Does a venture capitalist influence auditor going concern decisions?

Abstract

A growing number of firms that go public (e.g., IPO) are financially distressed often for several years of their initial existence, raising concerns about their ability to remain going concerns. Yet many IPOs do not receive going concern opinions (GCO) from their auditors who are charged with providing an assessment of their clients’ going concern status. A key feature of the IPOs is that a significant proportion of them are financed by venture capitalists (VCs). Unlike conventional sources of financing, such as banks, a VC offers financial as well as non-financial support to the new firm such as mentorship, strategic guidance and network access. The VC also provides monitoring as a member of the board of directors. An auditor’s assessment of its client’s going concern situation includes an audit of its financial statements and, if the client is financially distressed and in danger of ceasing to be a going concern, a review of factors that may mitigate the need for a GCO. I hypothesize that going concern opinions are assessed less often to financially distressed IPOs because the VC’s presence is viewed by the auditor as a factor that mitigates the need for a GCO. Thus, I explore whether the presence of a VC – in contrast to the presence of a banker – tempers the likelihood of issuance of a GCO to a financially distressed firm. I also explore whether varying degrees of involvement by a VC serve to mitigate an auditor’s need to issue a GCO since VCs are not all equally effective in their roles. I find support for hypothesis (H1) that going concern opinions are assessed less often to financially distressed IPOs with venture capital backing than to those with other forms of financial backing (e.g., banker financing) and no support for hypothesis (H2) that the negative association between the presence of a VC and the issuance of a going concern opinion to a financially distressed IPO is stronger the greater the involvement of a VC. This study will inform industry regulators, concerned with transparency and the adequacy of financial disclosures, determine whether financial disclosure requirements should be enhanced to account for the presence of a VC . This study will also assist institutional and individual investors understand the risk that a VC-backed IPO may fail even when a GCO was not issued by an auditor.