Technical Default, Auditors' Decisions and Future Financial Distress.

Abstract

Abstract The purpose of this paper is to document auditors' responses to first-time debt covenant violations and to determine whether these responses can be used to predict financial distress. The data reveal, consistent with SFAS No. 78, that auditors are more likely to require debt reclassification when the violations are not waived by lenders. In contrast, the waiver decision does not appear to significantly influence the auditor's qualification decision. The empirical tests also show that for firms experiencing technical default, the audit opinion is an important determinant of future financial distress, even after controlling for factors typically associated with bankruptcy.

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