If you spend much time reading financial statements, the auditors’ opinions have a numbing sameness to them. Once in awhile, with a troubled company, you come across a red flag called a “going concern” statement. It means that, in the auditors’ opinion, the company may not be long for this world. (For a local example, see Bakers Footwear.)
A layperson might think that the green-eyeshade crowd follows some objective rules about such things, but in reality, it can be a judgment call. Auditors have so much leeway, in fact, that a paper by three accounting professors finds that a company’s chances of getting a negative opinion depend on how close it is to an Securities and Exchange Commission office. Here’s their conclusion:
Our analysis finds that the likelihood of issuing a going concern audit report decreases as the distance between the auditor’s office and the SEC Regional Office increases, but only among non-Big 4 auditors.
Other studies have found that distance from an SEC office also influences the likelihood that a company will restate its financial results. Apparently, having a regulator in close proximity increases the incentive for auditors to get things right the first time. The authors hypothesize as to why location matters:
If auditors located farther from SEC Regional Offices believe there is less likelihood they will “get caught” in the event of a breach, it decreases the expected costs of compromising their independence: or, to paraphrase an ancient Chinese proverb, the mountains are high and the SEC Regional Office is far way. Thus, we predict that auditors located relatively farther away from SEC Regional Offices are less independent of their clients and because of this are less likely to issue a negative (going concern) audit report.
The authors are Mark L. DeFond of USC, Jere R. Francis of the University of Missouri and Xuesong Hu of the University of Oregon.
Perhaps the SEC, after reading this paper, should move some of its enforcement folks out to the hinterlands.