Is audit opinion of major customer informative? : evidence of supplier cash holding

Abstract

This study examines the informativeness of major customer audit opinions on supplier firms. Through the analysis of hand-collected data on major customer audit opinions, the findings reveal that suppliers significantly increase their cash holdings when the major customer receives a modified opinion that indicates material uncertainty or going concern. This reaction is motivated by the need for precautionary measures to mitigate liquidation risk. Cross-sectional tests demonstrate that modified opinions play a significant role in reducing information asymmetry between the supplier and the customer. Furthermore, firm level experience and industry level expertise of auditors will strengthen the informativeness of customer audit opinions. I use IV-2SLS design to resolve endogeneity concerns of omitted variables and reverse causality issues and conduct a series of robustness tests to facilitate the findings. In additional analysis, I also find that modified opinions of major customers are negatively correlated with supplier sales, the continuity of customer relationship, the trade credit granted to the major customer and the tone of supplier financial disclosure. This study contributes to the existing literature by highlighting the usefulness of audit opinions and emphasizing the incremental role that auditors can play in supply-chain relationships. This study also makes contributions to highlight the importance of office-level expertise in increasing the usefulness of audit outcomes to supply chain partners.