:
𝑅𝑖𝑗𝑡 = 𝛼𝑖𝑗 + 𝛽𝑖𝑗𝑅𝑚𝑗𝑡 + 𝜀𝑖𝑗𝑡 (1)
where
Rijt= the return of firm i in year j on day t, and
Rmjt= the market return in year j on day t.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
23
The stock returns (Ri) need to be calculated from changes in stock price (already adjusted
for dividends), using the following formula:
𝑅𝐸𝑇𝑡 = (𝑃𝑅𝐼𝐶𝐸𝑡 − 𝑃𝑅𝐼𝐶𝐸𝑡−1)/𝑃𝑅𝐼𝐶𝐸𝑡−1
The firm-year specific parameters of the model (𝛼 and 𝛽) are estimated over a 120-day
period, ending 30 days before the announcement date. The 3-day (from day −1 to day 1)
cumulative abnormal return (CAR) is calculated as follows:
𝐶𝐴𝑅𝑖𝑗 = 𝑅𝑖𝑗𝑡1𝑡=−1 − 𝑎𝑖𝑗 + 𝑏𝑖𝑗𝑅𝑚𝑗𝑡 (2)
where
CARij= the 3-day cumulative abnormal return for firm i in year j
aij and bij= firm-year specific parameters estimated by using equation 1
Based on the model implemented by Chen et al. (2000) for the first hypothesis, I will
develop the new model adapted to the sample of firms and considering only one year of analysis,
2012.
Therefore, the adjusted model looks like it follows:
𝐶𝐴𝑅𝑖𝑗 = 𝛼0 + +𝛼1𝑂𝑃𝑖𝑗 + 𝛼2∆𝐸𝑃𝑆𝑖𝑗 + 𝛼3𝑂𝑃𝑖𝑗 ∗ ∆𝐸𝑃𝑆𝑖𝑗 + +𝛼4𝐷𝐼𝑉𝑖𝑗 + 𝛼5𝑅𝐸𝑃𝐸𝐴𝑇𝑖𝑗 + 𝜀𝑖𝑗 (3)
where,
CAR = 3-day cumulative abnormal return from day −1 to 1,
OP = a dummy variable with a value of 1 for MAOs and 0 otherwise,
ΔEPS = change in earnings per share scaled by beginning price at day −1,
DIV = 1 for MAOs with dividend decreases and 0 otherwise,
REPEAT = 1 for non-initial MAOs and 0 otherwise
For the second hypothesis, which implies the effect of a modified audit opinion on cost of
debt, I will consider the model from Pittman and Fortin (2004), in order to adapt it for my case.
The following regression model will be used in order to analyse the relation between
auditor‟s opinion and the cost of debt:
𝐼𝑁𝑇_𝑅𝐴𝑇𝐸𝑖𝑡 = 𝛽 + 𝛽1𝑂𝑃𝑖𝑡 + 𝛽2𝐵𝐼𝐺4𝑖𝑡 + 𝛽3𝐿𝐸𝑉𝑖𝑡 + 𝛽4𝐶𝐹𝑖𝑡 + 𝛽5𝑆𝐼𝑍𝐸𝑖𝑡 + 𝛽6𝐴𝑆𝑆𝐸𝑇_𝑆𝑇𝑅𝑖𝑡 +
𝛽7𝑁𝐸𝐺_𝐸𝑄𝑈𝐼𝑇𝑌𝑖𝑡 + 𝜀𝑖𝑡
where,
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
24
𝐼𝑁𝑇_𝑅𝐴𝑇𝐸𝑖𝑡 - Interest rate is interest expense divided by the average of total short and long term
debt during the year,
OP = dummy variable with a value of 1 for MAOs and 0 otherwise,
𝐵𝐼𝐺4𝑖𝑡 - it has a value of one when the firm retains a Big 4 auditor; zero otherwise,
𝐿𝐸𝑉𝑖𝑡 - the book value of total short- and long-term debt deflated by firm market value (sum of
the market value of equity and the book value of total debt),
𝐶𝐹𝑖𝑡 – is cash flow from operations scaled by total assets,
𝑆𝐼𝑍𝐸𝑖𝑡 - firm size is the natural logarithm of one plus total assets,
𝐴𝑆𝑆𝐸𝑇_𝑆𝑇𝑅𝑖𝑡 - asset structure is total property, plant and equipment scaled by total assets,
𝑁𝐸𝐺.𝐸𝑄𝑈𝐼𝑇𝑌𝑖𝑡 - the negative book equity dummy indicates if the book value of equity is
negative.
4. Results
The focus of this study is on the modified audit opinion for U.S. companies in 2012.
Considering this, I expect that all the variables used differ between companies when they disclose
a clean opinion or a modified audit opinion. In order to show this difference, I will provide later
in this section some relevant tables. Each of the two hypotheses try to explain a different
influence of the auditor opinion, one over the stock market and the other over the cost of debt. In
order to show a better overview, this section is presenting separately the results of each
hypothesis.
4.1. The stock market reaction over the announcement of a modified audit opinion
As mentioned in the methodology part, I used for the first hypothesis an event research, which
consists on the analysis before and after the event, which in this case is the announcement date of
the auditor opinion. For this, it is necessarily to determine the abnormal returns for each
company, depending on its unique date of announcement, and right after that, the cumulative
abnormal returns over the 3 days window (-1,+1) are computed. This is the dependent variable,
which will remain in the discussion for the analysis.
In order to determine the way in which the cumulative abnormal returns are caused by the
type of audit opinion – clean or modified - it is important to take into consideration some other
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
25
variables which may or may not depend themselves on the type of opinion. Table 1 presents the
descriptive statistics of these variables, for each case: when there is a clean opinion, OP equals 0
and for a modified audit opinion the same variable takes the value of 1. As it can be seen below, I
had included some other important variables, that are not part of the model, like TA (total assets),
NI (net income), ROE (return on equity), AR (abnormal returns for the day 0) and also the two
numeric and continuous variables of the model, CAR (cumulative abnormal returns) and ∆EPS
(the difference between earnings per share for two consecutive years, 2011 and 2012 scaled by
the beginning price of day -1). The reason for including in the table these variables, is because
they represent important financial indicators for the company, which are of a big interest for the
investors. This is why I expect to notice a difference, but this doesn‟t mean that this is totally due
to the difference in audit opinions. Anyway, it is interesting to have an overview of the main
statistics for each of these variables.
The variables are corresponding with the 2012 year, except the last one, which states the
difference among years in the earnings per share. Considering this, we can see a significant
difference between the TA of the two groups, where the MAO firms are bigger in size, as
evidenced by the mean and median values. They are also more profitable, as the mean and
median of ROE are lower for the clean opinion group, which is contradictory with the Chen et.al
(2010). However, the MAO group exhibits a more negative mean and median change in earnings
per share than the clean group, fact that was also noticed for the chinese companies in the paper
afore-mentioned. Moreover, the abnormal returns show higher mean and median values for the
MAO group.
Having said that, apparently the firms that received a modified audit opinion are bigger
and more profitable, but this success over the other group of firms, comes with its shortcummings
like more risks, and more debts, which can cause the auditor to modify the audit opinion, with
some explanatory notes of a significant importance for the investors.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
26
Table 1
Descriptive statistics for main variables
OP Variable Mean sd p1 p25 Median p75 p99
0 TA 10,243.99 31,223.97 12.861 715.655 2,144.358 6,733.45 132,244
NI 630.9751 2,200.18 -985 23.706 109.768 449.7605 10,925
ROE 0.1345337 0.3711082 -0.7426036 0.0733614 0.1363148 0.1953806 1.17987
AR 0.0020013 0.0267145 -0.0738255 -0.0084635 0.0001363 0.0085047 0.1090047
CAR -2.842219 2.774461 -7.505228 -3.940635 -3.007319 -1.884142 1.151975
∆EPS 0.0035035 0.1626191 -0.6953125 -0.0136327 0.0041084 0.0167856 0.312
1 TA 22,848.22 41,546.75 6,955 1,026.317 5,356.978 20,405.3 144,810.5
NI 1,808.556 4,060.8 -441 7.371 260.213 1,226 15,417
ROE 0.2106174 0.7505479 -1.46713 .1047595 0.1443036 0.1810418 3.595.745
AR 0.0083655 0.028134 -0.0498975 -0.004116 0.003105 0.0174242 0.0996667
CAR -3.021553 1.763847 -6.057692 -0.418.663 -3.135211 -1.866331 0.380801
∆EPS -0.0209531 0.1083877 -0.2700403 -0.0318934 -0.0046982 0.0097703 0.3
Next, I will focus only on the variables that are part of the regression model. As I already
mentioned in the Research methodology, most of them are dummy variables, which can take
either the value of 1 or 0, depending on the situation applicable to each company. Table 2 shows
the descriptive statistics of each of these variables, in order to get an idea about the structure of
the sample. As you can see below, there are few companies that had a modified audit opinion, out
of which 12 were followed by a decrease in dividends and 17 were having a modified audit
opinion in the previous year as well.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
27
Table 2
Descriptive statistics: dummy variables
Variables Freq. Percent Mean Std. Dev.
OP
0.0940767 0.2924453
0 260 90.59
1 27 9.41
Total 287 100.00
DIV
0.0418118 0.2005086
0 275 95.82
1 12 4.18
Total 287 100.00
REPEAT
0.0522648 0.2229493
0 272 94.77
1 15 5.23
Total 287 100.00
Table 3 presents the descriptive statistics for the other 3 variables of the model.
It can be seen that the cumulative abnormal return has a negative mean value, which
prevent the investors about the financial distress and can influence their decision making process.
These kind of signs can be caused by many external or internal factors, but in this study I want to
focus only on the effect the audit opinion has on the returns, and implicitly on investors reaction.
Table 3
Descriptive statistics: continuous variables
Variable Obs Mean Std. Dev. Min Max
CAR 287 -2.85909 2.693792 -7.82156 33.1095
∆EPS 287 0.0012027 0.1583274 -1.210686 1.791667
OP*∆EPS 287 -0.0019712 0.0332496 -0.2700403 0.3
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
28
The correlations between variables are also important in proving the validity of the
implemented model. The results of this analysis are showed in Table 4, with Pearson correlations
presented below the diagonal and Spearman correlations presented above the diagonal. I have
chosen to run for two types of correlations in STATA in order to enhance the certainty over these
relationships. The values reported are not equal, but most of them are close enough and the
direction of influence is the same (positively or negatively).
Table 4
Pearson (below) & Spearman (above) correlations
Variable CAR OP ∆EPS OP*∆EPS div_MAO Repeat_MAO
CAR 1.0000 -0.0210 0.0151 0.0442 0.0553 -0.0006
OP -0.0195 1.0000 -0.0998 -0.1109 0.3501* 0.7287*
∆EPS 0.0954 -0.0452 1.0000 0.2988* -0.0567 -0.0529
OP*∆EPS 0.0238 -0.1843* 0.2112* 1.0000 -0.1691* 0.0526
DIV 0.0204 0.3501* -0.0487 -0.2553* 1.0000 0.1856*
REPEAT -0.0093 0.7287* -0.0279 -0.1104 0.1856* 1.0000
* significant at the 0.01 level
As we can see in the table above, CAR is positively correlated with ∆EPS but negatively
correlated with the dummy variable for MAOs (OP). The CAR is positively correlated with the
change in earnings and negatively correlated with OP. Another negative correlation is between
∆EPS and DIV, since a modified audit opinion caused by a decrease in dividends has a negative
impact on the earnings as well. However these correlations are not significant. For a significance
level of 0.01 we can see positive correlations between OP and the other 2 dummy variables DIV
and REPEAT, which is not surprising, but the OP are negatively correlated with the interaction
term OP*∆EPS, which can be explained by a negative influence of the changes in earnings over
the audit opinion.
In order to reduce any doubts about the multicolinerity of the independent variables, I
used Variance Inflation Factor (vif in STATA) which has the mean value of 1.59, which is less
than 10, and this means the variables are good and there is no need to drop any to be able to
continue with the model. (the output is provided in the Appendix no. 2)
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
29
For the variables checking, I have performed another test in STATA, the one for
specification error which basically checks whether more variables are needed in order to run the
regression. In order to prove that there is no specification error I have ran the test (linktest in
STATA) and I got a non-significant p-value of _hatsq, which means the model is correctly
specified (the output is provided in the Appendix no. 3).
Another way of showing the difference between groups with clean opinions and groups
with modified audit opinions is by performing a t-test (Table 5) of cumulative abnormal returns
for each of these groups. This test is based on the idea of proving the null hypothesis that both
groups have the same mean change in CAR. The alternative hypothesis is that this difference is
not equal to zero. For this one, the p-value is greater than 0.1 which means the alternative
hypothesis is not supported and implictly the null hypothesis cannot be rejected. Considering
this, we might still wonder whether the sample is representative for the first hypothesis.
Table 5
T-test CAR by OP
Group Obs Mean Std. Err. Std. Dev. [95% Conf. Interval]
0 260 -2.842219 0.1720647 2.774461 -3.181043 -2.503395
1 27 -3.021553 0.3394524 1.763847 -3.719308 -2.323799
combined 287 -2.85909 0.1590095 2.693792 -3.172068 -2.546113
diff
0.1793337 0.545525
-0.8944355 1.253103
The main results of the model for the first hypothesis are presented in Table 6, which shows the
estimated coefficients for each independent variable, mentioning the significant level where is the
case. We can see that the OP is negatively associated with the CAR, but not for a significant
level, since the p-value is quite high (0.684). This means that the hypothesis regarding the
negative influence of the auditor opinion, more specifically of a modified audit opinion, over the
returns is rejected by this model for this particular sample. However the Chen et al. (2000) has
proved that investors react negatively to the announcements of modified audit opinions, showing
in the regression table a consistently negative coefficient for OP at a significant level for the last
two year of their sample (1996 and 1997). The interaction between OP and ∆EPS is positive but
not significant (p>0.1) and the other control variables are not significant either in this model, but
this is also mentioned in Chen et al (2000).
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
30
Table 6
Regression results
CAR Coef. Std. Err. t P>t [95% Conf. Interval]
OP -0.3444228 0.845156 -0.41 0.684 -2.008063 1.319218
∆EPS 1.603401 1.032965 1.55 0.122 -0.4299314 3.636733
OP*∆EPS 0.6602399 5.107573 0.13 0.897 -9.393722 10.7142
Div_MAO 0.5026697 0.8746699 0.57 0.566 -1.219067 2.224407
Repeat_MAO 0.1754674 1.053281 0.17 0.868 -1.897854 2.248789
_cons -2.857504 0.1685286 -16.96 0.000 -3.189242 -2.525765
One explanation for this concluding remark that the hypothesis is not supported could be
the lack of sufficient data and the different economic period and region. As it is mentioned in
Chen et al (2010), the chinese investors were not that well informed and for them “the auditor‟s
opinions are the only source of financial information for their investment decisions”. But for U.S.
companies in 2012, this is not applicable anymore, and investors are given a lot more options and
reports to found out the information they need, without waiting for an audit report to confirm
their expectations.
4.2. The effect of modified audit opinion on the cost of debt
For the second hypothesis, the attention is directed towards the cost of debt, represented
by the dependent variable interest rate. As I already explained in the methodology, the model for
testing this includes 3 dummy variables: the modified opinion (OP), BIG4 which equals 0 or 1
depending on the auditor‟s rank, and the negative equity (NEG_EQUITY) that equals 1 for a true
statement and 0 otherwise. The other 4 variables are continuous, and they basically represent
important indicators of a firm‟s wealth which is often taken into consideration by creditors in
their decision making process.
In order to be consistent in my study, the same sample period and the same firms were
used for the second hypothesis. There is also one independent variable that is used for this second
model as well, represented by the auditor opinion, which is actually the main focus of this study.
For showing the importance of the modified opinion, I showed in Table 7 the overview on the
variables used, depending on the group which a company belongs to. Overall the differences in
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
31
variables for the two groups are not that big. If we take a look over the interest rate, the mean and
median values are greater for those firms with a clean opinion but the leverage and the size are
bigger for firms with a modified audit opinion. Furthermore, the mean value of negative equite is
significantly greater for the MAO group, which could be an explanation for the need of auditors
to provide some explanatory notes.
Table 7
Descriptive statistics
For a better overview of the variables, I sorted them in two categories as continuous and
dummy variables, providing separate descriptive statistics to each category as it follows in Table
8 and Table 9.
Table 8 reflects the descriptive statistics for the variables that are of a significant
importance for creditors. These basically represent the firm characteristics and they are supposed
to control for variation in debt pricing.
OP Variable Mean sd p1 p25 Median p75 p99
0 Interest_rate 0.0207625 0.0154843 0.0002008 0.009074 0.0198404 0.0283679 0.0930809
BIG4 0.85 0.3577601 0 1 1 1 1
Leverage 0.532182 0.1901859 0.1475694 0.3918369 0.5365013 0.6547937 1.12824
Cash-flow 0.1068334 0.0756232 -0.0411275 0.0741339 0.1033383 0.1395552 0.3053475
Size 7.659011 1.850382 2.629079 6.574578 7.671056 8.814535 11.79241
Asset_str 0.283388 0.2168861 0.0167108 0.1222447 0.2190149 0.3894942 0.8648329
Neg_equity 0.0192308 0.1376 0 0 0 0 1
1 Interest_rate 0.0196538 0.018974 -0.0106401 0.0050063 0.0158887 0.0262194 0.0754443
BIG4 0.8888889 0.3202563 0 1 1 1 1
Leverage 0.5552865 0.171736 0.2178218 0.4641084 0.5412867 0.6142384 1.0197
Cash-flow 0.0799327 0.1543938 -0.6306254 0.0589993 0.1016327 0.1607889 0.2048676
Size 8.101633 2.631362 2.073801 6.934706 8.586342 9.923599 11.88319
Asset_str 0.2648026 0.2374075 0.0008627 0.0951337 0.1891273 0.3457143 0.8996205
Neg_equity 0.037037 0.1924501 0 0 0 0 1
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
32
Table 8
Descriptive statistics: continuous variables
Variable Obs Mean Std. Dev. Min Max
Interest_rate 287 0.0206582 0.0158102 -0.0106401 0.0952311
Leverage 287 0.5343556 0.1883689 0.1248841 1.347441
Cash-flow 287 0.1043027 0.0860692 -0.6306254 0.3227785
Size 287 7.700651 1.935689 2.073801 12.83958
Asset_structure 287 0.2816395 0.2185227 0.0008627 0.9200945
Table 9 presents the descriptive statistics for the dummy variables, where it can be
observed the structure of the sample. Most of companies chosen are audited by BIG4 which gives
an increased credibility of the audit report and investors are more willing to rely on it. For the
negative equity variable there are only 6 firms that met this criterion.
Table 9
Descriptive statistics: dummy variables
Variables Freq. Percent Mean Std. dev
OP
0.0940767 0.2924453
0 260 90.59
1 27 9.41
Total 287 100.00
BIG4
0.8536585 0.3540656
0 42 14.63
1 245 85.37
Total 287 100.00
NEG_EQUITY
0.0209059 0.1433193
0 281 97.9
1 6 2.1
Total 287 100.00
For a better prediction of the influences of each variable the correlations of Pearson and
Spearman are provided in Table 10. In order to see whether the correlations between variables are
applicable, the significance for the 5% level is provided.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
33
Table 10
Pearson (below) & Spearman (above) correlations
Variable Interest_rate OP BIG4 Leverage Cash-flow Size Asset_str Neg_equity
Interest_rate 1.0000 -0.0438 0.0161 0.4114* -0.0829 0.0456 0.2059* 0.1825*
OP -0.0205 1.0000 0.0321 0.0362 -0.0140 0.0817 -0.0432 0.0363
BIG4 -0.0547 0.0321 1.0000 0.1184* 0.1713* 0.4654* -0.0333 -0.0084
Leverage 0.4342* 0.0359 0.1103 1.0000 -0.2086* 0.3333* 0.0866 0.2478*
Cash-flow -0.2187* -0.0914 0.2507* -0.0640 1.0000 0.1197* 0.0926 0.0400
Size -0.0605 0.0669 0.5093* 0.2879* 0.2611* 1.0000 0.0024 0.0341
Asset_str 0.2267* -0.0249 -0.0430 0.0773 0.1199* 0.0129 1.0000 0.0720
Neg_equity 0.2819* 0.0363 -0.0084 0.4597* 0.0365 0.0245 0.0367 1.0000
* significant at the 0.05 level
Having said that, we can notice that the interest rate is significantly positively correlated
with the leverage and negatively correlated with the cash flow. This is also the way in which I
expected the relationship to be, and consistent with Pittman and Fortin (2004). Furthermore, there
are positive correlations between BIG4 and leverage, cash flow and size. A possible explanation
for this could be that profitable and big companies can afford to pay a BIG4 auditor and in this
way to provide a more trusthy report to the creditors.
In order to mitigate any concerns regarding the multicolinearity of the independent
variables, I have used the variance inflation factor (vif in STATA) and I got a mean value of 1.28,
which is less than 10. This leads to the concluded remark that no variable need to be dropped for
keeping the validity of the model. Another test was for specification error, which has also proved
that the model is correctly specified. (the outputs for the two test are provided in Appendix no. 4
and Appendix no. 5)
The assumption of the regression model that impacts the validity of all tests is that
residuals behave normal. After generating the residuals in STATA I have used the Kernel density
graph to show that they are following a normal pattern. (Figure1)
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
34
Figure 1
The regression results for testing the second hypothesis are provided in Table 11. The
overall P-value is 0.000 which proves that the model supports the hypothesis and the R square is
0.3 which means the model explains 30% of the variance of the dependent variable: the interest
rate.
Table 11
Regression results
Interest rate Coef. Std. Err. t P>t [95% Conf. Interval]
i.OP -0.0023161 0.0027313 -0.85 0.397 -0.0076926 0.0030605
i.BIG4 0.0016197 0.0026311 0.62 0.539 -0.0035597 0.0067991
Leverage 0.0331596 0.0050889 6.52 0.000 0.0231422 0.043177
Cash-flow -0.0365717 0.0099599 -3.67 0.000 -0.0561777 -0.0169657
Size -0.0011697 0.0005087 -2.30 0.022 -0.002171 -0.0001684
Asset_structure 0.0158078 0.0036747 4.30 0.000 0.0085742 0.0230414
i.Negative_equity 0.0115683 0.0063172 1.83 0.068 -0.0008671 0.0240037
_cons 0.0099026 0.0037457 2.64 0.009 0.0025292 0.017276
0
10
20
30
Density
-.04 -.02 0 .02 .04 .06 Residuals
Kernel density estimate Normal density
kernel = epanechnikov, bandwidth = 0.0038
Kernel density estimate
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
35
Table 11 shows the specific coefficients for each independent variable. As expected, the
modified audit opinion has a negative influence on the interest rate as well as the cash flow and
the size of the company, but this is not significant since the p-value is greater than 0.1 If we take
a look over the p-values for the independent variables we can see that the leverage, cash flow and
asset structure are highly significant in explaining the interest rate (p-value =0). Furthermore, the
size of the company is also significant at a 5% level, but the influences of the audit opinion and
the presence of a BIG4 auditor are not significant. This leads to the conclusion that the audit
opinion is not statistically significant in explaining the interest rate and implicitly the cost of debt.
This means that the hypothesis regarding the negative influence of the modified audit opinion
over the cost of debt, is rejected according to the significance level of the p-value, which is
contradictory with the related findigs of Karjalainen (2011).
An explanation of this concluding remark could be that the audit opinion is not the main
source of creditor‟s decisions in lending or not a specific company, since there are other financial
indicators more relevant as identified in this model as well (leverage, cash-flow). Having said
that, there is evidence that neither a modified audit opinion has as a consequence a significant
increase in cost of debt nor a Big 4 audit.
5. Limitations
The results of this study are subject to some limitations, considering the results were
contradictory with most of other similar studies.
Firstly, for the statistical analysis, only publicly traded companies have been employed, in
order to follow the same path as in Chen et al (2000), so the results cannot be generalized.
Including privately held companies could have lead to different results for the research, maybe
consistent with previous studies. Furthermore, the sample is not that big, only 287 firm
observations are taken into consideration because of the restrictions imposed, and because of the
missing observations for the variables included in both models. A better way to do this research
could have been to choose different samples for the two hypotheses in order to avoid applying
restrictions needed for one hypothesis to the other as well. Moreover, the period of analysis is
only of one year, so quite short to consider the results generalizable.
Secondly, the methodology approach for the analysis of the first hypothesis, meaning the
event study, could have biased the results since it is quite impossible to exclude the concurrent
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
36
information around the day of the event. It is difficult as well to determine the exact date when
the audit opinion was publicly announced, since there is not a fixed date when the companies are
mandated to disclose this information. I did consider the signature date of opinion as the date of
event, since it was the only information available on Audit Analytics database. But these dates
were different for each company, so I had to compute the abnormal returns for each of them
separately.
Finally, despite the caveats I already mentioned, this study tries to contribute to the
literature by providing an analysis of U.S. companies that have issued a modified audit opinion in
the recent period and the impact of this on the market, in stock returns and cost of debt.
6. Summary and conclusion
The purpose of this study is divided in two main topics, but they are linked by the audit
opinion. I have focused only on the modified audit opinion, since there were not as many prior
studies to research this, and I was also restricted by the sample I got.
The first one is trying to answer the question of whether there is any influence a modified
audit opinion could have on investors, when making their decisions. More precisely, the attempt
is to analyse the fluctuations of the stock returns, around the announcement date of disclosing the
audit opinion, to see if there is a negative association as expected and proved by prior studies.
The second aim of this paper is to explore the link between auditor opinion and debt
pricing. This time, the point of interest is the creditors, because they decide over the debt
covenants, if the interest rate is appropriate considering the financial statements and the auditor
report of a specific company.
Extant theory and previous studies have proved that a modified audit opinion brings new
relevant information into stakeholder‟s attention that have lead to a negative market reaction,
suggested by significantly negative market returns. Furthermore, the firms with a modified audit
report have recorded a higher interest rate on the debt capital, as opposed to those firms with a
clean audit report.
The sample consists of U.S. publicly traded companies from 2012, that were continuously
audited, considering the previous year. Companies from bank and financial real estate sector have
been excluded for removing biases that could have result as a different application of economic
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
37
policies. After considering all the restrictions, the final sample reached 287 firms, which was
used for both hypotheses of this study.
The results of this study do not support the hypotheses afore mentioned, which lead to
different findings as comparing to previous studies.
Regarding the first hypothesis, there was no evidence that the modified audit opinion had
a significant negative impact on the cumulative abnormal returns, which means that the investors
were not affected by the information content of the audit report. This could be due to the
concurrent events that might have been of a higher relevance for investors, or to the biased
publicly announcement date of opinion.
As it concerns the second hypothesis, the results proved that there is no significant
negative effect a modified audit opinion can have on the interest rate, which can be translated as
the creditors do not consider the audit report as the main source of information when they decide
over the employment of a specific debt covenant.
As a recommendation for further research, this study could be extended by considering a
bigger sample and a longer period of time, since it will bring a significant improvement of the
analysis, and maybe the results would be aligned with those of most previous studies. Another
thing that could give more accuracy to the research could be the consideration of the earnings
announcement date, because this is more relevant for investors, and maybe after this date, they do
not look for more information to ensure about the validity of this indicator.
In conclusion, according to the findings of this study, a modified audit opinion turns out
to have negative influence neither on the stock returns nor on the cost of debt, but these results
are applicable only for the chosen sample.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
38
References
1. Ahsan Habib, (2013). A meta-analysis of the determinants of modified audit opinion
decisions, Managerial Auditing Journal, Vol. 28 Iss: 3, pp.184 - 216
2. Allen D. Blay, Marshall A. Geiger, David S. North (2011) The Auditor's Going-Concern
Opinion as a Communication of Risk. A Journal of Practice & Theory: May 2011, Vol.
30, No. 2, pp. 77-102.
3. Arber H. Hoti, Hysen Ismajli, Skender Ahmeti and Arben Dermaku, (2012). Effects of
Audit Opinion on Stock Prices: The case of Croatia and Slovenia. EuroEconomica, issue
2(31), pages 75-87
4. Armitage, S & Marston, C (2007), Corporate disclosure and the cost of capital: the views
of finance directors. Institute of Chartered Accountants in England and Wales
5. Bharath, S.T., Sunder, J., Sunder, S., 2008. Accounting quality and debt contracting. The
Accounting Review 83 (1), 1–28
6. Chen, Peter F.; Tenho, Shaohua; Ma, Zhiming; Stice, Derrald E, 2012. Qualified audit
opinions and debt contracting. The 3rd International Conference of The Japanese
Accounting Review, Kyoto, Japan
7. Chen, K.C., & Church B.K. (1996). Going concern opinions and the market’s reaction to
bankruptcy filings. The Accounting Review, Vol. 71 (1), pp. 117-128.
8. Chen, C. J. P., Su, X. and Zhao, r. (2000), An Emerging Market's Reaction to Initial
Modified Audit Opinions: Evidence from the Shanghai Stock Exchange. Contemporary
Accounting Research, 17: 429–455
9. Dodd, P., Dopuch, N., Holthausen, R., Leftwich, R., 1984. Qualified audit opinions and
stockprices. Information content, announcement dates and concurrent disclosures.
Journal of Accounting andEconomics 6 (1), 3–38.
10. Dennis M. O'Reilly, (2010) Do investors perceive the going-concern opinion as useful for
pricing stocks?, Managerial Auditing Journal, Vol. 25 Iss: 1, pp.4 – 16
11. Firth, M. (1978), Qualified audit reports: their impact on investment decisions, The
Accounting Review, Vol. 53 No. 3, pp. 642-50.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
39
12. Fortin, S. and Pittman, J. A. (2007), The Role of Auditor Choice in Debt Pricing in
Private Firms. Contemporary Accounting Research, 24: 859–896
13. Herbohn, K., V.Ragunathan& R. Garsden (2007). The horse has bolted: revisiting
the market reaction to going concern modifications of audit reports, Accounting and
Finance, 47:3, 473–493.
14. ISA 705 – Modifications to the Opinion in the Independent Auditor’s Report
15. Jensen, M. C. and Meckling, W. H. (2007) Theory of the Firm: Managerial Behavior,
Agency Costs, and Ownership Structure, in Economic Analysis of the Law: Selected
Readings (ed D. A. Wittman), Blackwell Publishing Ltd, Oxford, UK
16. Jere R. Francis, Inder K. Khurana and Rynolde Pereira (2005), Disclosure Incentives and
effects on cost of capital around the world. The Accounting Review, Vol. 80, No.4, pp.
1125 - 1162
17. Jones, F.L., 1996. The information content of the auditor’s going-concern evaluation.
Journal ofAccounting and Public Policy 13(1), 1–27.
18. Karjalainen, J. (2011), Audit Quality and Cost of Debt Capital for Private Firms:
Evidence from Finland. International Journal of Auditing, 15: 88–108
19. Kim, J.-B., Simunic, D. A., Stein, M. T. and YI, C. H. (2011), Voluntary Audits and the
Cost of Debt Capital for Privately Held Firms: Korean Evidence. Contemporary
Accounting Research, 28: 585–615
20. Manuel Cano-Rodríguez (2010). Big Auditors, Private Firms and Accounting
Conservatism: Spanish Evidence, European Accounting Review, 19:1, 131-159
21. Ogneva, M., and K. R. Subramanyam. 2007. Does the stock market underreact to going
concern opinions? Evidence from the U.S. and Australia. Journal of Accounting and
Economics 43 (2–3): 439–452.
22. Pittman, J.A. & Fortin, S. 2004, Auditor choice and the cost of debt capital for newly
public firms, Journal of Accounting and Economics, vol. 37, pp. 113-136.
23. Ruhani, A., Zamri, A. &Shangkari, V. (2011). Stock market overreaction and trading
volume: evidence from Malaysia. Asian Academy of Management Journal of Accounting
and Finance, 7: 103-119
24. Schaub, M. (2006). Investor overreaction to going concern audit opinion announcements.
Applied Financial Economics, 16(16), 1163–1170.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
40
25. Sengupta Partha, (1998). Corporate disclosure quality and the cost of debt. The
Accounting Review, Vol. 73, No. 4 (Oct., 1998), pp. 459-474
26. Syou-Ching Lai, Cecilia Lin, Hung-Chih Li, Frederick H. Wu (2009). The Information
Contents of Modified Unqualified Audit Opinions under the Control of Concurrent
Information: The Case of Taiwan, Journal of Accounting and Corporate Governance,
Volume 6 Number 1, June 2009, pp.31-56
27. Taffler, R.J., Lu, J., Kausar, A., 2004. In denial? Stock market underreaction to going-
concern audit report disclosures. Journal of Accounting and Economics 38, 263–285.
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
41
Appendices
Appendix no. 1 Variables measurement
Variable name Symbol Measurement
Cumulative abnormal return CAR 3-day cumulative abnormal return from day −1 to 1
Auditor opinion OP a dummy variable with a value of 1 for MAOs and
0 otherwise
Change in earnings ∆EPS change in earnings per share scaled by beginning
price at day −1
Dividends DIV 1 for MAOs with dividend decreases and 0
otherwise
Repeat REPEAT 1 for noninitial MAOs and 0 otherwise
Return on equity ROE net income/year-end total equity
Abnormal return (day 0) AR market model abnormal return on the day of
announcement
Interest rate INT_RATE interest expense divided by the average of total
short- and long term debt during the year
Big 4 audit firm BIG4 1 when the firm retains a Big 4 auditor and 0
otherwise
Leverage LEV book value of total short- and long-term debt
deflated by firm market value (sum of the
market value of equity and the book value of
total debt)
Cash-flow CF cash flow from operations scaled by total assets
Firm size SIZE the natural logarithm of one plus total assets
Structure of assets ASSET_STR total property, plant and equipment scaled by
total assets
Negative equity NEG_EQUITY 1 when there is a negative book equity and 0
otherwise
The influence of modified audit opinion on the stock market and cost of debt: U.S. evidence
42
Appendix no. 2 Table Multicolinearity (H1)
Variable VIF 1/VIF
OP 2.39 0.418270
REPEAT 2.16 0.463361
DIV 1.20 0.830740
OP*∆EPS 1.13 0.885966
∆EPS 1.05 0.955293
Mean VIF 1.59
Appendix no. 3 Table specification error (H1)
CAR Coef. Std. Err. t P>t [95% Conf. Interval]
_hat 1.415148 1.655102 0.86 0.393 -1.842675 4.672971
_hatsq 0.0819477 0.3063694 0.27 0.789 -0.521095 0.6849905
_cons 0.5108255 2.524594 0.20 0.840 -4.458465 5.480116
Appendix no. 4 Multicolinearity (H2)
Variable VIF 1/VIF
SIZE 1.55 0.645301
LEV 1.47 0.680847
BIG4 1.39 0.720872
NEG_EQUITY 1.31 0.763227
CF 1.17 0.851344
ASSET_STR 1.03 0.970235
OP 1.02 0.980591
Mean VIF 1.28
Appendix no. 5 Specification error (H2)
INT_RATE Coef. Std. Err. t P>t [95% Conf. Interval]
_hat 0.4853796 0.3034508 1.60 0.110 -0.1109185 1.083678
_hatsq 10.26165 5.79124 1.77 0.077 -1.137551 21.66085
_cons 0.00546 0.0036798 1.48 0.139 -0.001783 0.012703