Anticipation and reaction to going‐concern modified audit opinions by sophisticated investors

Institutional investors are an integral part of the financial markets and prior research finds that they often react to price-relevant information before its public release. We examine the trading behavior of institutional investors surrounding first-time going concern modified audit reports and find that institutional investors are net sellers of these firms beginning six months before the release of the report and remain net sellers through the subsequent three months. We also find that institutional investors are net sellers of firms that subsequently file for bankruptcy beginning three months prior to their receipt of a first-time going concern report and that the severity of the reasons auditor’s modify their reports is associated with trading activity, but only after the reports are publically available. Our study supports the premise that institutional investors are able to anticipate price-relevant information and that they react to this anticipation through their trading behavior.