Allen D. Blay
University of California, Riverside
Abstract: This paper tests the proposition that for similar firms facing financial distress, the going-concern modification results in a substantial shift in the market valuation mechanism away from net income and toward book value. Specifically, firms receiving a going-concern modification are valued almost exclusively based on the book value of common stock, whereas matched firms facing financial distress, but without a going-concern modification, are valued both on book value and net income. The result holds even after controlling for several common measures of financial distress. Additionally, time series tests indicate that prior to the receipt of the modification, there is little difference in the valuation mechanism for the matched firms. This provides a direct indication that the market interprets the going-concern opinion as a sign of imminent liquidation or restructuring and also documents that a specific informational event results in a rapid change in the market valuation mechanism.
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