Do auditors' opinions, industry factors and macroeco(2)

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Do auditors' opinions, industry factors and macroeconomic factors

signal financial distress? Evidence from Taiwan

Abstract

This study investigates the usefulness of auditors’ opinions, macroeconomic factors, and industry factors in predicting bankruptcy based upon a sample of public firms in Taiwan. Auditors’ opinions examined include going concern”, “consistency”, “contingency” (uncertainty), “long-term investment audited by other auditors” (“other auditor”), and “realized investment income based on non-audited financial statements” (“no auditor”). Macroeconomic factors assessed consist of currency (M1b) supply change ratio, 1-year depositary interest rate change ratio, and consumer price index change ratio. We also study the impact of electronic industry factor given electronic industry constitutes a vital part of Taiwan economy.

Our major empirical results are consistent with general bankruptcy literature and the unique nature of Taiwan economy. First, in addition to auditors’ “going concern” opinions, “other auditor” is also found to be a significant bankruptcy predictor. Due to auditors’ being lack of knowledge and tendency of sharing litigation risk, investment income audited by other auditors tend to have lower earnings quality and firms with such income items are more likely to fail. Secondly, higher currency supply and higher consumer price index are signals of better macroeconomic environment, in which the likelihood of bankruptcy is reduced. In contrast, higher interest rate imposes more burdens upon firms’ cost of raising capital and therefore increases the likelihood of bankruptcy. Thirdly, since electronic firms in Taiwan have lower debt ratios and therefore survival of electronic firms are less likely to be influenced by interest rate fluctuations.

Discrete-time hazard models are developed with different combinations of financial ratios, auditors’ opinions, macroeconomic factors, and industry factor. The models’ overall goodness-of-fits and out of sample prediction accuracy are compared using various criteria. Overall speaking, the models in incorporation with auditors’ opinions, macroeconomic factors, and industry factor perform better than the financial-ratio-only model. More importantly, not only do auditors’ opinions, macroeconomic factors, and industry factor contain incremental information beyond financial ratios in predicting bankruptcy, but also they have incremental contribution beyond one another.

Key Words: Financial distress, Auditors’ opinion, Discrete-time hazard model, Going

concern

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