Credit Rating Changes & Auditor Reporting Accuracy

This study addresses the question whether credit ratings are associated with auditor reporting accuracy. Given credit rating agencies’ private information access, experience and expertise, I examine whether the presence of poor credit ratings and especially credit rating downgrades contain incremental information for auditors’ going-concern opinion (GCO) decisions that improve auditors’ GCO decisions. Furthermore, I investigate if the association between credit rating downgrades and auditor reporting errors varies as a function of auditor specialisation. Based on a sample of financially distressed U.S. public companies with Standard and Poor’s credit ratings between 1999 and 2012, I find that poor credit ratings significantly increase Type I errors, but do not decrease Type II errors. However, credit rating changes and particularly more severe and more recent rating downgrades are associated with a higher (lower) probability of Type I (Type II) errors. Finally, I find weak evidence that auditors clearly not specialised in their client’s industry are less conservative but that credit rating downgrades reduce their Type II reporting error rate. Overall, the results imply that credit ratings function as external warning signals that increase auditor conservatism.

This seminar is organised by the Erasmus Accounting Research Group.