Why the going-concern accounting anomaly: gambling in the market?

The market fails to incorporate the adverse information conveyed by the going-concern (GC) opinion in a timely manner. This paper seeks to explain this market-pricing paradox. In particular, we argue that the lottery-like features of GC stocks attract a predominantly retail clientele who use such stocks to gamble in the market. Such trading behavior leads to underreaction to the GC event itself followed by a continuing fall in prices of almost 20% over the next 12 months. Using first time GC firms from 1993 to 2007 we show that GC stocks have extreme lottery-type characteristics. We further demonstrate that retail investors have a proclivity to be net-buyers of these stocks both at the GC event and subsequently, and such contrarian behavior is directly related to the lottery-like nature of GC firms. We test, and rule out, a range of alternative explanations for why retail investors are net-buyers of GC stocks, and conclude that it is their gambling-type behavior that appears to be driving the short-term market reaction to, and the longer-term market response following, the going-concern audit opinion.