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    Insider Trading, Litigation Concerns, and Auditor...
    research summary posted September 14, 2015 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 06.0 Risk and Risk Management, Including Fraud Risk, 06.09 Litigation Risk, 12.0 Accountants’ Reports and Reporting, 12.01 Going Concern Decisions 
    Insider Trading, Litigation Concerns, and Auditor Going-Concern Opinions.
    Practical Implications:

    The study offers two primary contributions. First, it provides insight into the incentive effect of corporate insider trading on auditor behavior. The study helps to fill this gap by providing evidence on the relationship between managers’ incentives and auditors’ opinions. Second, this study adds to the literature on insider trading. The evidence extends this literature by showing that insiders’ incentives to sell and their desire to avoid litigation can influence auditors’ reports.


    Chen, C., X. Martin, and X. Wang. 2013. Insider Trading, Litigation Concerns, and Auditor Going-Concern Opinions. Accounting Review 88 (2): 365-393.

    going-concern opinion, insider tracking, litigation risk, SOX
    Purpose of the Study:

    The authors investigate whether managers’ litigation concerns about insider selling affect the likelihood of firms receiving going-concern opinions. Prior studies show that managers face the risk of trade-related litigation around news events. To reduce their risk exposure, managers have at least two options. First, they can abstain from trading before notable events.  Alternatively, when managers do choose to trade, they can attempt to alter the information flow in the post-trading period to avoid price swings and escape regulators’ scrutiny. The authors focus on this option with respect to the association between managers’ insider sales and auditors’ going-concern modifications.

    At least two reasons motivate the focus on insider selling. First, the information content of the two types of auditor opinion is asymmetric. First-time going-concern opinions induce significantly negative market reactions, while clean opinions do not generate positive market reactions. Insiders are therefore less concerned about buying and the subsequent receipt of a clean opinion. Second, Roulstone (2008) argues that bad-news disclosures are more likely to trigger investor lawsuits that allege inadequate disclosure by management. Such lawsuits usually use pre-disclosure insider selling to indicate management’s foreknowledge of bad news. Thus, in contrast to insider purchases ahead of good news, insider sales ahead of bad news carry a significant legal risk.

    Design/Method/ Approach:

    The authors obtain insider trading data from Thomson Reuter. They obtain information about audit opinions and audit fees from Audit Analytics for the period 2000 through 2007. They then match the audit opinion data with the Compustat industrial annual file, the Center for Research in Security Prices (CRSP) database, and the Insider Trading database. The final sample retains 12,329 firm years, consisting of 801 observations with first-time going-concern opinions and 11,528 observations with clean opinions.

    • The authors find evidence that a higher level of insider selling is associated with a lower likelihood of receiving a first-time going-concern report.
    • For a one standard deviation increase in insider selling, the probability of receiving going-concern reports decreases by 1.39 percent.
    • The negative relation between insider selling and the probability of receiving a going-concern opinion is stronger for firms that are more economically important to their auditors but weaker for firms whose auditors have greater concerns about litigation exposure and reputation loss and for firms with more independent audit committees.
    • Auditors who issue clean opinions for clients with higher levels of insider selling have a lower frequency of dismissals in the subsequent year.
    • These results are consistent with the notion that management influences auditors’ opinions but are inconsistent with the notion that insiders reduce their selling in anticipation of going-concern reports.
    • The negative relation between insider selling and the likelihood of receiving a going-concern opinion holds for the pre- and post-SOX periods but is significantly weaker in the post-SOX period.
    Accountants' Reporting, Risk & Risk Management - Including Fraud Risk, Standard Setting
    Going Concern Decisions, Going Concern Decisions, Impact of SOX, Litigation Risk