The Information Content of Audit Qualifications.

Abstract In 1988, the "subject to" audit report was eliminated, presumably because it lacked substantive information value for financial statement users. Research on market response to "subject to" reports generally supported its lack of value. However, two exceptions were market reactions when the announcement appeared in a media story or when the qualification was subsequently withdrawn. The general failure to find a market response to "subject to" reports is still puzzling since auditors and clients behave as if audit opinions matter. This study varies from prior investigations by incorporating a variable which measures, to the extent possible, the market's assessment that a qualified opinion will be announced. It is based on a sample of firms which disclosed the "subject to" opinion on or after the earnings announcement date. Two results supported the value of the "subject to" qualification. First, the disclosure of an unexpected qualification registered an adverse market reaction. Second, delaying disclosure of an expected qualification also resulted in a negative market reaction. Taken together, these findings suggest that elimination of the "subject to" opinion may have been premature. From a methodological standpoint, the study demonstrates the benefits of explicitly incorporating expectations into an event study model when there are different prior probabilities of the sample firms experiencing the event under examination.