STRATEGIC AUDITOR BEHAVIOR AND GOING- CONCERN DECISIONS Ella Mae Matsumura, K.R. Subramanyam and Robert R. Tucker INTRODUCTION The going-concern opinion has long been a subject of controversy and debate in professional circles both in the UK and the US. In the US, the attention focused on this opinion has intensified due to political pressure and to a dramatic increase in auditors' legal costs resulting from reporting on a client's going-concern status. While considerable empirical work exists in this area, little theoretical analysis directly addresses the going concern issue. There is a need to examine this issue from a theoretical viewpoint, to understand better the nature of the problem and the effect of essential variables. This study presents a game-theoretic analysis permitting a flexible yet precise analysis of this difficult decision. Controversy has arisen over the value of the going concern opinion, the appropriateness and prudence of auditors making predictions, and the high Type I and Type II error rates for going concern reports. These controversial issues have inspired many empirical or experimental studies (Asare, 1990). While there is still conflicting evidence on whether going concern opinions have information content (Dodd, Dopuch, Holthausen and Leftwich, 1984; Dopuch, Holthausen and Leftwich, 1986) or whether going concern opinions are predictable (Dopuch, Holthausen and Leftwich, 1987), the evidence relating to the accuracy of the going concern opinions is more pervasive. Studies which use bankruptcy as a surrogate for the termination of business find that the frequency of going-concern exceptions is less than expected. Using UK data, Citron and Taffler (1992) found an 80% Type II error rate. Similarly, Altman (1982) and Altman and McGough (1974) report that while Altman's (1968) model predicted bankruptcy with 82% accuracy, auditors qualified in only 44% of the cases. Journal of Business Finance & Accounting, 24(6), July 1997, 0306-686X ß Blackwell Publishers Ltd. 1997, 108 Cowley Road, Oxford OX4 1JF, UK and 350 Main Street, Malden, MA 02148, USA. 727 * The authors are respectively, Associate Professor of Accounting at the University of Wisconsin- Madison; Assistant Professor of Accounting at the University of Southern California; and Visiting Associate Professor of Accounting at Northern Illinois University. The authors are grateful to Chris Czekai, Werner DeBondt, Don Hausch, Larry Rittenberg, Anthony Steele, Kam Tsui and an anonymous referee, workshop participants at the University of Southern California and the Auditing Symposium at the University of Illinois, and seminar participants at the University of Wisconsin for their comments and suggestions. (Paper received July 1996, revised and accepted January 1997) Address for correspondence: Ella Mae Matsumura, Associate Professor of Accounting, School of Business, University of Wisconsin-Madison, 975 University Avenue, Madison, Wisconsin 53706-1323, USA.