Disclosure policy choices of UK firms receiving modified audit reports

Abstract

This study examines discretionary disclosures and stock price effects for 81 UK firms that received first-time modified audit reports during 1982–1990. Results indicate that these firms' managers are forthcoming about adverse developments, and appear to perceive the advantages of withholding negative news to be minimal. However, managers of many of the 58 stressed sample firms make disclosures about expected future performance that are overly optimistic relative to financial outcomes. As expected, stock market participants discount these stressed firms' positive tone disclosures. Evidence in this study confirms that there is a strong incentive problem with voluntary disclosure.