AUDITORS AND ‘BUBBLES’: THE CASE OF INTERNET IPOs
Andrew J. Leone
School of Business
University of Miami
[email protected]
Sarah Rice
School of Business
University of Connecticut
[email protected]
Joseph P. Weber
Sloan School of Management
Massachusetts Institute of Technology
[email protected]
Michael Willenborg
School of Business
University of Connecticut
[email protected]
We thank David Erkens, Clive Lennox, Srini Sankaraguruswamy, Ann Vanstraelen, Jonathan
Weil and participants at Cornell University, Hong Kong University of Science and Technology,
International Symposium on Audit Research in Maastricht, Singapore Management University,
University of Southern California, University of Toronto and Yale University.
October 2, 2009
AUDITORS AND ‘BUBBLES’: THE CASE OF INTERNET IPOs
ABSTRACT
How do auditors behave during periods of market euphoria? To address this question, we study
auditor going-concern opinions around the time of the wave of stressed Internet companies filing
to go public on Nasdaq; a period of time that many characterize as the ‘dot com bubble’. We
find that during the 16-month period from January 1999 to April 2000 of very high volume of
stressed Internet companies attempting to go public, in contrast to non-Big5 audit firms (which
did not experience an increase in transaction volume of auditing such companies), Big5 audit
firms became much less likely to render going-concern opinions. Given this, we focus in on the
Big5 firms and report strong evidence that the presence of a going-concern opinion varies
inversely with both the number of such registrants a given Big5 firm was signing off on, and
with our proxy for venture capitalists’ rushing the registrant to market. Taken together these
findings seem consistent with the inference that the Big5 firms acceded to buoyant Internet IPO
audit market conditions by lowering their frequency of going-concern opinions.
“When you get a ‘going concern’ letter, the average investor says that’s a terrible thing. It doesn’t mean that at all.
The Internet is a brand new thing, and we don’t know the rules yet” – C. Everett Koop, M.D. (Simmons 2000)
1.
Introduction
The study of periods of market euphoria, such as Holland’s 17th-century ‘tulip mania’,
Britain’s 18th-century South Sea Company, America’s 19th-century railroads or, most recently, its
housing market, is of keen interest to economists. Theorists specify conditions under which
participants and / or institutions cause such ‘bubbles’ to arise and persist, and empiricists test
associated participant- and / or institution-centric explanations.1
In this paper, we study a
different type of market participant other than those (e.g., investors, advisors) that stand to gain
directly from price appreciation. Our interest is how auditors, as financial ‘gatekeepers’, behave
during such periods of euphoria. Given both the auditor’s longstanding role to act in the public’s
interest along with the seeming inevitability of bubbles (e.g., Rampell 2009), it is important to
examine the effect of such external market conditions on auditor decisions.
We study auditor opinion decisions around the time of the wave of stressed Internet firms
filing to go public on Nasdaq, the capital markets entry point for the companies that went on to
constitute what Ofek and Richardson (2003) term ‘dotcom mania’. Because of the confluence of
four empirical facts, the Internet IPO bubble provides an opportune setting for our research
question. One, there are only a few facets of the domestic audit market that are unambiguously
attributable to auditors; most notable of which are the specific audit firm and whether their
opinion expresses substantial doubt about a client’s ability to continue as a going concern. Two,
as many papers show (e.g., Hopwood, McKeown and Mutchler 1994), we observe going-concern
opinions only in instances when a company exhibits obvious indicators of financial stress (e.g.,
negative net income). Three, as Schultz and Zaman (2001) and Ljungqvist and Wilhelm, Jr.
1
With regard to theoretical literature, Hong, Scheinkman and Xiong (2008, p. 268) conclude “[m]otivated in part
by the behavior of Internet stocks during the late 1990s, a surge in new research has arrived at two conclusions. The
first is that differences in opinion among investors and short sales constraints are sufficient to generate a price
bubble. The second is that once a bubble begins, it is difficult for smart money to eliminate the mispricing (i.e.,
there are limits of arbitrage).” With regard to empirical literature, see for example: Schultz’s (2008) re-examination
of the role of short-sale constraints in the bursting of the Internet bubble; or Greenwood and Nagel’s (2009) study of
the relation between mutual fund manager age and their decisions to invest in technology and Internet stocks.
1
(2003) document, a clear ‘bubble’ took place during 1999–2000 in the IPO market consisting of
a sharp increase of offerings by stressed Internet companies (e.g., per Schultz and Zaman 2001,
over 90% of Internet companies that went public during the 15-month period from January 1999
through March 2000 were unprofitable)2. And, four, the SEC requires audit firms to consent to
inclusion of their opinion, which either does or does not refer to a stressed registrant’s goingconcern status, in their client’s IPO registration statement. Because of these four facts, the
Internet IPO bubble provides a relatively clean setting for our research question.
It is important to emphasize that in the opinion of some the answer to our research
question is that the behavior of auditors during such a time period is one of acquiescence.
“[b]ubbles … change the behavior of gatekeepers … in a bubble … auditors, and other gatekeepers may relax their
usual skepticism amidst the market euphoria that a sustained bull market generates … in an atmosphere of market
euphoria…investors generally rely less on gatekeepers …Accordingly, if we assume that euphoric investors will
largely ignore the auditor, the rational gatekeeper’s best competitive strategy, at least for the short term, is to become
as acquiescent and low cost as possible.” (Coffee 2004, p. 278, 293)
However, while it may seem logical to think auditors would become acquiescent during the
Internet IPO bubble, there are reasons to question this characterization. For one, the specter of
litigation risk under the Securities Act of 1933 should invoke a conservative discipline on
auditors when conducting an IPO audit. For another, in contrast to other gatekeepers (e.g.,
attorneys, investment bankers), independence rules preclude auditors from benefiting in their
client’s stock price upside. Also in contrast to others, professional standards require auditors to
maintain a degree of skepticism. Perhaps most important, given that if they have substantial
doubt about a client’s going-concern status that professional standards require auditors to
evaluate management’s plans, if a company envisions seasoned equity offerings to finance dayto-day operations it is appropriate for auditors to consider equity market conditions when making
their going-concern opinion decisions. Because of this, some of what may appear, ex post,
2
See also Ritter and Welch (2002, p. 1801), “… it was unusual for a prestigious investment banker in the 1960s
and 1970s to take a firm public that did not have at least four years of positive earnings. In the 1980s, four quarters
of positive earnings was still standard. In the 1990s, fewer and fewer firms met this threshold. Still, the investment
banking firm’s analyst would normally project profitability in the year after going public. During the bubble, firms
with no immediate prospect of becoming profitable became common.”
2
consistent with acquiescence may be more apt to characterize as ex ante reasonable by auditors.
As such, it is important to consider the effects of equity market conditions when examining
auditor decisions during a period of euphoria such as the Internet IPO bubble.
However, having said this, the perception of auditor acquiescence during the Internet IPO
bubble may have merit. While a bubble market for IPOs clearly implies a bubble market for IPO
audits, the Internet IPO market was unique in terms of its very high volume of fledgling,
unprofitable, venture-backed companies with prestige underwriters. Upon confronting this wave
of stressed registrants (along with their professional investors and reputable advisers), given the
fees they could earn and expect to earn, there were arguably ample opportunities and economic
incentives for auditors to acquiesce. Extending Schultz and Zaman’s (2001, p.348) observation
that the “hot issue market for Internet initial public offerings is an unprecedented phenomenon”,
Internet IPOs were a hot audit market without precedent.
We start by identifying a sample of Internet companies filing to go public on the Nasdaq
from March 1996 to December 2000, the very large majority of which evidence an obvious
indicator of financial stress (negative net income, negative operating cash flow, or negative
stockholders’ equity). Upon sorting these stressed registrants by the day on which the auditor
signs the opinion in the registration statement, it is evident that the Internet IPO audit market
bubble inflates quickly in January 1999 (as auditors begin signing off on audits of December
1998 financial statements) and bursts abruptly in April 2000. We examine auditor opinions
during this 16-month (bubble) period vis-à-vis the surrounding (non-bubble) periods.
From the standpoint of the market for auditing services, it is important to emphasize that
this 16-month audit market bubble was a period during which the Big5 firms were especially
dominant, with a market share that increases from 85% to 97%. Specifically, the number of
stressed Nasdaq Internet IPO registrants on which the Big5 (non-Big5) firms opine increases
from 2.4 (0.4) per month for the 36-months from January 1996 to December 1998 to 28.4 (1.0)
per month for the 16-months from January 1999 to April 2000. In essence, and likely due to the
large fraction of registrants with venture backing and prestige underwriting, the Internet IPO
3
bubble was a Big5 phenomenon. Put another way, the non-Big5 audit firms, most of which audit
just a single registrant in our sample, did not experience an increase in transaction volume of
stressed Internet IPOs (i.e., the non-Big5 auditors did not experience an audit market bubble).
Our tests pertain to the auditor’s decision to issue a going-concern opinion, and focus on
whether the incidence of such opinions varies with audit market conditions. For our multivariate
tests, we are mindful of the clientele differences associated with the types of companies that
retain Big5 versus non-Big5 auditors and to control for relevant covariates. To accommodate
clientele effects, we run regressions by audit firm type (Big5 / non-Big5) and pool these types
only to estimate the difference-in-differences in observing going-concern opinions between audit
firm types between market conditions (non-bubble / bubble). In terms of covariates, we control
for characteristics that the literature associates with going-concern opinions for already-public
companies (i.e., financial distress, debt default / covenant violation, company size) and for those
specific to our IPO context (i.e., age, start-up status, cash burn rate, underwriter reputation and
venture backing). We find that the presence of a going-concern opinion in an IPO registration
statement of a stressed Internet company varies positively with financial distress and cash burn
rate, and negatively with the presence of prestige underwriters and venture capital backing.
In terms of our research question, we use the difference in Internet IPO volume between
Big5 and non-Big5 firms to motivate our initial test. In contrast to the non-Big5 firms, which did
not experience an increase in auditing stressed Internet IPOs, we find that Big5 firms
significantly lower their rate of going-concern opinions in the bubble. This evidence is present
in descriptive statistics and multivariate tests. Of note, we observe a sharp decrease in the rate of
the Big5 render going-concern opinions coinciding with a sharp increase in the number of
stressed Internet registrants on which these audit firms were signing off. For the first quarter of
1999 (i.e., before the doubling of the Nasdaq Composite Index from April 1999 to March 2000),
4
the Big5 render three going-concern opinions for 120 stressed Internet IPO registrants (2.5%)
versus three going-concern opinions for 18 such clients (16.7%) for the first quarter of 1998.3
Given this, we focus the remainder of our tests on Internet IPO registrants with Big5
auditors. We examine the following possible influences that could lead auditors to shift their
going-concern opinion decision criteria in the Internet bubble: 1) equity-market expectations,
which we proxy with the return on the Nasdaq Composite Index for the three months prior to the
month the auditor signs the opinion in the IPO registration statement; 2) ‘dotcom mania’ which,
following Carter, Dimitrov and Rau (2001), we proxy with whether the registrant’s name
contains ‘dot com’ or ‘dot net’ or ‘Internet’; 3) the influence of transaction volume which,
instead of a simple dichotomous measure to capture the audit market bubble, we proxy with the
number of stressed, Internet IPO registrants for which a given Big5 firm renders an opinion in
the three months prior to the month during which it signs the opinion for a stressed Internet IPO
client; 4) auditor switching costs, which we proxy with whether the auditor’s office is within 50
miles of San Francisco, the nexus of Internet IPO companies; and 5) pressure to complete the
audit, particularly to facilitate a venture capitalist’s rush to market, which we proxy with whether
the number of calendar days from audit sign-off date to SEC filing date is ten or fewer.
Of these, our multivariate test results lend support to 3) and 5), the influence of
transaction volume and pressure to complete the audit to facilitate a venture-backed registrant’s
rush to market, respectively. We find that, ceteris paribus, the presence of a Big5 going-concern
opinion for a stressed Internet IPO registrant varies inversely with both the lagged number of
such companies these firms were signing off on and with whether the audit report date is within
10 calendar days of SEC filing date. Taken together, we interpret these findings as consistent
with acquiescence by the Big5 upon encountering the wave of stressed Internet IPO registrants.
3
This finding is counter to a contemporaneous increase in the frequency of going-concern opinions for the overall
Compustat population of stressed, already-public companies. Aside from a few ‘strange cases’, such as PwC’s
opinion in Drkoop.com’s 1999 S-1 filing (see our opening quote), the large majority of Big5 opinions during the 16month Internet IPO bubble do not express substantial doubt regarding a stressed registrant’s going-concern status.
5
We then attempt to assess consequences to IPO investors, if any, of the decrease in the
frequency of Big5 going-concern opinions during the Internet bubble and / or whether this
decrease is a reflection of greater access to equity financing (for which our cash burn covariate
inadequately controls). To do this, we track the listing status of the common stock of those
registrants that were able to successfully complete their IPO. We find a significant increase in
delisting within a two-year horizon by IPOs with clean audit opinions. Specifically, during our
pre-bubble period less than three percent of IPOs with clean Big5 opinions delist for deleterious
reasons within two years; whereas, during our bubble period this frequency increases four-fold to
eleven percent. Although we cannot rule out the effects of ready access to capital on auditor
opinion decisions, this finding suggests that Big5 firms became less effective at gauging the
effects of access to capital on a stressed company’s ability to continue as a going concern during
the Internet bubble and / or that their opinions became less useful to investors. We stress that we
are not drawing inferences about audit quality in accordance with professional standards, nor that
the Big5 are to blame for failing to foresee the bursting of the Internet bubble. Indeed, because
we find a sharp decrease in the rate of Big5 going-concern opinions that is simultaneous with a
sharp increase in volume of stressed Internet IPO registrants, our results suggest Big5 firms were
quick to ‘join the Internet party’ (as opposed to failing to foresee its’ abrupt end).
In our last analysis, we examine the going-concern opinions of the individual Big5 audit
firms. To do this, we use the Big5’s going-concern decisions during our 36-month pre-bubble
period to develop an expectation for their opinion decisions during our 16-month bubble, and
then contrast this expectation with each Big5 firm’s actual going-concern decisions. The major
finding of this analysis is that Arthur Andersen’s opinion decisions seem most lenient.
Independent auditors play a crucial role in the capital-raising process, though this role is
largely invisible to market participants. Indeed, from a financial statement user’s perspective,
the two visible facets are the audit firm and the audit opinion, which infrequently departs from a
standard, unqualified report. While these facets have ongoing value, they are arguably of special
value during periods of market euphoria because auditors are in arguably the best position among
6
‘gatekeepers’ to be objective. We examine these facets during a recent period of euphoria in the
equity and audit markets, the Internet IPO bubble. Overall, our findings are consistent with the
inference of Big5 auditors acceding to buoyant audit market conditions during the Internet IPO
bubble by lowering their frequency of going-concern opinions. We emphasize, however, that a
limitation of our study is that the presence of going-concern opinions for a company filing to go
public are low-frequency event; as are the occurrence of asset-pricing bubbles, which some
assert occur with generational frequency (Greenwood and Nagel 2009).
Section 2 discusses background and motivation; Section 3 covers the sample and
descriptive statistics; Section 4 provides the empirical analysis; and Section 5 concludes.
2.
Background and proxy variables of interest
By most accounts the Internet IPO market was a phenomenon without precedent, both in
terms of the very high volume of fledgling companies trying to go public and, for those that did,
by their very high level of first-day returns (Schultz and Zaman 2001). While some theoretical
papers show conditions under which the pricing of Internet stocks may have been rational
(Schwartz and Moon 2000; Pástor and Veronesi 2006), most literature characterizes this
phenomenon as a ‘bubble’ (e.g., Ljungqvist and Wilhelm, Jr. 2003). Following this, studies
examine potential causes of the bubble, such as a rush to grab market share (Schultz and Zaman
2001), a ‘get big fast’ cascade (Goldfarb, Kirsch and Miller 2007), stock analyst affiliation
(Bradley, Jordan and Ritter 2008), or misperceptions regarding the long-term benefits of
investing in stocks (Brennan 2004).4
In terms of transaction volume, Ljungqvist and Wilhelm Jr. (2003) report the number of
Internet IPOs increases gradually from 19 in 1996 to 22 in 1997 to 39 in 1998 and then sharply
4
The finance literature also examines explanations for why, in early Spring 2000, the Internet bubble burst so
abruptly, such as lockup expirations and insider selling (Ofek and Richardson 2003; Schultz 2008) as well as for the
high levels of Internet IPO underpricing (Ljungqvist and Wilhelm, Jr. 2003). There also exists an accounting
literature examining the valuation and returns of Internet stocks (Truman, Wong and Zhang 2000, Demers and Lev
2001, Bartov, Mohanram and Seethamraju 2002, Davis 2002, Core, Guay and VanBuskirk 2003, Rajgopal,
Venkatatachalam and Kotha 2002 and 2003, and Keating, Lys and Magee 2003).
7
to 257 in 1999 to 135 in 2000; of which, the majority were in the first half of 2000 (see also
Schultz and Zaman 2001). Moreover, the large majority of these issuers, particularly those going
public in 1999 and 2000, display clear indicators of financial distress (e.g., negative net income);
the presence of which are well known (e.g., Hopwood, McKeown and Mutchler 1994; DeFond,
Raghunandan and Subramanyam 2002) pre-requisites to observing a going-concern audit
opinion. Our interest is in the auditor’s role during this bubble, in terms of whether their goingconcern opinion decisions vary with changes in market conditions. To examine this, we suggest
the following (non-mutually exclusive) mechanisms that could lead auditors to shift their goingconcern opinion criteria in a bubble such as the Internet IPOs.
2.1
Whether or not an audit firm actively participates in the ‘bubble’
Likely because of the high fraction of IPO registrants with the backing of venture capital
firms and the underwriting of prestigious investment bankers (Schultz and Zaman 2001), the
Internet IPO bubble was a period during which the Big5 audit firms were especially dominant.
Because of limits to their participation in the audit-market bubble, there are limits to the extent to
which a non-Big5 firm could vary their opinion decisions. Simply put, since the non-Big5 firms
did not really participate in the bubble, they did not have an opportunity to acquiesce. Following
this, for our initial test, we use the non-Big5 firms as a benchmark to compare the opinion
decisions of the Big5 firms for the audit market ‘bubble’ period versus ‘non-bubble periods’.
While such a test is subject to concerns regarding endogenous auditor choice, our focus on a test
of the difference-in-differences renders them moot. This test for acquiescence by the Big5 audit
firms is (Pr(GC)Big5,
Bubble);
Bubble)
Bubble
– Pr(GC)Big5,
Non-Bubble)
< (Pr(GC)Non-Big5,
Bubble
– Pr(GC)Non-Big5,
Non-
or: (Pr(GC)Big5, Bubble – Pr(GC)Non-Big5, Bubble) – (Pr(GC)Big5, Non-Bubble – Pr(GC)Non-Big5, Non-
< 0.
To carry out this test, we regress the presence of a going-concern opinion on three
indicator variables: one for the presence of a Big5 audit firm (Big5); another for the period of
sharp increase in Internet IPO audit transaction volume (Bubble); and another for the interaction
8
between them (Big5*Bubble). The test of the difference-in-differences, as per the latter algebraic
formulation, is whether the coefficient on Big5*Bubble is significantly less than zero.
In
addition, to assess whether we can attribute such a finding to Big5 firms, we also test whether the
sum of the coefficients for Bubble and Big5*Bubble is significantly less than zero.
2.2.
Mechanisms that could lead auditors to shift their going-concern criteria
While we argue that a test of the difference-in-differences mitigates certain econometric
concerns, notably selection, it is nevertheless susceptible to potentially serious problems with
respect to identification and parameter estimation. In terms of identification, the problem is it
seems likely that other things were taking place during the period from January 1999 to April
2000 that we define as the audit market bubble. In terms of parameter estimation, the problem is
that the non-Big5 firms were very minor players in this bubble. In this section, we suggest five
potential mechanisms that could lead auditors to shift their going-concern criteria in the Internet
IPO bubble, the first two of which do not pertain to the notion that auditors became acquiescent.
2.2.1. Equity-market conditions
If an auditor has substantial doubt regarding the client’s ability to continue as a going
concern, professional audit standards require they evaluate management’s plans for dealing with
this uncertainty. If the client is going public and management’s plans envision subsequent equity
offerings to finance day-to-day operations (as was common for Internet IPO companies), it
seems particularly salient for auditors to consider equity market conditions when formulating
their going-concern opinion decisions.5
If auditors expect equity market performance to
increase, we would expect that the frequency of going-concern audit opinions should decrease.
5
It is worthwhile noting that some assert auditors may have gone too far regarding their equity market expectations.
Per Weil (2001, C1): “if an auditor has substantial doubt about a client’s ability to continue as a going concern, it
must say so in its report on the company’s financial statements. Investors often take those warnings to mean ‘run for
the hills’ and the inclusion of one can kill a company’s plans to go public…but rather than questioning the
sustainability of the bubble at a time when some dot-coms had stock-market valuations at several hundred times
their revenues, critics say many auditors appear to have presumed the capital markets would remain buoyant ”
9
Our proxy for the auditor’s equity market expectations is the Nasdaq composite index return for
the three months prior to the month in which the auditor signs the opinion that appears in the
registration statement (Nasdaq3).
2.2.2. ‘DotCom Mania’
With the benefit of hindsight, particularly given the disappearance of the spectacular
returns on Internet stocks (e.g., over 1000% in a period of less than two years ending with
February 2000), it is arguable that some market participants were in the grips of what Ofek and
Richardson (2003, p. 1113) term ‘dotcom mania’.
One prominent example suggestive of
irrationality is Cooper, Dimitrov and Rau (2001), which documents very large positive stock
price appreciation to a sample of companies that change to an Internet-related dotcom name.
They conclude (p. 2387), “[w]e argue that our results are driven by a degree of investor mania –
investors seem to be eager to be associated with the Internet at all costs … [e]vidence of investor
mania seems especially true when we consider the finding that firms with little or no sales
generated from the Internet experience the greatest long-horizon returns.” To test whether
auditors were susceptible to such mania, we follow Cooper et al. (2001) and specify an indicator
variable if an Internet IPO registrant has a name containing ‘dotcom’, ‘dotnet’, or ‘Internet’
(DotName).
An inverse association between the presence of a going-concern opinion and
DotName would suggest irrationality, as opposed to acquiescence, on the part of Big5 firms.
2.2.3. The extent to which an audit firm participates in the ‘bubble’
In Section 2.1, we advance a testable implication of auditor acquiescence that hinges on
whether (or not) a particular audit firm type actively participates in the audit-market bubble. For
at least three reasons, this is not a strong test: one, our definition of the audit-market bubble is ex
post; two, because many other phenomena are likely associated with the surge in Internet IPO
transaction volume, a simple dichotomous variable (i.e., Bubble) is a somewhat weak proxy for
the construct of auditor acquiescence; and three, because the non-Big5 firms play such a small
10
role in the Internet IPO audit market, using their opinion decisions as a benchmark to compare
the opinion decisions of the Big5 is a low power test.
Following Antle’s (1982) characterization of auditors as expected utility maximizers (see
also Goldman and Barlev 1974), because they are economic agents that their clients hire, pay and
retain, it is critical to consider the auditor’s incentives when examining their decisions. To
specify an ex ante proxy for the effect of auditor incentives on their Internet IPO opinion
decisions, we use the number of stressed Internet IPO registrants for which a Big5 firm renders
an opinion during the three months prior to the month during which they sign the opinion for a
given stressed Internet IPO client (Clients3). We interpret an n inverse association between
going-concern opinions and Clients3 as consistent with auditor acquiescence.
2.2.4. Auditor switching costs
As a client’s cost of changing auditors decreases, this should lead to an increase in the
client’s threat to replace their incumbent auditor who then may feel pressure to acquiesce so as to
retain the client (Matsumura, Subramanyam and Tucker (1997). Given its nexus during the
Internet IPO bubble, we proxy for the client’s cost of changing auditors in terms of whether the
auditor’s office is within 50 miles of San Francisco, California (NorthCalif). Because of the high
concentration of Internet companies in this region of the country (over 30% of our sample), and
the familiarity that auditors have with their business models, the costs of changing auditors
should be lower in this geographic area. If so, ceteris paribus, a lower frequency of goingconcern audit opinions in this region would be consistent with auditor acquiescence.
2.2.5. Pressure to complete the audit engagement to facilitate a ‘rush to market’
Using a sample of privately-financed biotechnology companies, Lerner (1994) provides
support for the view that venture capitalists are adroit at timing the IPO of the companies they
back public at or near market peaks. In a survey of chief financial officers, Brau and Fawcett
(2006) report that the presence of venture backing significantly raises managerial awareness
11
regarding the timing of an IPO to coincide with factors such as overall stock market condition
and the need to obtain capital to facilitate future growth.
In the case of IPOs by Internet companies, Schultz and Zaman (2001, p. 349) observe that
“… venture capitalists are far more likely to be involved with IPOs of Internet firms than other
IPOs.” Because an IPO registration statement must contain audited financial statements, if a
venture-backed registrant is being ‘rushed to market’, auditors may feel pressure to complete
their engagement and acquiesce by rendering a clean opinion.
However, because venture
capitalists play key roles in the development, financing, governance and monitoring of the
companies they back (Lerner 1995; Gompers 1995; Kaplan and Stromberg 2003; Hochberg,
Ljungqvist and Lu 2007), the issue is whether such pressure is distinct from an otherwise likely
inverse relation between the presence of a going-concern opinion and venture backing. To test
this, we specify three indicator variables: one for whether the IPO registrant has venture capital
backing (VC); another for whether the number of days from audit opinion date to the day the
company files its initial IPO registration statement is ten or fewer (RushToMkt); and another for
their interaction (RushToMkt*VC). Upon regressing the presence of a going-concern opinion on
these indicator variables, our interest is in whether the coefficients for RushToMkt and
RushToMkt*VC are less than zero. If so, this would support the inference that auditors were
acquiescing by providing a clean opinion to registrants rushing to go public.
3.
Sample, variables and descriptive statistics
3.1
Sample
As per panel A of Table 1, we use www.alert-ipo.com to identify 816 IPO filings from
March 1996 to December 2000 by companies this website designates ‘Internet-related’. Of these
816, we: cannot find a prospectus on Edgar for 47 registrants; eliminate 75 registrants that are
spin-offs from already-public companies; exclude 34 foreign registrants because of differences in
international audit standards; eliminate 39 companies because they do not file to go public on
Nasdaq (e.g., OTC Bulletin Board and NQB Pink Sheets); and exclude one company because it
12
has a pre-1996 audit opinion date. Of the remaining 620 companies, we exclude 34 (5.5%) that
do not manifest negative net income, or negative operating cash flow, or negative equity (after
excluding redeemable / convertible equity, if any). We eliminate such companies because prior
research emphasizes the conditioning analysis of going-concern opinions on financial stress
(Hopwood, McKeown and Mutchler 1994; Reynolds and Francis 2000; DeFond, Raghunandan
and Subramanyam 2002). Our sample consists of 586 stressed, stand-alone, domestic Internet
companies that, for the period from March 1996 to December 2000, file to go public on Nasdaq.
Panel B of Table 1 partitions these 586 registrants by audit opinion date, auditor type, and
audit opinion type. From the standpoint of the month during which the auditor signs their
opinion for these registrants, the Internet IPO audit market bubble inflates quickly in January
1999. For the 12 quarters prior to this, auditors sign opinions for 102 stressed, domestic Internet
companies that file to go public on Nasdaq (approximately 3 per month); of which 85.3% (87 of
102) have Big5 auditors and 18.6% (19 of 102) have a going-concern opinion on the financial
statements in their IPO registration filing. Consistent with clientele effects, the frequency of
going concern opinions varies significantly by auditor type, at 12.6% for Big5 versus 53.3% for
non-Big5 auditors (a z-statistic for the change in proportions of –3.95, significant beyond 1%).
For the next 16 months, from January 1999 through April 2000, auditors sign opinions
for 470 stressed, domestic Internet companies filing to go public on Nasdaq (almost 30 per
month, or a ten-fold increase in transaction volume over our pre-bubble period), of which 96.6%
(454 of 470) have Big5 auditors and 4.3% (20 of 470) have going-concern opinions.6 The
decrease in the frequency of going-concern opinions stems from the Big 5 firms, which also
substantially increase their market share of stressed Internet registrants during the bubble. For
registrants with Big5 auditors, the going-concern rate drops from 12.6% during 1996–1998 to
2.6% during January 1999–April 2000 (a z-statistic –4.24, significant beyond 1%).
6
This period of time that we define as the Internet ‘bubble’ is consistent with the empirical finance literature (e.g.,
see Schultz and Zaman 2001, Ljungqvist and Wilhelm 2003, and Bradley, Jordan and Ritter 2008).
13
Of note, per Figure 1, the frequency of Big5 going-concern opinions declines sharply to
2.5% (3 of 120) during the 1st quarter of 1999 (i.e., a period of time prior to the doubling of the
Nasdaq Composite Index from April 1999 to March 2000) from 16.7% (3 of 18) during the 1 st
quarter of 1998. In contrast, the frequency of going-concern opinions for registrants with nonBig5 auditors, which do not experience a substantial increase in stressed Internet IPO transaction
volume, decreases slightly to 50.0% (8 of 16) during the 16-months from January 1999 to April
2000 from 53.3% (8 of 15) during 1996–1998 (a z-statistic –0.19, insignificant).
For the next 8 months, from May 2000 to December 2000, auditors sign opinions for just
14 stressed Internet companies that file to go public on Nasdaq (less than 2 per month); 13 of
which have a Big5 auditor, and one of which has a going-concern opinion. To accord with our
regression framework, for which the intercept relates to companies that auditors sign off on in
non-bubble periods, Panel B of Table 2 provides the results of tests of differences in proportions
between bubble and a combination of pre-bubble and post-bubble periods. All descriptive
findings that we discuss above also hold upon comparing the 16-month bubble with the
surrounding 44-months (i.e., 36-month pre-bubble plus 8-month post-bubble).
It is important to emphasize this decrease in the frequency of going-concern opinions is
not evident for the Compustat population of stressed companies with Big5 auditors. For public
companies with Big5 auditors and 1996-1997 financial statement dates (likely have 1997-1998
opinion dates) and any of our three indicators of financial stress, the going concern rate averages
14.8% (14.0% in 1996 and 15.6% in 1997). In contrast to our findings with respect to stressed
Internet IPO registrants, for stressed public companies with Big5 auditors and 1998-1999
financial statement dates (likely have 1999-2000 opinion dates), the going concern rate increases
to an average of 18.3% (18.3% in 1998 and 18.2% in 1999).7 More important than the difference
7
Because EDGAR filing compliance was not yet mandatory, we do not include 1995 financial statement dates (i.e.,
that likely have 1996 audit opinion dates) for which Big5 auditors render going-concern opinions for 15.9% of their
clients (but the number of companies with Big5 auditors on EDGAR is less than half that in 1996). For stressed
companies on Compustat with NonBig5 auditors, the going-concern rate fluctuates as follows: 28.2%, 26.6%,
26.7% and 27.3% for 1996 through 1999 financial statements, respectively (18.9% for 1995).
14
in direction of change between stressed public companies and our stressed Internet IPO sample is
the magnitude of the difference. During our pre-bubble period, the difference is 2.2%; or 14.8%
going-concern rate for stressed, non-IPO companies minus 12.6% for stressed Internet
companies. During our bubble and post-bubble periods, it increases to 15.5%; or 18.3% for
stressed, non-IPO companies minus 2.8% for stressed Internet companies (a weighted average of
2.6% bubble and 7.7% post-bubble, see Table 1 panel B).
These results are important because our initial test specifies a time-period indicator
variable (Bubble) to capture changes in auditor going-concern decisions. However, other factors
likely influence such decisions in a given time period. If these other factors affect auditor
opinion decisions overall, we could also observe a decline in the rate of going-concern opinions
in the general population. By showing this is not the case we reduce concerns that Bubble is
reflective of these other factors.
In panel C of Table 1, we also present descriptive statistics of the frequency of goingconcern audit opinions for these 586 Internet IPO registrants that we sort by audit firm and audit
opinion date time period and present. Other than Arthur Andersen, which did not render a single
going-concern opinion for any of its eight pre-bubble clients, each Big5 firm evidences a
decrease in frequency of their going-concern opinions during the bubble.8
3.2
Independent variables
Our independent variables comprise three groupings: the first is control variables that are
standard in empirical going-concern studies; the second is control variables specific to an IPO
setting; and the third is our variables-of-interest. For the first group, we specify three variables.
Distress is per Zmijewski (1984) and, as such, incorporates return on assets, liabilities to assets
and current ratio; all of which are per audited financial statements in the IPO registration
8
There is also considerable variation in audit firm market share. For example, while PricewaterhouseCoopers
audits almost 33% (185 of 586) of sample observations, Deloitte & Touche’s market share is only about 7% (43 of
586). Moreover, there is considerable inter-temporal variation, as some firms substantially expand their market
share during the bubble (e.g., Arthur Andersen) whereas others contract their market share (e.g., KPMG).
15
statement. DebtFn is an indicator variable equal to one if the registrant’s debt footnote discloses
a payment default, a covenant violation, or that a default / violation has been waived or cured
(Chen and Church 1992; Foster, Ward and Woodroof 1998). Assets are total assets from the
audited balance sheet in the IPO registration statement.
We specify five covariates specific to our IPO setting. Age is the number of years from
company founding (or incorporation, if founding date is unavailable) and the year of IPO filing.
We expect that younger IPO registrant companies are more likely to receive a going-concern
opinion. StartUp is an indicator variable equal to one if annualized, pre-IPO revenues are less
than $1 million. We expect companies in start-up stage to be more likely to receive a goingconcern opinion. PrestigeIB is an indicator variable equal to one if the lead underwriter has the
highest Carter, Dark and Singh (1998) / Loughran and Ritter (2004) rank.9 VC is an indicator
variable equal to one if the IPO has venture capital backing.
Because of the monitoring,
development and governance roles that prestigious underwriters and venture capitalists play, we
expect both PrestigeIB and VC to be negatively associated with going-concern opinions.
CashBurn is a measure of the extent to which a registrant’s IPO proceeds plus liquid assets could
sustain its historical operating and investing cash flows. To compute this, we divide the sum of
annualized pre-IPO operating and investing cash flows by the sum of IPO proceeds and pre-IPO
cash / marketable securities and then (because the numerator is negative more than 95% of the
time) multiply this quotient by minus one (see Keating, Lys and Magee 2003). A larger positive
CashBurn suggests a company is more likely to consume its IPO and on-hand cash more quickly.
We expect a positive association between CashBurn and the presence of going-concern opinions.
We specify several variables-of-interest. Bubble is an indicator variable equal to one if
the day on which the auditor signs the opinion in the IPO registration statement is during the 16month audit-market bubble from January 1999 to April 2000. Nasdaq3 is the cumulative raw
return on the Nasdaq Compsite index for the three calendar months prior to the month in which
9
PrestigeIB underwriters are Credit Suisse First Boston, Deutsche Bank, Donaldson, Lufkin and Jenrette, Goldman
Sachs, J. P. Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley Dean Witter and Salomon Smith Barney.
16
the auditor signs the opinion in the registration statement, and is our proxy for the influence of
equity market conditions on going-concern decisions. DotName is an indicator variable equal to
one if registrant’s name contains ‘dot com’, ‘dot net’, ‘Internet’, and zero otherwise (Cooper,
Dimitrov and Rau 2001), and proxies for the influence of ‘dotcom mania’ on auditor decisions.
We specify four variables to proxy the construct of auditor acquiescence. NorthCalif is
an indicator variable equal to one if the auditor’s office is within 50 miles of San Francisco,
California (i.e., Mountain View, Oakland, Palo Alto, San Francisco, San Jose or Walnut Creek),
and is our proxy for the effect of switching costs on auditor decisions. Clients3 is the number of
stressed, Internet IPO registrants for which a specific Big5 audit firm renders an opinion during
the three calendar months prior signing the opinion for a given stressed Internet IPO registrant
(e.g., prior to their March 14, 1999 going-concern opinion for drkoop.com, PwC had signed
opinions for 23 other stressed Internet IPO clients during the three-month period from December
1998 through February 1999). Since this variable ranges from zero to 44, we logarithmically
transform it for our regression specifications.10 RushToMkt is an indicator variable equal to one
if the number of days from audit opinion date to the day the IPO registrant files their initial SEC
registration statement is ten or less. Because Lerner (1994) shows that venture capitalists are
adroit at timing the IPO market, we specify RushToMkt*VC, which is the interaction between
RushToMkt and an indicator variable equal to one if the registrant has venture backing (VC).
3.3
Descriptive statistics
Table 2 presents descriptive statistics by audit opinion date (January 1996–December
1998 pre-bubble / January 1999–April 2000 bubble / May 2000–December 2000 post-bubble)
and audit opinion type (going concern / non-going concern). Panel A is for registrants with Big5
audit firms and panel B is for registrants with non-Big5 audit firms.
10
Primarily because 15 of the 20 NonBig5 audit firms in our sample audit only one registrant each, and another
three NonBig5 firms audit just two registrants each (one in our ‘pre-bubble’ period and one in our ‘bubble’ period),
specification of the #Clients3 variable is not feasible for the NonBig5 audit firms in our sample (e.g., this variable is
equals zero for 28 of 32 NonBig5 observations; and ranges from zero to two).
17
In terms of control variables that are standard in empirical going-concern studies, and
consistent with expectations, Internet IPO registrants with going-concern opinions have higher
Pr(Bankrupt) and lower Assets than their counterparts with clean opinions. In contrast to our
expectation, Internet IPO registrants with Big5 auditors that footnote disclose debt-related
problems (DebtFn) are less likely to have going-concern opinions.11 In terms of covariates
specific IPOs, stressed Internet IPO registrants with going-concern opinions are younger (Age),
more likely in StartUp stage, and less likely to have prestige investment banks (PrestigeIB) and
the backing of venture capital firms (VC)12.
In terms of differences for Big5 registrants between pre-bubble and bubble, of note, mean
and median values of Distress decline (e.g., for non-going-concern opinion companies, the mean
value of Distress decreases from 0.302 to 0.288). To understand this, it is important to note the
increase in the fraction of Big5 registrants with venture capital backing during the bubble. This
is because venture capitalists often infuse a pre-IPO company with liquid assets, which leads to
an increase in the current ratio and a decrease in Distress. During our pre-bubble period, mean
(median) Distress for the 18 companies with clean opinions but without venture backing is 0.336
(0.040) versus 0.430 (0.148) for the 62 such companies in the bubble, respectively.
As for our variables-of-interest, for both pre-bubble and bubble, the lagged-quarterly raw
return on the Nasdaq Composite (Nasdaq3) is lower for those IPOs with going-concern opinions;
and, not surprisingly, Nasdaq3 is higher during our bubble period than either pre- or post-bubble
periods. In terms of our proxies for auditor acquiescence, stressed Internet IPO registrants with a
Big5 going-concern opinion are more likely to have an audit firm with less recent participation in
11
The majority of cases where DebtFn equals one are when a creditor waives a payment default or cures a
covenant violation. Given a creditor’s knowledge of their debtor’s plans to go public, such waivers / cures are likely
not an unambiguous negative signal in our Internet IPO context.
12
The frequency of going-concern opinions declines from ‘pre-bubble’ to ‘bubble’ periods for Big5 registrants both
with and without venture backing. For registrants with venture capital backing, the going-concern rate declines
from 4.9% (3 of 61) during our ‘pre-bubble’ period to 1.6% (6 of 386) during our ‘bubble’ period; z-statistic for the
change in proportions of –1.69, significant beyond 10% two-tailed test. For registrants without venture capital
backing, the going-concern rate declines from 30.8% (8 of 26) during our ‘pre-bubble’ period to 8.8% (6 of 68)
during our ‘bubble’ period; z-statistic for the change in proportions of –2.67, significant beyond 1% two-tailed test.
18
the audit market bubble (Clients3), to reside in the San Francisco area (NorthCalif), and less
likely to have both venture capital backing and to file their initial IPO registration statement soon
after the auditors sign off on their financial statements (RushToMkt*VC).
Finally, consistent with expectations, our sample of Internet IPO registrants with Big5
auditors are less stressed, larger, less likely in start-up stage and more likely to have venture
backing and prestige underwriters than their counterparts with non-Big5 auditors.13 As we
discuss below, we accommodate clientele effects by estimating separate regressions by audit
firm type; and combine these types only for the purpose of testing the difference-in-differences.
4.
Empirical analysis
4.1
Going-concern reporting for stressed Internet IPO registrants
We include several controls in our going-concern regressions (Tables 3 and 4). We start
with Distress, DebtFn and Ln(Assets), the coefficients for which we expect should be positive,
positive and negative, respectively. Because Distress is per Zmijewski (1984), and incorporates
return on assets, liabilities to assets and current ratio, Distress, DebtFn and Ln(Assets)
encompass the primary factors (profitability, leverage, liquidity, debt trouble and size) extant
literature associates with company bankruptcy and / or the presence of a going-concern opinion.
We also control for Age, StartUp, CashBurn, PrestigeIB and VC. We expect the coefficients for
StartUp and CashBurn to be positive, and Ln(Age), HighIB and VC to be negative. Because we
are unwilling to assume the decisions by a given audit firm are independent, for all regression
estimations we compute robust standard errors that we cluster by audit firm.14
We begin with regressions to conduct multivariate tests for auditor acquiescence that we
discuss in Section 2.1, and our variables of interest are Big5, Bubble and Bubble*Big5.
We
13
The following relate to comparisons between the 554 IPOs with Big 5 auditors versus the 32 IPOs with NonBig 5
auditors, respectively: median Distress 0.029 versus 0.836 (significant beyond 1%): median Assets $13.644 million
versus $0.825 million (significant beyond 1%); mean StartUp 0.222 versus 0.625 (significant beyond 1%); mean VC
0.827 versus 0.094 (significant beyond 1%); mean PrestigeIB 0.606 versus 0.000 (significant beyond 1%).
14
Our sample contains the following 27 audit firms: Arthur Andersen, Deloitte & Touche, Ernst & Young, KPMG,
PricewaterhouseCoopers, Coopers & Lybrand (pre-bubble period only) Price Waterhouse (pre-bubble period only),
BDO Seidman, Grant Thornton and 18 different Non-National firms (only three of which audit more than one IPO).
19
estimate equation (1) separately for non-bubble and bubble periods, as our interest is the change
in Big5’s coefficient. We estimate equation (2) separately for registrants with Big5 and nonBig5 firms, as our interest is the change in Bubble’s coefficient. Last, we estimate equation (3)
using the full sample, as our interest is whether Bubble*Big5’s coefficient and the sum of the
coefficients for Bubble and Bubble*Big5 differ from zero.

1 if GCOpinion i, t 
0 Otherwise
 Stressi,t = 0 + 1Distressi,t + 2DebtFni,t + 3Ln(Assets)i,t + 4Ln(Age)i,t +


5StartUpi,t + 6CashBurni,t + 7PrestigeIBi,t + 8VCi,t + 9Big5i,t + i,t
(1)

1 if GCOpinion i, t 

0 Otherwise
 Stressi,t = 0 + 1Distressi,t + 2DebtFni,t + 3Ln(Assets)i,t + 4Ln(Age)i,t +


5StartUpi,t + 6CashBurni,t + 7PrestigeIBi,t + 8VCi,t + 9Bubblei,t + i,t (2)

1 if GCOpinion i, t 

0 Otherwise
 Stressi,t = 0 + 1PrDistressi,t + 2DebtFni,t + 3Ln(Assets)i,t + 4Ln(Age)i,t +



5StartUpi,t + 6CashBurni,t + 7PrestigeIBi,t + 8VCi,t + 9Big5i,t +

Where:
10Bubblei,t + 11Big5*Bubblei,t + i,t
GCOpinion
=
Distress
DebtFn
=
=
Ln(Assets)
Ln(Age)
StartUp
CashBurn
=
=
=
=
PrestigeIB
=
VC
Big5
Bubble
=
=
=
Big5*Bubble
=
(3)
One if the audit opinion in a IPO registration statement expresses substantial doubt about a
stressed registrant’s ability to continue as a going concern, and zero otherwise
Zmijewski’s (1984) index (see Table 3B 40:800 choice-based sample)
One if registrant’s debt footnote, if any, indicates payment default, covenant violation, or
that a payment default or a covenant violation is waived or cured, and zero otherwise
Natural logarithm of pre-IPO total assets (in $ millions)
Natural logarithm of one plus number of years from founding / incorporation to filing
One if annualized pre-IPO revenues are less than $1 million, and zero otherwise
((Annual pre-IPO operating cash flows + annual pre-IPO investing cash flows) ÷ (Pre-IPO
cash and marketable securities + actual or expected IPO proceeds)) * (-1)
One if the IPO is underwritten by an investment bank with the highest Carter, Dark and
Singh (1998) rank (as Loughran and Ritter 2004 update), and zero otherwise.
One if registrant has venture capital backing, and zero otherwise
One if the registrant’s auditor is one of the Big5 firms, and zero otherwise
One if the month the auditor signs the opinion in the IPO registration statement is from
January 1999 to April 2000, and zero otherwise
Big5*Bubble
Column one of Table 3 presents results of estimating equation (1) for the 116 stressed
non-bubble registrants (i.e., 102 from our pre-bubble period and 14 from our post-bubble
period), for which the presence of a going-concern opinion varies positively with Distress and
20
negatively with VC. In terms of our variable of interest, and in contrast to the test of difference
in proportions in Table 1 panel B, Big5’s coefficient, while negative, is insignificant. This
indicates that the difference between non-bubble going-concern rates for Big5 and non-Big5
auditors (12.0% and 50.0%, respectively), while significant on a descriptive level, is no longer so
when we control for factors associated with going-concern opinions and auditor choice.
Column two of Table 3 presents results of estimating equation (1) for the 470 stressed
registrants during our bubble period, for which the presence of a going-concern opinion varies
positively with Distress and CashBurn and negatively with PrestigeIB, VC and Big5. This latter
finding is consistent with the test of difference in proportions in Table 1 panel B between the
bubble period rates of going-concern opinions for the Big5 and non-Big5 (2.6% and 50.0%,
respectively). In contrast to the non-bubble, during which neither type of firm experiences a
substantial increase in Internet IPO transaction volume, Big5 auditors became significantly less
likely than non-Big5 auditors to issue going-concern opinions in the 16-month bubble period
(during which only Big5 auditors experience a sharp increase in transaction volume).15
Column three of Table 3 presents results of estimating equation (2) for the 554 stressed
registrants with Big5 auditors. The coefficients on Distress, Ln(Age), CashBurn, PrestigeIB and
VC are significant in the directions we expect.16 In terms of our variable of interest, Bubble’s
coefficient is negative and highly significant. That is, after controlling for other effects, and
consistent with the test of difference in proportions in Table 1 panel B, the 2.6% rate (12 of 454)
of going-concern opinions among Big5 registrants during the bubble period is significantly less
than the 12.0% rate (12 of 100) during a combination of the pre-bubble and post-bubble periods.
Column four of Table 3 presents results of estimating equations (2) using the 32 stressed
Internet IPO registrants with non-Big5 auditors. While the coefficients for Distress and StartUp
15
We also ran regressions for the non-bubble and bubble periods for which, in place of Big5, we specify indicator
variables for each of the Big5. For the non-bubble period, none of the coefficients for these Big5 firm indicators are
significant. In contrast, for the bubble period, each Big5 variable coefficient is significantly negative; and, except
for PwC, Chow tests of the difference in Big5 firm coefficients are significant beyond the 10% level (one-sided).
16
In contrast to expectations, but consistent with Table 2, DebtFn’s coefficient is negative (see footnote 11).
21
are significant in the directions we expect, consistent with the test of difference in proportion in
Table 1 Panel B, Bubble’s coefficient is (positive and) insignificant.17
Last, we estimate equation (3) with the full sample to test the difference-in-differences.
To reiterate, we are mindful of clientele differences between the types of companies that
typically retain Big5 versus non-Big5 firms. Our intent in combining the Big5 and non-Big5
samples to estimate equation (3) is to test for the difference in the coefficients for Big5 between
the equation (2) estimations that use the non-bubble and bubble period samples. Column five of
Table 3 presents the results and confirms the importance of Distress, CashBurn, PrestigeIB and
VC. In terms of variables of interest, Bubble*Big5’s coefficient is negative and significant,
which tests the difference between Big5’s coefficient for the non-bubble and bubble periods. In
addition, a test of whether the sum of the coefficients for Big5 and Bubble is less than zero yields
a chi-square statistic of 42.26, which is significant well beyond the 1% level. This result
indicates that the difference-in-differences is driven by the change in going-concern decisions of
the Big5 firms (not the non-Big5 firms) between non-bubble and bubble periods.
4.2
Examining the decrease in Big5 going-concern opinions during the ‘bubble’
In this section, we focus on those stressed Internet IPO registrants with Big5 auditors to
conduct tests of mechanisms that could lead auditors to shift their going-concern criteria in the
Internet IPO bubble (see Section 2.2). To do this, we use the sub-sample of registrants with Big5
auditors and estimate equation (4), which augments equation (1) by specifying, in place Big5, six
additional variables; the latter four of which proxy for auditor acquiescence.

1 if GCOpinion i, t 
0 Otherwise



 Stressi,t = 0 + 1Distressi,t + 2DebtFni,t + 3Ln(Assets)i,t + 4Ln(Age)i,t +

5StartUpi,t + 6CashBurni,t + 7PrestigeIBi,t + 8VCi,t + 9Nasdaq3i,t +
10DotNamei,t + 11Ln(Clients3)i,t + 12NorthCalifi,t + 13RushToMkti,t +
14RushToMkt*VCi,t + i,t
17
(4)
Despite a sample size of 32 observations, this regression model’s chi-square is significant beyond the 5% level.
22
Where:
Nasdaq3
=
DotName
=
Ln(Clients3)
=
NorthCalif
=
RushToMkt
=
RushToMkt*VC =
Cumulative raw return for the Nasdaq Composite Index for the three calendar months prior
to the month in which the auditor signs the opinion in the initial IPO registration statement
One if registrant’s name contains ‘dot com’, ‘dot net’, ‘Internet’, and zero otherwise (see
Cooper, Dimitrov and Rau 2001)
Natural logarithm of one plus the number of stressed, Internet IPO registrants the specific
Big5 audit firm has signed opinions for during the three calendar months prior to the month
in which they sign their opinion for a given, stressed, Internet IPO registrant.
One if auditor’s office is within 50 miles of San Francisco (i.e., Mountain View, Oakland,
Palo Alto, San Francisco, San Jose or Walnut Creek), and zero otherwise
One if the number of days from audit opinion date to initial IPO registration statement
filing date is ten or less, and zero otherwise
RushToMkt*VC (VC is one if registrant has venture capital backing and zero otherwise)
Columns one through five of Table 4 present the results of specifying each of these
variables individually, and column six presents the results of estimating equation (4), using the
554 stressed Internet registrants with Big5 auditors. The signs and magnitudes of variables that
are common to estimating equations (1), (2) and (3) do not change. For all specifications, the
results show a positive association between Big5 going-concern opinions and Distress and
CashBurn; and for a negative association between such opinions and Ln(Age) and VC.
In terms of our variables of interest, when we specify it by itself, the coefficient on
Nasdaq3 is negative and, given this is the direction we expect, marginally significant. This
provides some evidence in support of the influence of equity market conditions on the goingconcern opinion decisions of the Big5 firms with respect to their stressed, Internet IPO clients.
In contrast to the weak statistical result for Nasdaq3, the coefficients on Ln(Clients3) and
RushToMkt*VC are negative and highly significant. The former provides evidence of an inverse
relation between the presence of a Big5 going-concern opinion and the sheer number of stressed,
Internet IPO clients on which these firms were recently signing off. The latter provides evidence
of an inverse relation between the presence of a Big5 going-concern opinion and our proxy for
pressure venture capitalist’s place on these auditors to facilitate rushing to market the companies
they are backing. Taken together, these finding are consistent with the Big5 firms acquiescing
during the Internet IPO bubble by lowering their frequency of going-concern opinions.
23
4.3
Consequences associated with the decrease in Big5 going-concern opinions
To assess consequences to investors, if any, associated with the decrease in frequency of
Big5 going-concern opinions during the 16-month period from January 1999 through April 2000,
we track those of our sample registrants that successfully went public for up to two years after
IPO date. We define an IPO registrant as ‘successful’ if they go public within one year of initial
SEC filing date. Of our 586 stressed, Internet registrants, 400 companies went public within a
year of the date of initial filing date. Following Willenborg and McKeown (2000), we identify
those IPOs that delist from CRSP for deleterious reasons (codes 550–572 and 574–584).18 Table
5 provides delisting statistics by audit firm type, audit opinion type, and whether the audit
opinion date is during our pre-bubble or bubble periods. 19
Of the 102 stressed Internet registrants in our pre-bubble (January 1996–December 1998
opinion dates), 92 (90.1%) went public within one year of initial filing. Of these 92 IPOs, the
Big5 audit 81 (88.0%) and render going-concern opinions for 10 (12.3%). Three of these 10
going-concern IPOs delist from CRSP for deleterious reason within two years of their IPO date.
As for the remaining 71 Big5 pre-bubble IPO registrants with clean opinions, two (2.8%) delist
within two years of IPO. In contrast, of the 470 stressed Internet registrants in the bubble (i.e.,
January 1999–April 2000 opinion dates), 305 (64.7%) complete the IPO within a year of initial
filing. Of these 305 IPOs, the Big5 audit 300 (98.4%) and render going-concern opinions for 9
(3.0%). Three of these nine going-concern IPOs delist from CRSP for deleterious reason within
two years of IPO. As for the remaining 291 Big5 IPOs with clean opinions during the bubble, 32
(11.0%) delist within two years of going public. A comparison of the 2.8% pre-bubble versus
11.0% bubble yields a z-statistic for the change in proportions of 2.12 (significant beyond 5%).
These results suggest that during the Internet IPO bubble the largest audit firms were less
effective in gauging how access to capital would affect a company’s ability to continue as a
18
We exclude CRSP code 573 (i.e., delisted by current exchange-company request, deregistration (gone private)).
Because we study stock delisting within a two-year horizon from IPO date (and not company bankruptcy within,
per U.S. audit standards, a one-year horizon from financial statement date), the intent of Table 5, and the discussion
in the text, is to assess consequences to investors and not to draw inferences regarding auditor quality.
19
24
going concern. They also suggest a significant decline in the extent to which pre-offering audit
opinions provide useful information to IPO investors. We emphasize that, because our research
design does not permit us to draw inferences with respect to audit quality, we are not suggesting
the Big5 are to blame for failing to foresee the bursting of the Internet bubble. Rather, because
the frequency of their going-concern opinions sharply decreases simultaneous with their sharp
increase in transaction volume by stressed Internet registrants, it seems that the Big5 firms were
quick to ‘join the Internet party’ (as opposed to failing to foresee its’ abrupt end).
4.4
Big5 going-concern opinions in the bubble – Actual versus expected
In this section, we use the Big5’s opinion decisions during our pre-bubble period as a
benchmark to assess the opinion decisions of these individual five firms during the bubble. To
do this, we estimate the equation (1) regression (after excluding the Big5 variable) using the 87
pre-bubble registrants with Big5 auditors, and then use the coefficients to specify the variable
E(GCOpinion) for the 454 bubble registrants with Big5 auditors. We then sort E(GCOpinion) by
quintile and, then within each quintile, by Big5 firm. For each quintile / Big5 firm sort, we
provide the actual going-concern opinion decisions for these 454 Big5 bubble registrants and for
the 300 IPOs (i.e., of these 454 registrants) that go public within one-year of initial filing date.
Of these 300 IPOs, 35 delist off CRSP for deleterious reasons within two years of their IPO.20
Table 6 depicts this sort of E(GCOpinion) and provides four important findings. One, per
the bottom row, average E(GCOpinion) exceeds average GCOpinion, 7.4% versus 2.6%,
respectively.
The sign and magnitude of this difference is consistent with the significant
negative coefficient on Bubble in column three of Table 3. Two, per the bottom rows, while
Andersen’s bubble registrants exhibit the highest expected average probability of observing a
going-concern opinion (i.e., average E(GCOpinion) of 13.0%), they render only two goingconcerns for their 89 stressed, Internet bubble registrants (i.e., average GCOpinion of 2.2%). No
other Big5 firm exhibits a disparity of this magnitude / direction.
20
Three, in terms of
This delisting rate, while not as high as some may expect, accords with Goldfarb, Kirsch and Miller (2007).
25
E(GCOpinion)’s predictive accuracy, eight of the 12 going-concern opinions the Big5 render
during our bubble period reside in the 5th quintile of E(GCOpinion). Four, for this 5th quintile,
average E(GCOpinion) of 30.4% is triple average GCOpinion of 8.8%; and Andersen’s average
E(GCOpinion) exceeds its average GCOpinion by several orders of magnitude, at 37.0% versus
3.6%. One interpretation of this differential is to suggest that Andersen should have rendered
about ten going-concern opinions for their 28 clients in this 5th quintile, instead of just one.
Nontheless, caution is appropriate when interpreting these results given our small sample size.
5.
Conclusion
How do auditors behave during periods of market euphoria? To address this question, we
study auditor going-concern opinions around the time of the wave of stressed Internet companies
filing to go public on Nasdaq, a period of time that many characterize as a ‘bubble’. We find
that during the period from January 1999 to April 2000 of a very high volume of stressed
Internet companies filing to go public, in contrast to non-Big5 auditors (which did not experience
an increase in transaction volume), the Big5 became much less likely to render going-concern
opinions. Given this, we focus in on the Big5 firms and report strong evidence that the presence
of a going-concern opinion varies inversely with the number of such registrants a given Big5
firm was recently signing off on, and with our proxy for venture capitalists’ rushing the registrant
to market. Taken together, we interpret these findings as consistent with the inference of Big5
firms acceding to buoyant Internet IPO audit market conditions by lowering their frequency of
going-concern opinions. While we are not suggesting the Big5 were a major cause of the
Internet bubble, it does appear that these largest audit firms did little to slow it from inflating.
Because of the possibility of future bubbles, our findings may be of interest to regulators and
standard setters.21.
21
Per Stone and Richtel (2007, A-1), “Silicon Valley’s math is getting fuzzy again. Internet companies with funny
names, little revenue and few customers are commanding high prices. And investors, having seemingly forgotten
the pain of the first dot-com bust are displaying symptoms of the disorder known as irrational exuberance.”
26
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29
Table 1
Nasdaq IPO filings by stressed Internet companies
Panel A: Sample
IPO filings from March 1996 to December 2000 that www.alert-ipo.com designates as ‘Internet related’
Less:
IPO registration statement not found on Edgar
Spin-offs from an already-public parent company
Foreign companies
Companies that do not file to go public on Nasdaq (e.g., OTC BB and NQB ‘pink sheets’)
Audit opinion date is prior to January 1, 1996 (Ace Communications Corporation)
Companies with no obvious indicator of financial stress (i.e., IPO registrant company has
negative net income, or negative operating cash flow, or negative stockholders’ equity)
Final sample
816
47
75
34
39
1
34
586
30
Table 1
Nasdaq IPO filings by stressed Internet companies
Panel B: Sample by audit opinion quarter / month, audit firm type and audit opinion type
Big5 Auditors
NonBig5 Auditors
Overall
GC
Non-GC
GC
Non-GC
GC
Non-GC
Opinion Opinion
Total Opinion Opinion
Total
Opinion Opinion
Total
0
2
2
0
0
0
0
2
2
1
6
7
0
1
1
1
7
8
1
2
3
1
1
2
2
3
5
1
1
2
1
1
2
2
2
4
2
9
11
1
0
1
3
9
12
0
5
5
0
0
0
0
5
5
0
4
4
0
0
0
0
4
4
1
4
5
1
0
1
2
4
6
3
15
18
1
1
2
4
16
20
0
10
10
1
1
2
1
11
12
0
9
9
1
1
2
1
10
11
2
9
11
1
1
2
3
10
13
11
76
87
8
7
15
19
83
102
Pre-Bubble
(12.6%) (87.4%)
(53.3%)
(46.7%)
(18.6%)
(81.4%)
1999
Jan
0
16
16
0
3
3
0
19
19
Feb
1
47
48
1
0
1
2
47
49
Mar
2
54
56
2
0
2
4
54
58
Apr
2
27
29
0
0
0
2
27
29
May
0
28
28
0
0
0
0
28
28
Jun
0
22
22
0
1
1
0
23
23
Jul
1
18
19
1
0
1
2
18
20
Aug
1
14
15
0
0
0
1
14
15
Sep
0
16
16
1
0
1
1
16
17
Oct
0
11
11
0
0
0
0
11
11
Nov
1
15
16
1
0
1
2
15
17
Dec
0
22
22
0
1
1
0
23
23
2000
Jan
1
33
34
1
0
1
2
33
35
Feb
1
49
50
0
3
3
1
52
53
Mar
1
51
52
1
0
1
2
51
53
Apr
1
19
20
0
0
0
1
19
20
12
442
454
8
8
16
20
450
470
Bubble
(2.6%)
(97.4%)
(50.0%)
(50.0%)
(4.3%)
(95.7%)
2000
May
1
3
4
0
0
0
1
3
4
Jun
0
3
3
0
1
1
0
4
4
Jul
0
2
2
0
0
0
0
2
2
Aug
0
2
2
0
0
0
0
2
2
Sep
0
2
2
0
0
0
0
2
2
Oct
0
0
0
0
0
0
0
0
0
Nov
0
0
0
0
0
0
0
0
0
Dec
0
0
0
0
0
0
0
0
0
1
12
13
0
1
1
1
13
14
Post-Bubble
(7.7%) (92.3%)
(0.0%)
(100.0%)
(7.1%)
(92.9%)
24
530
554
16
16
32
40
546
586
Overall
(4.3%) (95.7%)
(50.0%)
(50.0%)
(6.8%)
(93.2%)
Tests of difference in proportions:
• 2.6% Big5 Bubble versus 12.0% Big5 Non-Bubble:
z-statistic = –4.16 (significant beyond 1%)
• 50.0% NonBig5 Bubble versus 50.0% NonBig5 Non-Bubble:
z-statistic = 0.00 (insignificant)
• 2.6% Big5 Bubble versus 50.0% NonBig5 Bubble:
z-statistic = –9.23 (significant beyond 1%)
• 12.0% Big5 Non-Bubble versus 50.0% NonBig5 Non-Bubble
z-statistic = –3.74 (significant beyond 1%)
Audit
Opinion Date
1996
Q1
Q2
Q3
Q4
1997
Q1
Q2
Q3
Q4
1998
Q1
Q2
Q3
Q4
31
Table 1
Nasdaq IPO filings by stressed Internet companies
Panel C: Going-concern opinions by audit firm type by audit opinion date partition
AA
D&T
E&Y
KPMG
PwC
Pre-Bubble
(Jan 1996–Dec 1998)
0 of 8
(0.0%)
2 of 10 (20.0%)
3 of 23 (13.0%)
2 of 23
(8.7%)
4 of 23 (17.4%)
Bubble
(Jan 1999–April 2000)
2 of 89
(2.2%)
1 of 32
(3.1%)
2 of 112
(1.8%)
1 of 64
(1.6%)
6 of 157
(3.8%)
Post-Bubble
(May 2000–Sept 2000)
1 of 6 (16.7%)
0 of 1
(0.0%)
0 of 0
(0.0%)
0 of 1
(0.0%)
0 of 5
(0.0%)
Total
(Jan 1996–Dec 2000)
3 of 103
(2.9%)
3 of 43
(7.0%)
5 of 135
(3.7%)
3 of 88
(3.4%)
10 of 185
(5.4%)
Big5
NonBig5
11 of 87
8 of 15
(12.6%)
(53.3%)
12 of 454
8 of 16
(2.6%)
(50.0%)
1 of 13
0 of 1
(7.7%)
(0.0%)
24 of 554
16 of 32
(4.3%)
(50.0%)
Total
19 of 102
(18.6%)
20 of 470
(4.3%)
1 of 14
(7.1%)
40 of 586
(6.8%)
Panel C depicts the fraction of going-concern audit opinions for each of three sample partitions based on the audit
opinion date (see Panel C for more information). Of the NonBig 5 auditors: Grant Thornton audits 2 registrants
during the pre-bubble and 4 during the bubble, rendering 0 and 2 going-concern opinions respectively; BDO
Seidman audits 5 registrants during the Pre-Bubble, rendering 3 going-concern opinions, and zero registrants during
the Bubble; and 18 different non-National firms audit the remaining 21 registrants (8 during the Pre-Bubble, 12
during the Bubble and 1 during the Post-Bubble), for which they render a total of 11 going-concern opinions.
32
Figure 1
Nasdaq IPO filings by stressed Internet companies – by audit firm type
33
Table 2
Descriptive statistics – by audit firm type, audit opinion date and audit opinion type
Panel A: Internet IPO registrants with Big5 audit firms
Variable
n (%)
Total
(Jan 1996 – Dec 2000)
GC
Non-GC
Opinion
Opinion
24 (3.8%) 530 (96.2%)
0.632
0.947
0.302
0.053
0.545
0.596
0.288
0.016
Post-Bubble
(May 2000 – Dec 2000)
GC
Non-GC
Opinion
Opinion
1 (7.7%) 12 (92.3%)
mean
median
DebtFn
mean
0.042
0.100
0.091
0.171
0.000
0.090
0.000
0.000
Assets
mean
median
11.103
6.101
28.472
14.132
11.197
3.851
16.728
10.196
10.858
10.459
29.936
14.885
13.009
13.009
48.913
22.628
Age
mean
median
3.633
3.010
4.706
3.540
3.449
2.760
4.905
3.325
3.882
3.170
4.620
3.590
2.660
2.660
6.617
4.435
mean
0.333
0.217
0.364
0.211
0.333
0.222
0.000
0.083
CashBurn
mean
median
0.163
0.099
0.142
0.104
0.168
0.094
0.153
0.104
0.146
0.106
0.139
0.104
0.330
0.330
0.202
0.162
PrestigeIB
mean
0.250
0.623
0.182
0.487
0.250
0.643
1.000
0.750
VC
mean
0.417
0.845
0.273
0.763
0.500
0.860
1.000
0.833
Nasdaq3
mean
median
0.110
0.106
0.196
0.181
0.012
0.016
0.070
0.040
0.208
0.157
0.224
0.181
0.010
0.010
–0.053
–0.003
DotName
mean
0.333
0.258
0.273
0.197
0.333
0.276
1.000
0.000
mean
median
11.458
3.500
15.647
13.000
1.091
1.000
1.789
2.000
20.000
19.500
18.066
17.000
23.000
23.000
14.333
13.000
NorthCalif
mean
0.208
0.319
0.273
0.303
0.167
0.319
0.000
0.417
RushToMkt
mean
0.292
0.392
0.182
0.237
0.417
0.414
0.000
0.583
RushToMkt*VC
mean
0.042
0.325
0.000
0.171
0.083
0.348
0.000
0.417
Clients3
0.288
0.020
Bubble
(Jan 1999 – Apr 2000)
GC
Non-GC
Opinion
Opinion
12 (2.6%) 442 (97.4%)
Distress
StartUp
0.589
0.711
Pre-Bubble
(Jan 1996 – Dec 1998)
GC
Non-GC
Opinion
Opinion
11 (12.6%) 76 (87.4%)
0.643
0.643
0.167
0.005
34
Table 2
Descriptive statistics – by audit firm type, audit opinion date and audit opinion type
Panel B: Internet IPO registrants with non-Big5 audit firms
Variable
n (%)
Total
(Jan 1996 – Dec 2000)
GC
Non-GC
Opinion
Opinion
16 (50.0%) 16 (50.0%)
Pre-Bubble
(Jan 1996 – Dec 1998)
GC
Non-GC
Opinion
Opinion
8 (53.3%)
7 (46.7%)
Bubble
(Jan 1999 – Apr 2000)
GC
Non-GC
Opinion
Opinion
8 (50.0%)
8 (50.0%)
Post-Bubble
(May 2000 – Dec 2000)
GC
Non-GC
Opinion
Opinion
0 (0.0%) 1 (100.0%)
Distress
mean
median
0.810
1.000
0.406
0.159
0.849
1.000
0.523
0.666
0.771
1.000
0.355
0.140
n/a
n/a
0.000
0.000
DebtFn
mean
0.063
0.063
0.000
0.000
0.125
0.125
n/a
0.000
Assets
mean
median
0.890
0.473
3.816
1.243
1.074
0.825
2.308
0.746
0.722
0.142
5.382
1.244
n/a
n/a
1.843
1.843
Age
mean
median
3.575
1.940
3.424
3.195
4.620
2.680
3.633
3.610
2.530
0.825
3.511
3.075
n/a
n/a
1.270
1.270
mean
0.813
0.438
0.750
0.571
0.875
0.375
n/a
0.000
CashBurn
mean
median
0.087
0.040
0.092
0.088
0.118
0.099
0.077
0.088
0.056
0.018
0.103
0.081
n/a
n/a
0.117
0.117
PrestigeIB
VC
mean
mean
0.000
0.063
0.000
0.125
0.000
0.125
0.000
0.000
0.000
0.000
0.000
0.250
n/a
n/a
0.000
0.000
Nasdaq3
mean
median
0.130
0.114
0.145
0.168
0.028
0.009
0.084
0.046
0.232
0.181
0.255
0.271
n/a
n/a
–0.301
–0.301
DotName
mean
0.438
0.500
0.125
0.286
0.750
0.625
n/a
1.000
mean
median
0.313
0.000
0.000
0.000
0.250
0.000
0.000
0.000
0.375
0.000
0.000
0.000
n/a
n/a
0.000
0.000
NorthCalif
mean
0.063
0.063
0.125
0.143
0.000
0.000
n/a
0.000
RushToMkt
mean
0.438
0.125
0.375
0.143
0.500
0.125
n/a
0.000
RushToMkt*VC
mean
0.000
0.063
0.000
0.000
0.000
0.125
n/a
0.000
StartUp
Clients3
35
Observations are 586 stressed (i.e., pre-IPO negative net income; or pre-IPO negative current ratio; or pre-IPO negative stockholders’ equity), stand-alone,
domestic Internet companies filing to go public as Nasdaq IPOs between March 1, 1996 and December 31, 2000 with audit opinions dates from January 1,
1996 to December 31, 2000 (see Table 1 for more information).
Variables are as follows:
Distress
= Zmijewski’s (1984) index (see Table 3B 40:800 choice-based sample)
DebtFn
= Equals one if registrant’s debt footnote, if any, indicates payment default, covenant violation, or that a payment default or a covenant
violation is waived or cured, and zero otherwise
Assets
= Pre-IPO total assets (in $ millions)
Age
= Number of years from founding / incorporation to year of filing
StartUp
= Equals one if annualized pre-IPO revenues are less than $1 million, and zero otherwise
CashBurn
= ((Annual pre-IPO operating cash flows + annual pre-IPO investing cash flows) ÷ (Pre-IPO liquid assets + expected IPO proceeds)) * (-1)
PrestigeIB
= Equals one if underwriter has the highest Carter, Dark and Singh (1998) rank (as Loughran and Ritter 2004 update), and zero otherwise.
VC
= Equals one if registrant has venture capital backing, and zero otherwise
Nasdaq3
= Cumulative raw return for the Nasdaq Composite Index for the three calendar months prior to the month in which the auditor signs the
opinion in the initial IPO registration statement
DotName
= Equals one if registrant’s name contains ‘dot com’, ‘dot net’, ‘Internet’ and zero otherwise (see Cooper, Dimitrov and Rau 2001)
Clients3
= The number of stressed, Internet IPO registrants the specific Big5 audit firm has signed opinions for during the three calendar months
prior to the month in which they sign their opinion for a given, stressed, Internet IPO registrant
NorthCalif
= Equals one if auditor’s office is within 50 miles of San Francisco (i.e., Mountain View, Oakland, Palo Alto, San Francisco, San Jose or
Walnut Creet), and zero otherwise
RushToMkt
= Equals one if the number of days from audit opinion date to initial IPO registration statement filing date is ten or less, and zero otherwise
RushToMkt*VC
= RushToMkt*VC
Bubble
= Equals one if date of the audit opinion in the registration statement is between January 1, 1999 and April 30, 2000, and zero otherwise
Big5
= Equals one if the registrant’s auditor is one of the Big5 firms, and zero otherwise
36
Table 3
Audit opinions for Nasdaq IPO filings by stressed Internet companies
Variable
E[sign]
Constant
Eq (1)
Non-Bubble
-2.00
(-1.22)
1.39
(3.38)***
Eq (1)
Bubble
0.24
(0.18)
0.51
(2.11)**
Eq (2)
Big5
0.28
(0.21)
0.59
(3.65)***
Eq (2)
Non-Big5
-3.03
(-1.50)
1.28
(2.00)**
Distress
+
DebtFn
+
-0.68
(-1.54)
-0.72
(-1.27)
-0.78
(-1.89)*
0.17
(0.24)
Ln(Assets)
–
0.08
(0.89)
-0.04
(-0.46)
-0.06
(-0.75)
0.10
(0.89)
Ln(Age)
–
0.04
(0.12)
-0.09
(-0.55)
-0.15
(-1.51)*
0.09
(0.25)
StartUp
+
0.07
(0.16)
0.26
(0.92)
-0.03
(-0.13)
1.13
(1.67)**
CashBurn
+
0.75
(0.88)
1.02
(1.42)*
PrestigeIB
–
-0.18
(-0.51)
-0.50
(-1.66)**
-0.42
(-1.36)*
VC
–
-1.19
(-2.76)***
-0.62
(-2.54)***
-0.76
(-3.41)***
-0.28
(-0.31)
-0.37
(-0.74)
-1.13
(-3.08)***
-0.65
(-6.46)**
0.15
(0.32)
Big5
+/–
Bubble
+/–
Big5*Bubble
+/–
Observations
Pseudo R2
116
31.0%
470
32.7%
1.10
(3.20)***
554
24.3%
0.58
(0.26)
n/a
32
24.3%
Eq (3)
Total
-0.57
(-0.52)
0.75
(4.52)***
[ 0.041]
-0.61
(-1.83)*
[-0.021]
0.00
(0.06)
[ 0.000]
-0.11
(-0.93)
[-0.006]
0.21
(0.92)
[ 0.013]
0.87
(2.72)***
[ 0.048]
-0.42
(-1.45)*
[-0.025]
-0.75
(-3.62)***
[-0.064]
-0.36
(-0.94)
[-0.027]
0.16
(0.43)
[ 0.008]
-0.82
(-2.26)**
[-0.094]
586
35.3%
Dependent variable is one if a going-concern opinion in the IPO registration statement and zero otherwise.
Probit coefficients with t-statistics using robust standard errors clustered by audit firm (in parentheses) and
Ai and Norton (2003) marginal effects [in brackets]. See Tables 1 and 2 for sample information and
variable definitions. Test of whether the sum of the coefficients for Bubble and Bubble*Big5 in equation
(1c), that is in column five, differs from zero yields a Chi-square of 42.26, significant at the 1% level.
***, **, * Significant at 1%, 5% and 10% levels, respectively (one-sided tests where E[sign] is directional).
37
Table 4
Audit opinions for Nasdaq IPO filings by stressed Internet companies – Big5 registrants
Variable
E[sign]
Constant
-0.26
(-0.23)
0.57
(3.56)***
0.27
(0.21)
0.55
(3.65)***
0.33
(0.24)
0.60
(3.73)***
0.00
(0.00)
0.57
(3.52)***
-0.04
(-0.03)
0.53
(3.05)***
Distress
+
DebtFn
+
-0.70
(-1.44)
-0.69
(-1.35)
-0.76
(-1.70)*
-0.69
(-1.30)
-0.65
(-1.28)
Ln(Assets)
–
-0.04
(-0.62)
-0.08
(-1.07)
-0.07
(-0.91)
-0.07
(-1.02)
-0.06
(-0.86)
Ln(Age)
–
-0.16
(-1.88)**
-0.20
(-2.14)**
-0.18
(-1.71)**
-0.17
(-1.69)**
-0.20
(-2.06)**
StartUp
+
-0.00
(-0.01)
-0.03
(-0.13)
-0.05
(-0.23)
-0.03
(-0.11)
-0.04
(-0.19)
CashBurn
+
PrestigeIB
–
-0.43
(-1.45)*
-0.47
(-1.50)*
-0.41
(-1.28)
-0.44
(-1.50)*
-0.48
(-1.53)*
VC
–
-0.78
(-3.71)***
-0.86
(-3.97)***
-0.76
(-3.42)***
-0.80
(-3.64)***
-0.66
(-1.99)**
Nasdaq3
–
-1.26
(-1.29)*
DotName
–
Ln(Clients3)
–
NorthCalif
–
RushToMkt
–
-0.02
(-0.07)
RushToMkt*VC
–
-0.62
(-2.52)***
Observations
2
Pseudo R
1.11
(3.51)***
1.28
(3.41)***
1.26
(3.96)***
1.28
(3.33)***
1.17
(2.88)***
-0.23
(-0.88)
-0.17
(-2.93)***
-0.05
(-0.26)
554
21.8%
554
20.9%
554
22.0%
554
20.5%
554
22.0%
Eq (4)
0.13
(0.10)
0.56
(3.23)***
[0.022]
-0.78
(-1.89)*
[-0.017]
-0.04
(-0.54)
[-0.002]
-0.21
(-2.41)***
[-0.008]
-0.05
(-0.25)
[-0.002]
1.04
(3.31)***
[0.041]
-0.43
(-1.32)
[-0.019]
-0.59
(-1.93)**
[-0.036]
-1.03
(-1.21)
[-0.040]
-0.19
(-0.69)
[-0.007]
-0.14
(-2.82)***
[-0.005]
-0.09
(-0.42)
[-0.003]
0.12
(0.48)
[0.004]
-0.71
(-3.32)***
[-0.076]
554
24.6%
Dependent variable is one if a going-concern opinion in the IPO registration statement and zero otherwise. Probit
coefficients with t-statistics using robust standard errors clustered by audit firm (in parentheses) and Ai and
Norton (2003) marginal effects [in brackets]. See Tables 1 and 2 for sample information and variable definitions.
***, **, * Significant at 1%, 5% and 10% levels, respectively (one-sided tests where E[sign] is directional).
38
Table 5
Audit opinions for Nasdaq IPO filings by stressed Internet companies – Subsequent delistings
Audit
firm
type
Audit
opinion type
GoingConcern
Pre-Bubble
(Jan 1996–Dec 1998)
IPO
Delist
IPO
within within
filings 1 year 2 years
11
10
3
Bubble
(Jan 1999–April 2000)
IPO
Delist
IPO
within within
filings 1 year 2 years
12
9
(70.0%)
3
(66.7%)
Big5
Non-GoingConcern
GoingConcern
76
71
2
442
291
(2.8%)
87
81
8
4
32
(11.0%)
5
454
300
0
8
1
(100%)
35
1
(0.0%)
NonBig5
Non-GoingConcern
Total
7
7
0
8
4
(0.0%)
0
(0.0%)
15
11
0
16
5
1
102
92
5
470
305
36
Observations are 572 stressed, stand-alone, domestic Internet companies filing to go public as Nasdaq IPOs between
March 1996 and April 2000 with audit opinion dates from January 1996 to April 2000 (see Table 1). Of these 572
IPO registrants, 397 companies went public within a year of initial SEC filing; and, of these 397 IPOs, 41 delist from
CRSP for deleterious reasons (i.e., delisting codes 550-572 and 574-584) within two years of IPO date.
•
2.8% Big5 Pre-Bubble Type II versus 11.0% Big5 Bubble Type II z-statistic = –2.12 (significant beyond 5%)
39
Table 6
Big5 GC registrants during the Internet bubble by pre-bubble expected GC opinion
Big5
Auditor
AA
D&T
E&Y
KPMG
PwC
4th
4.5%
6.1%
4.4%
5.1%
4.6%
4.7%
AA
D&T
E&Y
KPMG
PwC
5.3%
0.0%
0.0%
0.0%
3.0%
2.2%
(1 of
(0 of
(0 of
(0 of
(1 of
(2 of
19)
4)
20)
15)
33)
91)
0.0%
0.0%
0.0%
0.0%
5.0%
1.8%
(0 of
(0 of
(0 of
(0 of
(1 of
(1 of
9)
3)
11)
12)
20)
55)
0 of
0 of
0 of
0 of
0 of
0 of
1
1
0
0
0
2
3rd
1.4%
1.2%
1.4%
1.5%
1.3%
1.3%
AA
D&T
E&Y
KPMG
PwC
0.0%
0.0%
0.0%
9.1%
0.0%
1.1%
(0 of
(0 of
(0 of
(1 of
(0 of
(1 of
17)
11)
23)
11)
28)
90)
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
(0 of
(0 of
(0 of
(0 of
(0 of
(0 of
12)
6)
13)
6)
19)
56)
0 of
0 of
0 of
0 of
0 of
0 of
1
0
1
1
2
5
2nd
0.4%
0.3%
0.4%
0.4%
0.4%
0.4%
AA
D&T
E&Y
KPMG
PwC
0.0%
0.0%
0.0%
0.0%
2.8%
1.1%
(0 of
(0 of
(0 of
(0 of
(1 of
(1 of
13)
1)
25)
16)
36)
91)
0.0%
0.0%
0.0%
0.0%
4.2%
1.5%
(0 of
(0 of
(0 of
(0 of
(1 of
(1 of
12)
0)
18)
12)
24)
66)
0 of 2
n/a
0 of 0
0 of 2
0 of 3
0 of 7
1st
0.1%
0.1%
0.2%
0.2%
0.1%
0.1%
AA
D&T
E&Y
KPMG
PwC
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
(0 of
(0 of
(0 of
(0 of
(0 of
(0 of
12)
9)
24)
12)
34)
91)
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
(0 of 5)
(0 of 7)
(0 of 15)
(0 of 9)
(0 of 22)
(0 of 58)
0 of 1
0 of 3
0 of 1
0 of 1
0 of 4
0 of 10
Quintile
5th
Bubble IPO filings
with GCOpinion
3.6% (1 of 28)
14.3% (1 of 7)
10.0% (2 of 20)
0.0% (0 of 10)
15.4% (4 of 26)
8.8% (8 of 91)
Bubble IPO issuances
with GCOpinion
4.5% (1 of 22)
25.0% (1 of 4)
8.3% (1 of 12)
0.0% (0 of 5)
18.2% (4 of 22)
10.8% (7 of 65)
Delist
within 2 years
with GCOpinion
0 of 2
0 of 0
1 of 2
0 of 2
2 of 5
3 of 11
PreBubble
E(GCOpinion)
37.0%
22.7%
23.7%
28.9%
31.0%
30.4%
Overall
13.0%
AA
2.2% (2 of 89)
1.7% (1 of 60)
0 of 7
6.2%
D&T
3.1% (1 of 32)
5.0% (1 of 20)
0 of 4
5.4%
E&Y
1.8% (2 of 112)
1.4% (1 of 69)
1 of 4
6.1%
KPMG
1.6% (1 of 64)
0.0% (0 of 44)
0 of 6
6.4%
PwC
3.8% (6 of 157)
5.6% (6 of 107)
2 of 14
7.4%
2.6% (12 of 454)
3.0% (9 of 300)
3 of 35
Observations are 454 stressed, stand-alone, domestic Internet companies filing to go public as Nasdaq IPOs with
audit opinion dates from January 1999 to April 2000 by a Big5 audit firm (see Table 1). Of these 454 registrants,
300 went public within one year of initial SEC filing; and, of these 300 IPOs, 35 delist from CRSP for deleterious
reasons (i.e., delisting codes 550-572 and 574-584) within two years. The variable E(GCOpinion) is the probability
of observing a going-concern opinion using the coefficients from estimating the equation (1) regression (after
excluding the Big5 variable) with the 87 Pre-Bubble IPO registrants with Big5 auditors.
40