Japanese stock market reaction to announcements of news …kotan/japanese_stock_market... ·...

Journal of Contemporary Accounting & Economics 10 (2014) 206–224

Contents lists available at ScienceDirect

Journal of ContemporaryAccounting & Economics

journal homepage: www.elsevier .com/locate / jcae

Japanese stock market reaction to announcements of newsaffecting auditors’ reputation: The case of the Olympus fraud

http://dx.doi.org/10.1016/j.jcae.2014.08.0041815-5669/� 2014 Elsevier Ltd. All rights reserved.

⇑ Corresponding author. Address: Graduate School of Economics, Nagoya University Furo-cho, Chikusa-ku, Nagoya, 464-8601, Japan. Tel.: +81 01287.

E-mail addresses: [email protected] (Frendy), [email protected] (D. Hu).

Frendy ⇑, Dan HuGraduate School of Economics, Nagoya University, Furo-cho, Chikusa-ku, Nagoya 464-8601, Japan

a r t i c l e i n f o a b s t r a c t

Article history:Received 30 August 2013Revised 26 August 2014Accepted 26 August 2014Available online 3 September 2014

Keywords:Olympus fraudJapanAuditors’ reputationEvent studyInvestors’ reaction

The revelation of accounting fraud by the Olympus Corporation gave rise to shareholderallegations of audit failure against Olympus’ auditors—Ernst & Young ShinNihon LLC andKPMG AZSA LLC—in 2011. In this study, we investigate whether the auditors’ affiliationwith Olympus contributes to divergent perceptions of audit quality in the event of newsannouncements affecting the reputation of Olympus’ auditors. First, we use a nonparamet-ric generalized rank event study methodology on 918 sample firms from the First Section ofthe Tokyo Stock Exchange (TSE) to observe Japanese investors’ perceptions of auditorreputation as proxied by abnormal returns. Second, we perform a multivariate linearregression on firms’ abnormal returns after controlling for firm-specific variables. We findthat Japanese investors do not respond to negative or neutral reputational informationarising from news announcements concerning Olympus’ auditors for firms affiliated andnot affiliated with those auditors. In the absence of legal penalties imposed on Olympus’auditors, we argue that Japanese investors consider the Olympus fraud case as an expectedoccurrence of audit failure due to a lack of evidence suggesting systematic audit failure onthe part of Olympus’ auditors and an expectation of lower audit quality in the Japanesecapital market. As a result, Japanese investors do not consider news announcements affect-ing the Olympus auditors’ reputation as sufficient evidence to change their prior expecta-tion regarding the reputations of the audit firms affiliated with the Olympus fraud case.

� 2014 Elsevier Ltd. All rights reserved.

1. Introduction

In the fourth quarter of 2011, Olympus shareholders requested an independent investigation to confirm whether Olym-pus’ independent auditors (Ernst & Young ShinNihon LLC and KPMG AZSA LLC; hereafter referred to as E&Y and KPMG,respectively) were legally responsible for the fraud orchestrated by the company (Olympus, 2011b). Their request signaledthat Olympus’ auditors had failed to fulfill their duty in issuing a proper audit opinion on Olympus’ financial statements.Although no legal penalties were imposed on the auditors, events prior to the conclusion of the investigation in 2012 providea unique opportunity to assess the impact of news announcements regarding the potential involvement of Olympus’ auditorson their reputation. We observe these changes in the auditors’ reputation by investigating Japanese investors’ abnormal mar-ket price reactions surrounding the news announcements.

Two main features differentiate the Olympus fraud case from other major incidents of accounting fraud perpetrated byJapanese companies. First, Olympus represents a very small group of Japanese companies that employ foreign CEOs, a group

90 9908

http://crossmark.crossref.org/dialog/?doi=10.1016/j.jcae.2014.08.004&domain=pdf

http://dx.doi.org/10.1016/j.jcae.2014.08.004

mailto:[email protected]

mailto:[email protected]

http://dx.doi.org/10.1016/j.jcae.2014.08.004

http://www.sciencedirect.com/science/journal/18155669

http://www.elsevier.com/locate/jcae

Frendy, D. Hu / Journal of Contemporary Accounting & Economics 10 (2014) 206–224 207

that includes Sony, Nissan, Nippon Sheet Glass, and Shiseido (Nakamoto, 2012). In addition, the Olympus scandal is the firstcase of major accounting fraud in Japan in which the whistleblower was a non-Japanese, Michael Woodford, who served asOlympus CEO when the fraud was first uncovered in late 2011. Second, the perceived impact of the Olympus fraud case issignificant in terms of the relatively strong market position of Olympus among giant Japanese electronics firms,1 the amountof monetary loss due to the fraud2 and the extensive media coverage.3

The Japanese audit environment is characterized by a lower litigation risk compared with the US, which makes it moreappropriate to utilize the auditor reputation hypothesis in examining market reactions following the Olympus fraud case.The ability of Japanese shareholders to successfully indict auditors and demand compensation for audit negligence due to fraudis relatively low (Numata and Takeda, 2010). The reputation hypothesis asserts that the economic value of audit services isderived from the high quality and reliable assurance of financial statements’ conformity with GAAP. In the event of audit failure,auditors’ reputation will suffer because they are not able to meet stakeholders’ expectations of providers of high quality audits.Consequently, Japanese auditors are particularly vulnerable to news or information that might cast doubt on their reputation.

Events surrounding the announcement of the Olympus fraud case provide unique opportunities to test whether newscoverage affecting the auditors’ reputation had an observable impact on the share prices of other Japanese public firmsaudited by the auditors affiliated with Olympus. This study aims to provide empirical evidence on the influence of newson auditor reputation for Japanese firms whose auditors were alleged to be involved in the Olympus fraud case. To the bestof our knowledge, this paper represents the first attempt to ascertain a change in auditors’ reputation resulting from newscoverage of their potential involvement in accounting fraud in the Japanese institutional setting.

Most previous research on market reactions to auditors’ reputation was conducted on Anglo-American markets, whoseresults might not be generalizable to the Japanese market. Investors’ expectations regarding auditors’ reputation for con-ducting high quality audits rely on the institutional environment where the audits take place. In the US, higher quality auditsby the Big 4 auditors have been associated with a stricter US litigation regime against auditors (Khurana and Raman, 2004).However, the Japanese financial reporting environment is characterized by the strong influence of government institutionsin shaping accounting policies, a less effective and independent CPA profession, a highly leveraged corporate structure, and anon-litigious audit environment. We argue that these institutional features contribute to weak and lower quality Japaneseaudit institutions and an environment in which only significant financial reporting fraud can be considered relevant newswith a significant effect on auditors’ reputation. Consequently, Japanese investors are expected to have a lower quality auditthreshold compared with Anglo-American investors. We argue that this lower quality audit expectation diminished themagnitude of Japanese investors’ reactions following the news announcements affecting the Olympus auditors’ reputation.

Section 2 of the paper reviews the existing literature on audit value, news announcements and market reaction, examinesthe characteristics of Japanese audit and market institutions, and develops the hypotheses. Section 3 includes a discussion ofthe research method, the sample selection criteria, and the statistical estimation models used in the paper. Sections 4 and 5present a quantitative analysis and discussion of the results, respectively. Section 6 concludes.

2. Literature review and hypotheses development

2.1. Value of audit: reputation and insurance hypothesis

The relationship between an audit and its economic value can generally be explained by two hypotheses in the account-ing literature: the insurance and reputation hypotheses. The insurance hypothesis assumes that the main role of auditors istaking responsibility in case investors suffer losses from management misrepresentation of financial statements.4 On theother hand, the reputation hypothesis holds that auditors derive value from providing reliable assurance services by certifyingthe reasonability of management’s assertion of financial information presented to stakeholders.5

Both the reputation and insurance hypotheses attempt to explain the audit value and market reaction following audit fail-ure. However, it is difficult to clearly differentiate which hypothesis has better power in explaining the true causal factor of themarket reaction from the loss of audit value in previous empirical studies (Ball, 2009). Piot (2005) investigated the determi-nants of auditors’ reputation in three distinct capital markets and legal frameworks: Canada, France, and Germany. The authorconcluded that evidence for the insurance hypothesis was more salient in Canada (high auditor litigation risk) compared with

1 Olympus commands 75% of the gastroenterological medical endoscope global market share (Lorsch et al., 2012). Olympus is also a major leader in Japan’shigh-growth mirrorless consumer camera market with a 30.7% Japanese market share, exceeding rival companies such as Panasonic, Nikon, and Sony (Olympus,2012).

2 The total amount of financial losses involved in the Olympus fraud case is estimated to be 252.5 billion yen/2.4 billion USD (Third Party Committee, 2011b).To put this number into perspective, the restated net income of Olympus for fiscal year 2011 was 3.87 billion yen (36.8 million USD), which means that losseswere approximately 65 times higher than the 2011 net income.

3 The scandal attracted a large amount of coverage from both domestic and international media, which is explained, in part, by the factors mentioned above.The media even nicknamed the Olympus scandal ‘‘the Enron of Japan’’ (Armitage, 2012).

4 In the competitive audit market, the success of audit firms largely depends on maintaining their reputation as providers of high quality auditing. Thisargument forms the basis of the reputation hypothesis as the main determinant of inherent economic value in audit services.

5 The value of audit services is mainly derived from the role auditors play in providing their clients with an additional buffer against litigation claims in theevent of clients’ business failure (Menon and Williams, 1994). Auditors are frequently viewed as a party with ‘‘deep pockets’’ that is able to share the burden ofa litigation charge directed against fraudulent companies by affected stakeholders.

208 Frendy, D. Hu / Journal of Contemporary Accounting & Economics 10 (2014) 206–224

Germany (limited auditor litigation risk). The litigation characteristics of the jurisdiction where auditors operate determinewhether it is more appropriate to apply the reputation or the insurance hypothesis in research on auditors’ reputations.

Weber et al. (2008) applied the reputation hypothesis rationale to find evidence for negative abnormal returns for KPMGclients following the disclosure of the ComROAD AG scandal in Germany. Japan shares many similar features with Germanyregarding auditor litigation, which is considerably less litigious compared with the US. Shareholder plaintiffs in Japan aregenerally characterized by a low win percentage, few settlements of lawsuits, low monetary settlements, and low correla-tions between stock prices and lawsuits (West, 2001). Because this paper investigates market reactions in the Japanese cap-ital market environment, we consider the reputation hypothesis the most appropriate theory when analyzing the effect ofaudit failure in the Olympus fraud case.

2.2. Market effect of news announcements and press coverage

The efficient market hypothesis postulates that share prices should be responsive to new information released to the public.However, no new news content from news publications can result in more significant share price reactions and industry spill-over effects compared with the release of original news that was published earlier (Huberman and Regev, 2001). Hubermanand Regev (2001) showed that the act of publishing news without any new news content could result in market reactions.

The press plays an important role in disseminating new information to capital markets by publishing original investiga-tive articles. Journalists are in a good position to expose high profile corporate fraud due to high reputational incentives andextensive public exposure (Dyck et al., 2010). The incentives for the press to publish investigative articles on fraudulent firmsare linearly related to the degree of public visibility that the articles will produce (Miller, 2006). Articles that expose highprofile corporate fraud with significant social costs have a higher chance of being covered by the press.

Negative rumors regarding auditors have been shown to influence investors’ expectations of auditors’ reputation andaudit quality. Hillison and Pacini (2004) concluded that investors in Ernst and Young clients reacted negatively followingthe rumor of bankruptcy litigation against E&Y in late 2000. Linthicum et al. (2010) concluded that the social responsibilitymeasures enacted by Arthur Andersen clients during the uncovering of the Enron fraud case were not able to mitigate thenegative market spillover effect from the loss of Arthur Andersen’s reputation.

Potential corporate fraud leaked to the media is also generally reliable. The business media, which regularly publishesinvestigative articles on potential fraud cases, generally have access to relevant information from other external sources(analysts, short sellers, or key employees) and can confirm the validity of information (Dyck et al., 2010). Because mediaoutlets are also exposed to the risk of losing their reputation by publishing false positive news, they generally only publisharticles that they are confident reflect the facts.

The Japanese stock market demonstrates less conservative market reactions to bad accounting news. Ball et al. (2000)showed that the Japanese market does not exhibit different price behavior for bad news events than for good news comparedwith a more conservative price reaction to bad news in the US market. It is very likely that the different levels of accountingconservatism between the Japanese and US capital markets trigger different investor reactions in response to the disclosureof new information.

2.3. Market effect of auditors’ reputation loss

The need for empirical research on the effect of an auditor reputational penalty in the event of accounting fraud is argu-ably more important in the Japanese capital market because legal sanctions for corporate scandals are negligible in Japan.The total penalty for a corporate scandal consists of the explicit legal penalties that can be imposed through criminal, civiland regulatory actions and reputational losses (Tanimura and Okamoto, 2013). In the event of a legitimate corporate scandal,as in the Kanebo fraud case in 2004, Japan’s Financial Service Agency revoked the CPA licenses of convicted auditors and tem-porarily suspended the operation of ChuoAoyama PwC (Konishi, 2010). Empirical research conclusively demonstrated theadverse reputational penalties following these events in the form of negative market spillover and auditor switching(Numata and Takeda, 2010; Skinner and Srinivasan, 2012).

2.3.1. Market reaction to poor audit qualityWhen auditors are perceived to be responsible for an audit failure, investors expect that audit reports produced by the

alleged auditors will provide lower levels of assurance compared with other auditors. Empirical evidence has shown thatclients of auditors with a history of audit failure are more likely to overstate their earnings and book value (Chaney andPhilipich, 2002). The extent of auditors’ reputation losses due to their involvement in financial statement fraud is expectedto adversely affect their clients’ market value.

Investor reactions to adverse news related to auditors’ performance are generally negative. In particular, an inspection ofauditors by capital market regulators usually triggers negative investor reactions.6 Negative market reactions were also

6 Auditors reported that an investigation by the U.K. Department of Trade negatively affected the auditors’ reputation in providing high quality service, whichin turn negatively impacted their clients’ market value and resulted in a loss of audit clients and fees (Firth, 1990). In the US, E&Y clients exhibited moderatenegative market reaction when the California State Board of Accountancy threatened to revoke E&Y’s practice license due to audit failure (Pacini and Hillison,2003).


observed for Deloitte clients when the Public Company Accounting Oversight Board (PCAOB) announced financial penaltiesagainst Deloitte for audit failure with respect to Ligand; financially distressed clients are more susceptible to negative news(Dee et al., 2011).

2.3.2. Market reaction on Arthur Andersen reputation loss during Enron fraudAuditors’ reputation will suffer if they release unqualified opinions on fraudulent financial statements. Audit failure

caused by fraud invites greater concern because clients are able to systematically misrepresent financial statements to inves-tors and deliberately withhold key information to keep auditors in the dark. The Enron accounting fraud case and the sub-sequent failure of Arthur Andersen (AA) prompted many researchers to investigate market reactions in the event of auditorfailure. In general, US investors reacted negatively during the Andersen–Enron scandal, which indicates an adverse effect onAA’s reputation.7 Other research found evidence of Andersen clients switching auditors following the investigation of fraud atEnron.8

However, a number of empirical papers failed to observe negative market reactions following the events of the Andersen–Enron case. It might not be appropriate to generalize the observed negative investor reactions to audit failures in the US marketto non-US capital markets. The failure of Arthur Andersen in Spain did not trigger a negative market reaction to their clientsdespite the firm’s dominance in the audit market (Barbera and Martinez, 2006). It is plausible that the disparity of shareholderreactions among national capital markets to a similar event can be attributed to institutional environment differences betweennon-US and US capital markets. After controlling for global macroeconomic confounding factors and the industrial structure ofAA clients, Nelson et al. (2008) demonstrated that there was insufficient evidence to support the influence of auditors’ reputa-tion losses on negative market reactions. Contrary to the negative market reactions generally observed in for-profit AA clients,the non-profit clients of AA did not experience a negative change in their income despite the perceived importance of auditorreputation in securing donations (Harris and Krishnan, 2012).

2.4. Characteristics of Japanese audit institutions

2.4.1. Commercial law structure and audit litigation environmentThe German Commercial Code influenced the development of Japan’s Companies Act at the end of the 19th century,

which categorized Japan as a code law country. In Japanese commercial laws, the protection of creditors is regarded to beat least as important as the protection of shareholders (Nobes and Parker, 2012). Although American financial and commer-cial laws have influenced the modernization of Japanese laws post-World War II, the basic characteristics of German civil lawhave remained in place (Porta et al., 1998). Code law countries, including Japan, are generally characterized by a closerelationship between shareholders and managers.

The Japanese capital market is characterized by the absence of litigation risk against auditors even in the case of corporatefailure (Sakagami et al., 1999). Yoshimi (2002) argued that the Japanese people have no expectation for audits, which con-tributes to a significant expectation gap between auditors and the public. In the majority of corporate fraud cases in Japan,the public did not consider the auditor of the fraudulent companies to be a complicit party responsible for the fraud. Thisattitude contributes to the low rate of litigation against auditors following cases of accounting fraud in Japan.

2.4.2. CPA profession in JapanThe Japanese government has a stronger influence on the formation of accounting policies compared with the Japanese

Institute of Certified Public Accountants (JICPA), which is typical of code law countries (Ball et al., 2000). While the AICPA inthe US has the authority to set auditing standards, Japanese auditing standards are controlled by the Business AccountingCouncil (BAC), an advisory body under the public Financial Service Agency (FSA) (Nobes and Parker, 2012). The size, influ-ence, and role of Japanese CPAs are also not directly comparable to the more mature and developed CPA institutions inAnglo-American countries (Jinnai, 1990). We expect that Japanese shareholders’ expectations on audit quality will be rela-tively lower compared with shareholders in Anglo-American countries when considering the less independent and effectiverole of CPAs in the Japanese capital market. This lower expectation might lead to weaker market reactions following newsannouncements affecting the reputation of auditors of Japanese firms.

2.4.3. Japanese corporate financial structureCompared with US companies, the majority of Japanese companies rely more on debt than equity as their source of

financing (Nobes and Parker, 2012). Our analysis (Table 4) shows that the non-financial sample firms in this paper exhibita relatively high degree of financial leverage. Banks play a more significant role in the Japanese corporate governance systemas the main source of debt financing. Shares of Japanese public companies are also generally held for a longer investment

7 Evidence of negative market reactions was observed in: Andersen clients audited by the Houston Andersen office (Chaney and Philipich, 2002; Huang andLi, 2009); an adverse contagious effect on peer firms (Akhigbe et al., 2005); a negative market effect on Andersen clients’ secondary equity offerings (Rauterkusand Song, 2005); and a susceptibility of companies with higher information ambiguity to adverse news (Autore et al., 2009).

8 Clients with more capital market visibility are more likely to switch to other Big 5 auditors earlier (Barton, 2005), and investors react positively whenclients switch auditors earlier (Krishnamurthy et al., 2006). In addition, clients with strong corporate governance are more likely to switch auditors earlier, andpublic disclosure of auditor switching leads to positive investor reactions (Asthana et al., 2010).


horizon. Japanese stockholders tend to focus less on short-term earnings information compared with US investors (Nobesand Parker, 2012). We argue that these features of the Japanese financial structure might contribute to weaker stock marketreactions to the disclosure of new information.

2.5. Summary of the Olympus fraud case

On October 14, 2011, the Japanese business world was shocked by the sudden dismissal of Olympus CEO Michael C.Woodford. Although Olympus cited an incompatible management style as the reason for Woodford’s dismissal (KyodoNews Service, 2011a), investors responded to this unexpected news negatively, as shown by a 24% loss in the company’sstock on the next trading day (Kyodo News Service, 2011b). One week after the event, Olympus’ stock value had decreasedby approximately 50%, from 2482 yen on October 13, the day before Woodford’s dismissal, to 1231 yen (Kyodo News Service,2011c).

The purpose of the Olympus fraud scheme was to hide investment losses on financial assets resulting from the bursting ofthe Japanese economic bubble in the 1990s. Olympus utilized tobashi (improper transfer of losses) to hide losses from itsinvestments in financial assets in the 1990s. Using specified money trusts and specified fund trusts (tokkin) to recover theirlosses, the amount of unrealized investment losses had grown to tens of billions of yen by 1995 (Third Party Committee,2011a).9

To avoid recognizing the unrealized valuation losses on financial assets that had grown to 95 billion yen (903 millionUSD) in 1998, Olympus executives arranged to establish ‘‘receiver funds’’ in the Cayman Islands that would not be consol-idated with Olympus (Third Party Committee, 2011a). In 2008, Olympus utilized acquisition transactions of Gyrus, a Britishmedical equipment manufacturer, as a cover to pay the ‘‘receiver funds’’ an unreasonable amount of acquisition consultingfees amounting to 687 million USD. To put this amount into perspective, the consulting fees alone represented 31% of thetotal acquisition price of Gyrus, which was 2.2 billion USD. The amount paid for the acquisition would later be recognizedas goodwill. Overall, the total amount of financial losses involved in the Olympus fraud case was estimated to be 252.5 billionyen (2.4 billion USD), which consisted of 117.7 billion yen (1.12 billion USD) involved in an ‘‘unrealized loss separationscheme’’ and 134.8 billion yen (1.28 billion USD) appropriated in a ‘‘loss disposition scheme’’ (Third Party Committee,2011b).

KPMG was the designated independent auditor of Olympus from the fiscal year ending in March 2003 to March 2009, andE&Y replaced KPMG starting with the fiscal year that ended in March 2010. The investigation report published by Olympus inDecember 2011 acknowledged that although both auditors were involved in approving the fraudulent transactions, Olym-pus’ management was able to withhold essential information from the auditors, preventing them from raising any red flags.Although the report described in detail the involvement of Olympus’ auditors in the scheme and ‘‘insufficient functioning ofauditors’’ was cited in the analysis of the cause of the scandal, there was no explicit allegation of auditor responsibility in thefraud (Third Party Committee, 2011b).

2.6. Hypotheses development

The failure of Olympus’ auditors to issue a modified or qualified audit report in the appropriate circumstances representsan instance of audit failure (Francis, 2004). The reputation hypothesis postulates that auditors’ reputation is dependent onaudit quality. The inability of Olympus’ auditors to expose the company’s accounting fraud might provide a rationale for Jap-anese investors to downgrade the quality of the financial statements of firms audited by Olympus’ auditors, which in turnwould adversely affect the auditors’ reputation. Those factors also might contribute to negative stock price pressure for firmswhose auditors were affiliated with Olympus. Although the Olympus fraud case was followed by a significant number of neg-ative news announcements on the auditors’ involvement, the independent investigation ultimately concluded that Olympus’auditors were not legally responsible for the fraud and would not face any regulatory penalties (Non-Director ManagementLiability Investigation Committee, 2012).

Shareholders’ reaction to changes in the reputation of auditors is subject to the shareholders’ institutional market envi-ronment. The Japanese audit environment is characterized by the government’s strong influence on accounting though com-mercial laws, a less effective and independent CPA profession, a highly leveraged corporate structure, and a non-litigiousaudit environment. These characteristics strongly indicate that Japanese investors are more likely to expect a lower auditquality compared with audits performed in Anglo-American markets. Because Japanese investors have lower expectationsfor audit quality, we hypothesize that they were less likely to exhibit strong market reactions following the news affectingthe Olympus auditors’ reputation.

The purpose of this study is to identify the market reaction of clients of auditors whose reputation was affected by newscoverage that implied responsibility in the Olympus fraud case. We examine whether investors in Japanese public companiesaudited by firms associated with Olympus exhibited abnormal market reactions during the news announcements that had apotential adverse reputational effect on the auditors. In addition, we assess whether the extent of the market reactions was

9 A revision in Japanese accounting standard No. 10, ‘‘Accounting Standards for Financial Products’’, which went into effect in fiscal year 2000, requires majorfinancial assets to be marked at fair value. Consequently, an accounting scheme to hide unrealized losses that occurred in the bubble economy period throughtobashi to fund trust accounts and the non-consolidation of affiliates was no longer viable (Yamazaki, 1999).


more severe for clients audited by firms associated with Olympus compared with clients audited by auditors who were notaffiliated with Olympus.

H1. Abnormal share returns of publicly listed clients of auditors associated with Olympus (E&Y and KPMG) are not observedfollowing news publications affecting the reputation of Olympus’ auditors.

H2. No difference is observed in the market reaction between firms whose auditors are associated with Olympus (E&Y andKPMG) and other firms whose auditors are not associated with Olympus following the news publications affecting the rep-utation of Olympus’ auditors.

3. Method and data

3.1. Determination of event days and samples

We determined six events that had the largest possibility to alter investor perceptions regarding the reputation of Olym-pus’ auditors, as shown in Table 1. The event date (t0) is based on the date when news was first made available to the public.We investigate whether abnormal investor reactions were observed on clients whose auditors were alleged to be involved inthe fraud around these event dates. The following discussion of each event date is arranged chronologically.

From the six events identified, the first two events (Event 1 and Event 2) covered the initial publication of articles on sus-picious acquisition transactions by the Japanese financial magazine FACTA prior to the start of the official investigations byOlympus. The rest of the events (Events 3, 4, 5 and 6) covered the announcement dates of official press releases and inves-tigation reports published by Olympus. Event 1 to Event 5 covered news publications that had negative implications for thereputation of Olympus’ auditors, while Event 6 had a neutral auditors’ reputational effect.

Event 1 included the earliest public press coverage that cast doubt on the fairness of Olympus’ 2008 acquisition of Gyrus,a subsidiary that was alleged to be involved in an improper acquisition transaction (Abe, 2011a). Event 2 involved the pub-lication of a follow-up article by FACTA that reported no official response from Olympus regarding FACTA’s initial inquiry inJuly 2011 (Abe, 2011b). We argue that these events might give rise to a negative perception of the Olympus auditors’ auditquality if investors associated the non-reply from Olympus as a reliable indicator admitting the existence of inappropriatetransactions.

Event 3 covered the publication of Olympus’ official press release in response to the media report regarding an inappro-priate auditor switch by Olympus from KPMG to E&Y in fiscal year 2010. The media alleged that the reason for the auditorswitch was due to KPMG’s withdrawal from auditing Gyrus. Olympus stated that the motivation for the change in auditorwas reasonable because KPMG’s audit contract had expired, and KPMG reported an unqualified audit opinion for the fiscalyear 2009 consolidated financial statements (Olympus, 2011a). We argue that this press release was announced in responseto the FACTA inquiries in Events 1 and 2. We investigate whether this event generated different investor reactions comparedwith the prior events.

Event 4 covered the announcement of Olympus shareholders’ request to investigate whether Olympus’ independent auditfirms since 1999 (KPMG and E&Y) were negligent in their duty of care to report the inappropriate transactions to the board ofauditors (Olympus, 2011b). If such a breach of duty existed, Olympus would be required to file legal actions against thoseaudit firms for breach of contract. In response to this request, Olympus commissioned the Non-Director Management Liabil-ity Investigation Committee to issue a report that was published in January 2012 to investigate which parties could be heldlegally responsible for the fraud (Event 6). This was the first occasion in which an Olympus press release explicitly men-tioned independent auditors as potential parties responsible for the fraud.

On December 6, 2011, the Third Party Committee released its investigative results concerning Olympus’ inappropriateacquisition transactions (Event 5). The report contained a chronological summary of transaction schemes, institutions,

Table 1News announcements affecting Olympus auditors’ reputation.

Publication date of FACTA articles on Olympus fraudEvent 1 July 15, 2011 FACTA, a Japanese financial magazine, published an article questioning suspicious M&A activities by

OlympusEvent 2 September

15, 2011FACTA published a second article reporting no response from Olympus regarding FACTA’s initial inquiryand investigation of Olympus’ suspicious acquisitions in July

Official Olympus press releases and investigation reportsEvent 3 October 24,

2011Olympus published a press release denying that the reason for their auditor change was due to KPMG’swithdrawal from auditing a subsidiary of Olympus

Event 4 November25, 2011

Olympus received requests from its shareholders to investigate whether Olympus’ independent auditors(KPMG and E&Y) were negligent in their duty of care

Event 5 December 6,2011

The Investigation Report was issued by Olympus’ Third Party Committee that mentioned the potential roleof Olympus’ audit firms in the fraud

Event 6 January 17,2012

The Olympus Corporation Non-Director Management Liability Investigation Committee’s InvestigationReport was released. It concluded that no legal liability would be pursued against Olympus’ independentauditors

Table 2Selection and distribution of sample firms.

Firms listed in First Section of TSE in 2011 (excluding Olympus) 1751Less: Missing stock price data (195)

Missing firm-specific variables from NEEDS financial database (400)Missing audit firm data from NEEDS auditor database (102)Firms that changed auditors between fiscal year 2010 and 2011 (18)Finance and insurance companies (118)

Final sample 918

Distribution of final sample categorized by auditorShinNihon (E&Y) 290 (31.59%)AZSA (KPMG) 246 (26.80%)Tohmatsu (Deloitte) 204 (22.22%)Aarata (PwC) 29 (3.16%)Non Big-4 149 (16.23%)

Final sample 918

Distribution of final sample categorized by stock listingFirms listed only on Japan exchanges 891 (97.06%)Firms listed on Japan and US exchanges 15 (1.63%)Firms listed on Japan and non-US exchanges 12 (1.31%)

Final sample 918


and individuals involved in hiding deferral losses and the implementation of the acquisition transactions. With respect toauditor involvement, the report documented the Olympus independent auditors’ rationale and opinion on the accountingtreatments for the transaction schemes designed by the Olympus executives and their role in Olympus’ internal controland corporate governance system (Third Party Committee, 2011a). The section of the summary report analyzing the causeof the incident also noted, ‘‘the auditing firm(s) did not function sufficiently’’ (Third Party Committee, 2011b). However,there was no reference to legal responsibility directed toward any parties because that was not the objective of the report.Events 1, 2 3, 4, and 5 indicate events with a negative reputational effect on Olympus’ auditors.

Event 6 covered the release date of the Non-Director Management Liability Investigation Committee’s InvestigationReport, the objective of which was to assess the possibility for Olympus to file legal suit to pursue liability against non-direc-tor parties involved in the fraud. In relation to the involvement of Olympus’ independent auditors, the report investigatedwhether violations of the duty of care existed, and whether the auditor succession from KPMG to E&Y in 2010 and E&Y’sdecision to accept the accounting treatment of goodwill were appropriate (Non-Director Management LiabilityInvestigation Committee, 2012). The report concluded that both Olympus audit firms were not legally liable for the fraud.Event 6 represents the news announcement with a neutral reputational effect on Olympus’ auditors.

We sample all of the firms listed in the First Section of the Tokyo Stock Exchange (TSE) during the observed events. Stockinformation, industry classification and financial variables data are obtained from fiscal year 2011 Japanese securities filingsinformation (Yukashoken-Hokokusho) extracted from the NEEDS (Nikkei Economic Electronic Database Systems) Financial-Quest database. Of the 1751 firms that were initially sampled (excluding Olympus), we exclude firms with missing stockprices and other variables, firms with qualified or disclaimer audit opinions, and financial and insurance companies. We alsoexclude firms that changed auditors between fiscal year 2010 and 2011 to control for auditor reputation effects that mightarise from switching auditors. Only 18 firms changed auditors during this period. The statistical results and estimations inthis paper are robust to the inclusion of these firms.

The distribution of our final sample of firms as categorized by their auditors is approximately similar to the overall audi-tor market share in the Japanese market. The majority (97.06%) of our sample firms are exclusively registered in Japanesedomestic stock markets. There are only 15 Japanese listed firms registered with US stock exchanges (New York or NASDAQ),and the other 12 Japanese listed firms are traded on non-US stock exchanges, including London, Paris, Luxembourg, Frankfurtand Singapore. The description and distribution of the sample firms are presented in Table 2.

3.2. Event study method

We employ Kolari and Pynnonen’s (2011) nonparametric generalized rank (GRANK) test methodology for multiple eventwindows to evaluate whether abnormal price reactions were observed around the news events related to the Olympus audi-tors’ reputation, as described in Hypothesis 1. This study utilizes daily stock and excess returns for individual securities thatexhibit substantial departures from normality that are not observed with monthly data (Brown and Warner, 1985). This testprocedure improves on the nonparametric rank testing approach of Corrado (1989) and Corrado and Zivney (1992).10

10 The distribution-free characteristic of the nonparametric GRANK test procedure makes it less sensitive to the distributional assumption of parametric tests.The GRANK test also exhibits robustness to event-induced cross-sectional volatility, autocorrelation of abnormal returns, and cross-correlation caused by eventday clustering (Kolari and Pynnonen, 2011).


The accuracy of an event study’s findings is highly dependent on the existence of any confounding events that concur withthe events of interest to the researcher (Kothari, 2001). To control for confounding surrounding events that could dispropor-tionately affect the sample firms across different industry sectors, we examined news announcements around the event win-dows from The Wall Street Journal, Financial Times, The New York Times, Nikkei Business, Yomiuri Shinbun, and The JapanTimes extracted from the LexisNexis database. From our observations, we did not identify any global macroeconomic newsduring the event windows that could disproportionately result in systematic return differences across different industries.

If an event is unanticipated by a market and incomplete prior information exists, an abnormal return observed during theevent measures shareholder reactions to the impact of the events (Brown and Warner, 1980). We denote the event day as t0,the initial date of the event window as t1, and the final date of the event window as t2. We select four event windows(t1, t2) = (0,1), (0,2), (0,3), and (�1,3) to guarantee a robust measure of price reaction (Numata and Takeda, 2010). The cumu-lated abnormal return that covers a window of multiple days is calculated to capture the price effects of announcements thatoccurred after the stock market closed on the announcement day. Price reaction one day prior to the event is also included toobserve the possibility of information leaked prior to the event day (MacKinlay, 1997). The estimation window is set at 250trading days before the event window of the first event.

We use the Fama–French three-factor model rather than a market model to estimate abnormal returns because threestock market factors (overall market, firm size and book-to-market equity) can explain the differences in common variationand the cross section of average stock returns (Fama and French, 1993). Event study analysis aims to isolate the incrementalimpact of an event on security price performance, and the Fama–French three-factor model is more capable of isolating per-formance associated with an event from the three known performance determinant factors (Kothari and Warner, 2007).11

Expected returns for each sampled firm in each event period are estimated using the following Fama–French three-factormodel illustrated in Eq. (1) (Fama and French, 1996).12 Stock and market return data used to estimate the Fama–French modelare first transformed into their natural logarithm value:

11 Froreturnswas hig

12 Theken.fren

Ri;t � Rf ;t ¼ aþ bi;mðRm;t � Rf ;tÞ þ bi;smbSMBt þ bi;hmlHMLt þ u;t ð1Þ

Excess (abnormal) returns are then estimated as the difference between a firm’s excess market returns over the risk freerate and its expected returns using the following equation (Kolari and Pynnonen, 2011):

ARi;t ¼ ðRi;t � Rf ;tÞ � ½aþ bi;mðRm;t � Rf ;tÞ þ bi;smbSMBt þ bi;hmlHMLt � ð2Þ
where
Ri,t

m a statis(MacKinlher thanFama–F

ch/data_

daily stock return
Rf,t market risk-free rate Rm,t � Rf,t excess stock returns on a broad market portfolio (Tokyo Stock Price Index/TOPIX) SMB the difference between the return on a portfolio of small stocks and the return on a portfolio of large stocks
(SMB: small minus big)
HML the difference between the return on a portfolio of high-book-to-market stocks and the return on a portfolio
of low-book-to-market stocks (HML: high minus low)
ARi,t estimated abnormal return
We then calculated the standardized abnormal return (SAR) for each stock over the estimation window:

SARit ¼ARit

SARi

ð3Þ

where SARiis the standard deviation of the regression prediction errors for abnormal returns defined in MacKinlay (1997).

The cumulative abnormal return (CAR) and standardized abnormal return (SCAR) are computed for each stock in theevent window:

CARiðt1; t2Þ ¼Xt2

t¼t1

ARi;t ð4Þ

SCARi;ðt1 ;t2Þ ¼CARiðt1; t2Þ

SCARiðt1 ;t2Þð5Þ

where SCARiðt1 ;t2Þ is the standard deviation of the prediction errors for cumulative abnormal returns as defined in MacKinlay(1997).

tical power perspective, the multifactor model reduces the variance of the abnormal returns by explaining more of the variation in the normalay, 1997). Using return data in this study, we found that the R2 value of the expected return estimated by the Fama–French three-factor modelthe market model.

rench factor data for the Japanese stock market are obtained from Prof. French’s website (http://mba.tuck.dartmouth.edu/pages/faculty/library.html). The monthly return values of the Fama–French factors are then adjusted to the daily returns.

http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html


Next, we compute the re-standardized SCAR (SCAR*) to account for possible event-induced volatility (Boehmer et al.,1991):

SCAR�i ¼SCARi;ðt1 ;t2Þ

SSCARðt1 ;t2 Þ

ð6Þ

where

SSCARðt1 ;t2 Þ¼

ffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi1

n� 1

Xn

i¼1ðSCARi;ðt1 ;t2Þ � SCARðt1 ;t2Þ

2

rð7Þ

is the cross-sectional standard deviation of SCARi.The generalized standardized abnormal return (GSAR) is then computed for each event window and sample group:

GSARit ¼SCAR�i ; for CAR window ðt1; t2ÞSARit; for other time period

�ð8Þ

where SCAR�i is defined in Eq. (6), and SARit is defined in Eq. (3).The demeaned standardized abnormal ranks of the GSAR are then calculated according to the following formula:

Uit ¼RankðGSARitÞðT þ 1Þ � 1=2 ð9Þ

where T is equal to the length of estimation period (250 days) plus one CAR event day that represents the total number ofobservations.

Given the null hypothesis of no mean event effect:

H0 : lðt1 ;t2Þ ¼ 0

where lðt1 ;t2Þ is the expected value of the CAR over the period of the event window (t1, t2).The generalized rank t-statistic (GRANK-T) for testing H0 is defined as:

tgrank ¼ ZT � 2

T � 1� Z2

� �12

ð10Þ

where

Z ¼ U0

SU

ð11Þ

with

Ut ¼1nt

Xnt

i¼1

Uit ð12Þ

SU ¼ffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi1T

Xt2T

nt

nU2

t

rð13Þ

nt is the number of valid GSARit available at time point t, T is the number of observations and U0 is the mean Ut at t = 0 (thecumulative abnormal return). Asymptotic distribution of GRANK-T follows Student t-distribution with T � 2 degrees offreedom.

3.3. Cross-sectional regression

We perform a cross-sectional analysis to analyze the firm-specific variables that influence the mean CAR observed dur-ing the six events. The following multivariate regression models are estimated using a fixed effect model after correctingfor heteroscedastic standard errors (Eq. (14)). A fixed effect model is utilized to control for sample heterogeneity acrossdifferent industries. To complement our analysis, we add interaction variables between the Olympus dummy variableand each control variable. We perform a centering procedure for each interaction variable to mitigate the multicollinearityproblem.

CARi ¼ b1 þ b2Olympusi þ b3Opinioni þ b4RoAi þ b5Assetsi þ b6Leveragei þ b7FreeFloatRatioi þ b8Segmentsi

þ b9ForeignShareholdersi þ b10OverseasSalesi þþb11CrossListingi þX

bjOlympusi � Controlij

� �þ ui ð14Þ


where

CAR
mean cumulative abnormal return (%) Olympus dummy variable for clients audited by an Olympus auditor (ShinNihon or AZSA) (1 = true,
0 = otherwise)
Opinion dummy variable for type of audit opinion (1 = unqualified, 0 = unqualified with explanatory
paragraph)
RoA return on assets (net income divided by total assets (%) Assets natural logarithm of total assets Leverage total liabilities divided by total assets (%) FreeFloatRatio ratio of listed shares available for trading in the market (number of floating shares divided by total
number of shares owned by shareholders) (%)
Segments number of distinct divisions for which shares of total sales are reported ForeignShareholders ratio of listed shares owned by foreign corporations (number of shares owned by foreign
corporations divided by total number of shares owned by shareholders) (%)
OverseasSales ratio of sales outside Japan to total sales (%) CrossListing dummy variable for cross listing status (1 = stock listed on foreign exchange outside of Japan,
0 = stock only listed in Japan)

The control variables are drawn from previous research on stock market reactions and include type of audit opinion, lever-age, return on assets, total assets, free float ratio, ratio of foreign shareholders, overseas sales ratio, number of segments, andcross listing (Numata and Takeda, 2010; Skinner and Srinivasan, 2012). The dummy variable Olympus is included as the mainindependent variable for the purpose of testing Hypothesis 2. The variable takes a value of 1 if a firm was audited by anOlympus auditor (ShinNihon or AZSA) and 0 if otherwise. We predict that the estimated coefficients should be insignificantwhen there is no difference in market reaction between firms audited by the Olympus auditors and firms not affiliated withthe Olympus auditors. Conversely, we estimate a negative and significant coefficient for the variable if the Olympus auditors’clients experienced more negative market reactions compared with the clients of other auditors.

The opinion variable is a dummy variable that we use to control for differences in audit opinions. It takes a value of 1 if theaudit opinion for a firm in fiscal year 2011 was unqualified, and 0 if the opinion released was unqualified with an explanatoryparagraph. Variable RoA controls for the profitability performance for each firm, which is affected by earnings management. Thenext two balance sheet variables, Assets and Leverage, control for the firm size effect and the risk of debt insolvency, respectively.The variable FreeFloatRatio controls for the trading liquidity of each stock. Firms with a higher free float ratio imply that share-holders can trade their stock more easily compared with firms with a lower free float ratio. In addition, we use the Segmentsvariable as a proxy to control for firms’ business operation complexity. Firms with a higher number of business segmentsrequire more complex audit procedures, which in turn involves the need for higher audit quality and more dependence onthe auditors’ reputation. Two variables, ForeignShareholders and OverseasSales, control for the degree of influence of foreignstockholders on the sampled Japanese firms from the equity and income perspectives, respectively. The CrossListing dummyvariable classifies firms by whether their stock is only listed on the domestic market or is also listed on foreign stock exchanges.

4. Analysis results

4.1. Descriptive statistics

The descriptive statistics of the industry distribution of the sample firms is provided in Table 3. We classified the sample’sindustry distribution by auditor’s affiliation to Olympus and auditor size. Group I consists of 536 firms (58.39% of the totalsample) audited by E&Y and KPMG, which are considered affiliated with Olympus. Group II comprises 382 firms (41.61% ofthe total sample) audited by other auditors not affiliated with Olympus, such as other Big 4 and non-Big 4 auditors.

We observe that 918 sample firms in this study are diversely distributed across 30 industries out of 33 industry categoriesof firms registered on the Tokyo Stock Exchange (TSE). We find that there is not a single industry group that comprises morethan 10% of the total sample in each sample group. There is also a minor difference in industry group composition betweenGroup I and Group II firms. The diversified samples across industries for both within and between sample groups make oursamples less susceptible to cross-industry confounding factors.

Table 4 presents descriptive statistics for the variables used for the cross-sectional analysis described in Eq. (14). We clas-sify the descriptive statistics into three groups: the firms’ respective auditors, the auditors’ size (Big 4 and Non Big-4) and theauditors’ affiliation with Olympus. The sample firms’ auditor affiliation with Olympus is categorized into three subgroups:Group I includes clients of auditors affiliated with Olympus (E&Y and KPMG), Group II comprises clients of auditors notaffiliated with Olympus (Deloitte, PwC and non-Big 4) and Group III consists of clients of Big 4 auditors not affiliated withOlympus (Deloitte and PwC).

From the results of Table 4, we find that the mean values of the CAR variable for each sample group of auditors are notsignificantly different from each other. There is no significant mean CAR difference between the firms audited by Big 4 and

Table 3Sample firms’ TSE industry sectors as classified by auditors’ affiliation with Olympus.

Industry Group I (clients of auditors affiliated withOlympus)

Group II (clients of auditors not affiliated withOlympus)

Freq. % Freq. %

Air Transportation 1 0.19 0 0.00Chemicals 54 10.07 31 8.12Construction 50 9.33 17 4.45Electric Appliances 56 10.45 39 10.21Electric Power & Gas 9 1.68 7 1.83Fishery, Agriculture & Forestry 4 0.75 1 0.26Foods 21 3.92 15 3.93Glass & Ceramics Products 14 2.61 6 1.57Information & Communication 30 5.60 31 8.12Iron & Steel 11 2.05 8 2.09Land Transportation 20 3.73 8 2.09Machinery 40 7.46 32 8.38Marine Transportation 4 0.75 3 0.79Metal Products 8 1.49 11 2.88Mining 3 0.56 1 0.26Nonferrous Metals 14 2.61 4 1.05Oil & Coal Products 3 0.56 1 0.26Other Financing Business 0 0.00 1 0.26Other Products 10 1.87 10 2.62Pharmaceutical 8 1.49 7 1.83Precision Instruments 7 1.31 8 2.09Pulp & Paper 7 1.31 2 0.52Real Estate 11 2.05 14 3.66Retail Trade 35 6.53 24 6.28Rubber Products 8 1.49 1 0.26Services 24 4.48 31 8.12Textile & Apparels 13 2.43 10 2.62Transportation Equipment 15 2.80 14 3.66Warehousing and Harbor Transportation 11 2.05 4 1.05Wholesale Trade 45 8.40 41 10.73

Total 536 58.39 382 41.61


non-Big 4 audit firms. The results are also presented for firms classified into three groups: Group I (firms whose auditors areaffiliated with Olympus – KPMG and E&Y), Group II (firms whose auditors are not affiliated with Olympus – Deloitte, PwCand non-Big 4) and Group III (firms audited by Big 4 not affiliated with Olympus – Deloitte and PwC). We find that there is adifference in the mean CAR between Group I and Group II. A similar difference is also observed between the mean CAR ofGroup I and III. These results suggest that there is a weak significant difference in market reactions among the firms asso-ciated with Olympus’ auditors during the event windows. The negative signs of the mean CAR variable indicate negativemarket sentiment in the Japanese capital market surrounding the news announcements of the spillover effect of the Olym-pus auditors’ association with the fraud.

4.2. Events study analysis results

Table 5 presents the GRANK-T statistical results of the null hypothesis that there are no abnormal returns observed forfirms categorized by their auditor’s affiliation with Olympus for each event described in Section 3. We observe six eventsrelated to news announcements affecting the Olympus auditors’ reputation, as identified in Section 3.1. We use four eventwindows for each event to achieve robust results.

With the exception of a statistically weak, significant result for Event 6 in event window (0, 3), we conclude that there aregenerally no abnormal market reactions observed across the two groups of firms categorized by their auditors’ affiliationwith Olympus. Therefore, we cannot reject the H1 null hypothesis that news coverage affecting the reputation of the auditorsassociated with Olympus did not contribute to abnormal share returns of the publicly listed clients of the auditors associatedwith Olympus (E&Y and KPMG). The results presented in Table 5 are not controlled for firm-specific characteristics. To deter-mine whether there are market reaction differences that are attributable to firms’ auditor association with Olympus, we per-form a cross-sectional regression analysis for abnormal returns in the next subsection.

4.3. Comparison between domestic and cross-listed companies

Table 6 presents the descriptive statistical results of the regression variables for the sample companies classified by theirregistered stock exchange. We classified the sample into four categories for our analysis: firms listed only on domestic stockexchanges in Japan (Column A), firms listed on both Japanese and US markets (Column B), firms listed on both Japanese and

Table 4Descriptive statistics of regression variables by firms’ auditors’ affiliation.

Variables Statistics Auditor name Auditor size Auditor affiliation with Olympus

E&Y KPMG Deloitte PwC NonBig-4

Big 4(A)

NonBig-4(B)

Meandifference(A) � (B)

t-Statistics(A) � (B)

Group IclientsofauditorsaffiliatedwithOlympus(A)

Group IIclients ofauditorsnotaffiliatedwithOlympus(B)

Group IIIclients ofauditorsnotaffiliatedwithOlympus– Big 4Only (C)



Meandifference(A) � (C)

t-Statistics(A) � (C)

CAR Mean �0.003 �0.003 �0.005 �0.002 �0.004 �0.004 �0.004 0.001 0.500 �0.003 �0.005 �0.005 0.002 1.765* 0.002 1.792*

Median �0.006 �0.004 �0.007 0.001 �0.005 �0.005 �0.005 �0.005 �0.006 �0.006Std. dev. 0.016 0.015 0.014 0.013 0.014 0.015 0.014 0.015 0.014 0.014

Olympus Mean 1 1 – – – 0.697 – 1 – –Median 1 1 – – – 1 – 1 – –Std. dev. – – – – – 0.460 – – – –

Opinion Mean 0.783 0.756 0.863 0.655 0.691 0.791 0.691 0.099 2.441** 0.771 0.780 0.837 �0.010 �0.343 �0.066 �2.190**

Median 1 1 1 1 1 1 1 1 1 1Std. dev. 0.413 0.430 0.345 0.484 0.464 0.407 0.464 0.421 0.415 0.370

RoA Mean 0.024 0.029 0.032 0.037 0.023 0.028 0.023 0.005 1.657* 0.026 0.029 0.032 �0.002 �0.946 �0.006 �2.114**

Median 0.022 0.024 0.029 0.027 0.018 0.025 0.018 0.023 0.024 0.028Std. dev. 0.033 0.038 0.035 0.042 0.036 0.036 0.036 0.036 0.036 0.036

Assets Mean 11.830 12.160 11.760 12.360 11.270 11.940 11.270 0.664 5.847*** 11.980 11.620 11.840 0.365 3.665*** 0.145 1.192Median 11.740 11.970 11.520 12.140 11.210 11.760 11.210 11.820 11.400 11.590Std. dev. 1.450 1.580 1.510 1.860 1.210 1.530 1.210 1.520 1.460 1.570

Leverage Mean 0.547 0.531 0.501 0.458 0.528 0.526 0.528 �0.002 �0.116 0.540 0.508 0.496 0.031 2.425** 0.044 2.866***

Median 0.560 0.537 0.522 0.438 0.516 0.534 0.516 0.547 0.507 0.505Std. dev. 0.186 0.189 0.203 0.181 0.192 0.192 0.192 0.187 0.197 0.200

FreeFloatRatio Mean 0.209 0.186 0.170 0.139 0.218 0.189 0.218 �0.029 �2.565** 0.199 0.186 0.166 0.012 1.544 0.032 3.792***

Median 0.188 0.160 0.150 0.102 0.188 0.168 0.188 0.177 0.166 0.146Std. dev. 0.117 0.117 0.105 0.098 0.129 0.114 0.129 0.117 0.117 0.104

Segments Mean 6.270 6.370 6.400 6.830 6.090 6.360 6.090 0.272 2.336** 6.320 6.310 6.450 0.006 0.057 �0.138 �1.147Median 6 6 6 7 6 6 6 6 6 6Std. dev. 1.600 1.400 1.540 1.510 1.250 1.520 1.250 1.510 1.440 1.540

ForeignShareholders Mean 0.128 0.150 0.155 0.163 0.106 0.144 0.106 0.038 3.899*** 0.138 0.137 0.156 0.001 0.171 �0.018 �1.873*

Median 0.103 0.121 0.122 0.179 0.068 0.112 0.068 0.107 0.100 0.123Std. dev. 0.105 0.122 0.133 0.103 0.106 0.119 0.106 0.114 0.123 0.129

OverseasSales Mean 0.187 0.192 0.156 0.300 0.144 0.184 0.144 0.041 2.146** 0.189 0.162 0.174 0.027 1.707* 0.015 0.784Median 0.065 0.000 0.000 0.289 0.000 0.000 0.000 0.022 – –Std. dev. 0.231 0.248 0.233 0.259 0.205 0.239 0.205 0.239 0.228 0.241

CrossListing Mean 0.021 0.041 0.034 0.069 0.013 0.033 0.013 0.019 1.671* 0.030 0.029 0.039Median – – – – – – – – – –Std. dev. 0.143 0.198 0.182 0.258 0.115 0.177 0.115 0.170 0.167 0.193

Observations 290 246 204 29 149 769 149 536 382 233

* Statistical significance at the 10% level.** Statistical significance at the 5% level.

*** Statistical significance at the 1% level.

Frendy,D.H

u/Journal

ofContem

poraryA

ccounting&

Economics

10(2014)

206–224

217

Table 5Event study GRANK test results by firms’ auditor affiliation with Olympus.

Events Group I (clients of auditors affiliated with Olympus) Group II (clients of auditors not affiliated with Olympus)

GRANK t statistics p-Value GRANK t statistics p-Value

Event 1 (0,1) 0.4343 0.6645 0.3231 0.7469(0,2) �0.1714 0.8640 �0.1541 0.8777(0,3) �0.7628 0.4463 �0.7117 0.4773(�1,3) �0.8318 0.4063 �0.6641 0.5072

Event 2 (0,1) 0.2474 0.8048 0.2237 0.8232(0,2) �0.1011 0.9195 �0.1192 0.9052(0,3) �1.0420 0.2984 �0.8435 0.3998(�1,3) �1.3846 0.1674 �0.9259 0.3554

Event 3 (0,1) 0.3459 0.7297 0.3412 0.7332(0,2) 0.3081 0.7583 0.3471 0.7288(0,3) �0.7835 0.4341 �0.6800 0.4972(�1,3) �0.3653 0.7152 �0.3710 0.7110

Event 4 (0,1) 0.1716 0.8639 0.1729 0.8628(0,2) �0.9128 0.3622 �0.8284 0.4082(0,3) �1.1847 0.2373 �1.1471 0.2524(�1,3) �1.0282 0.3048 �1.0146 0.3113

Event 5 (0,1) 0.1461 0.8839 0.1029 0.9181(0,2) �0.0175 0.9860 �0.2063 0.8368(0,3) 0.7411 0.4593 0.5903 0.5555(�1,3) 0.7185 0.4731 0.6690 0.5041

Event 6 (0,1) 0.1900 0.8495 0.1678 0.8669(0,2) �1.0855 0.2788 �1.2493 0.2127(0,3) �1.8448 0.0662* �1.9345 0.0542*

(�1,3) �1.2320 0.2191 �1.3731 0.1710

Observations 536 382




non-US markets (Column C), and firms listed on both Japanese and foreign exchanges (Column D). We perform a three-waymean difference analysis to determine whether there are firm-specific variable differences among these four groups. We findthat foreign-listed firms tend to have larger asset sizes, more stock available for trading, a higher number of business seg-ments, and a higher ratio of foreign shareholders and overseas sales compared with Japanese-listed firms. Although the num-ber of domestic-only listed companies is significantly higher (891 firms) compared with foreign-listed companies (27 firms),we find that the firms in those two groups are comparable in terms of types of audit opinions, profitability (return on assets)and leverage. We find no difference in cumulative abnormal returns (CAR) between Japan- and US-listed firms, although weobtain a weak, statistically significant, negative CAR difference between Japan- and foreign-listed firms. This result suggeststhat firms listed on Japanese stock exchanges exhibited slightly more negative stock market reactions during the Olympusevents. However, this observed market reaction difference is not controlled for firm-specific variables.

Table 7 presents the GRANK-T statistical results that show whether differences in the firms’ stock listings exhibited dif-ferent market reactions surrounding the six events affecting the Olympus auditors’ reputation. We also categorize each firminto one of the four groups as described in the previous descriptive analysis. We conclude that there are no observed abnor-mal market reactions across all four groups. This finding is consistent with our previous findings in Table 5. To validate thefindings from Tables 6 and 7, we perform a multivariate regression analysis in the next section to observe whether the mar-ket reaction difference between Japan- and foreign-listed firms still holds after controlling for firm-specific variables.

4.4. Cross-Sectional multivariate regression results

Table 8 presents the multivariate regression estimation results from Eq. (14) with the dependent variables of mean CARcategorized by both sources of events (FACTA and Olympus Events) and news content (Negative and Neutral News). Panel Afrom Table 8 shows the estimation results without interaction with the control variables, while Panel B shows the estimationresults of the interaction of the Olympus variable with each control variable. We perform the regression for six categories ofmean CAR as dependent variables: all six events (Column A), news published by FACTA – Events 1 and 2 (Column B), newspublished by Olympus – Events 3, 4, 5 and 6 (Column C), events with negative news content – Events 1, 2, 3, 4, and 5 (ColumnD), and the event with neutral news content – Event 6 (Column E).

The regression results for the Olympus variable in both Panel A and Panel B of Table 8 yield statistically insignificant coef-ficients, which suggests that for all instances of CAR observed in this study, there is no market reaction difference betweenfirms audited by the Olympus auditors and firms not affiliated with the Olympus auditors. The results of Table 8 Panel B

Table 6Descriptive statistics results of regression variables by firms’ listing status.

Variables Statistics Cross-listing status

Listedonly inJapan(A)

Listedin US(B)



p-Value(A) � (B)

Listed inothernon-UScapitalmarkets (C)

Meandifference(A) � (C)

t-Statistics(A) � (C)

p-Value(A) � (C)

Listed inforeign capitalmarket(D = B + C)

Meandifference(A) � (D)

t-Statistics(A) � (D)

p-Value(A) � (D)

CAR Mean �0.004 0.000 �0.004 �0.818 0.427 0.007 �0.011 �2.157 0.054* 0.003 �0.007 �2.019 0.054*

Median �0.006 0.004 0.007 0.004St. dev. 0.014 0.017 0.017 0.017

Olympus Mean 0.584 0.533 0.667 0.593Median 1 1 1 1St. dev. 0.493 0.516 0.492 0.501

Opinion Mean 0.778 0.467 0.311 2.321 0.036** 0.917 �0.139 �1.644 0.127 0.667 0.111 1.188 0.245Median 1 – 1 1St. dev. 0.416 0.516 0.289 0.480

RoA Mean 0.027 0.031 �0.004 �0.664 0.517 0.036 �0.009 �2.240 0.043** 0.034 �0.007 �1.578 0.125Median 0.023 0.026 0.037 0.037St. dev. 0.036 0.026 0.014 0.021

Assets Mean 11.760 14.620 �2.860 �5.777 <0.001*** 13.890 �2.137 �4.562 <0.001*** 14.300 �2.539 �7.306 <0.001***

Median 11.570 14.630 14.070 14.470St. dev. 1.430 1.910 1.610 1.790

Leverage Mean 0.527 0.486 0.041 0.869 0.399 0.531 �0.004 �0.060 0.953 0.506 0.021 0.579 0.567Median 0.533 0.498 0.556 0.521St. dev. 0.192 0.183 0.203 0.190

FreeFloatRatio Mean 0.195 0.118 0.077 4.721 <0.001*** 0.179 0.016 0.464 0.652 0.145 0.050 2.662 0.013**

Median 0.174 0.103 0.150 0.106St. dev. 0.118 0.062 0.121 0.096

Segments Mean 6.280 7.800 �1.519 �2.362 0.033** 7 �0.719 �1.454 0.173 7.440 �1.164 �2.766 0.010**

Median 6 7 6.500 7.000St. dev. 1.440 2.480 1.710 2.170

ForeignShareholders Mean 0.133 0.282 �0.148 �6.952 <0.001*** 0.263 �0.129 �4.077 0.002*** 0.273 �0.140 �7.625 <0.001***

Median 0.101 0.256 0.293 0.274St. dev. 0.116 0.081 0.109 0.093

OverseasSales Mean 0.171 0.427 �0.256 �3.116 0.007*** 0.379 �0.208 �2.414 0.034** 0.406 �0.235 �3.985 <0.001***

Median – 0.488 0.398 0.452St. dev. 0.229 0.317 0.298 0.304

Observations 891 15 12 27



Frendy,D.H

u/Journal

ofContem

poraryA

ccounting&

Economics

10(2014)

206–224

219

Table 7Results of event study GRANK tests by firms’ listing status.

Events Group I firms listed onlyin Japan (A)

Group II firms listed in USmarkets (B)

Group III firms listed in non-US markets (C)

Group IV firms listed in bothUS and non-US markets(D = B + C)

GRANK tstatistics

p-Value GRANK tstatistics



p-Value

Event 1 (0,1) 0.3851 0.7005 0.1661 0.8682 0.1859 0.8527 0.2239 0.8231(0,2) �0.1540 0.8777 �0.4706 0.6383 �0.2039 0.8386 �0.4436 0.6577(0,3) �0.7117 0.4773 �1.5426 0.1242 �0.6447 0.5197 �1.4401 0.1511(�1,3) �0.7289 0.4667 �1.8274 0.0688* �0.3550 0.7229 �1.4634 0.1446

Event 2 (0,1) 0.2329 0.8160 0.2123 0.8321 0.2186 0.8271 0.2719 0.7859(0,2) �0.1501 0.8808 0.9719 0.3320 1.3006 0.1946 1.4211 0.1565(0,3) �1.0017 0.3175 0.8315 0.4065 1.0672 0.2869 1.1890 0.2356(�1,3) �1.2296 0.2200 1.2997 0.1949 0.3382 0.7355 1.0712 0.2851

Event 3 (0,1) 0.3418 0.7328 �0.1096 0.9128 0.5679 0.5706 0.2665 0.7901(0,2) 0.3117 0.7555 0.3225 0.7473 0.7858 0.4327 0.6926 0.4892(0,3) �0.7567 0.4500 0.2838 0.7768 0.1726 0.8631 0.2977 0.7662(�1,3) �0.3893 0.6974 0.4733 0.6364 0.4652 0.6422 0.6019 0.5478

Event 4 (0,1) 0.1685 0.8663 0.3611 0.7183 �0.0109 0.9913 0.2346 0.8147(0,2) �0.9013 0.3683 1.0784 0.2819 �0.3489 0.7275 0.5076 0.6122(0,3) �1.2079 0.2282 0.9821 0.3270 0.3634 0.7166 0.8776 0.3810(�1,3) �1.0619 0.2893 1.2493 0.2127 0.1917 0.8482 0.9495 0.3433

Event 5 (0,1) 0.1210 0.9038 0.2633 0.7925 0.1790 0.8581 0.2823 0.7779(0,2) �0.0845 0.9327 �0.3743 0.7085 �0.7064 0.4806 �0.6733 0.5014(0,3) 0.6890 0.4914 �0.8663 0.3872 0.6130 0.5405 �0.2050 0.8377(�1,3) 0.7400 0.4600 �1.5770 0.1161 �0.3400 0.7342 �1.2580 0.2096

Event 6 (0,1) 0.1795 0.8577 0.0195 0.9844 0.1643 0.8696 0.1132 0.9100(0,2) �1.1615 0.2465 �1.6298 0.1044 1.0625 0.2890 �0.4427 0.6584(0,3) �1.9119 0.0570* �0.6356 0.5256 0.8309 0.4068 0.0807 0.9357(�1,3) �1.3237 0.1868 �0.4114 0.6811 1.1603 0.2471 0.4325 0.6657

Observations 891 15 12 27




extend the regression modeled in Eq. (14) by including the interaction effect between the Olympus dummy variable and firm-specific variables to examine whether a firm’s affiliation with the Olympus auditors influences the CAR variation across firm-specific variables.

For the CARs observed for all six events (Column A), statistically significant interaction effects are observed for the Olym-pus variable with the Leverage and OverseasSales variables. For the FACTA events, significant interaction effects are detectedfor the RoA and OverseasSales variables (Column B). In addition, significant interaction effects are observed for the Leverage,FreeFloatRatio and OverseasSales variables in the news events published by Olympus (Column C). Among the six groups ofdependent variables, we find that the events with negative news content (Column D) exhibit the strongest interactioneffects. The Opinion and Assets variables show statistically weak relationships, while the Leverage and OverseasSales variablesreveal statistically stronger effects. For the event with neutral news content (Column E), there is only a statistically weakinteraction effect with the OverseasSales variable. We do not observe any statistically significant estimate influence forthe CrossListing variable in either regression.

5. Discussion of results

The event study and multivariate regression results presented in Tables 5 and 8, respectively, indicate that there was noobserved change in the Olympus auditors’ reputation surrounding the news announcements of their potential involvementin the fraud. The non-statistically significant estimates for the Olympus variable in both tables suggest that we are unable toreject the H2 null hypothesis. We find that the extent of market reaction observed during the news announcements affectingthe reputation of the auditors associated with Olympus (E&Y and KPMG) is no different from that of other firms whose audi-tors were not associated with Olympus after controlling for relevant firm-specific variables.

Table 8 Panel B builds on the regression model by including interaction variables with the Olympus dummy variable andfirm-specific variables. We find that the strongest interaction effect was observed in the events with negative news effects onthe Olympus auditors’ reputation (Column D). The negative signs for the Opinion and RoA interaction estimates have weakstatistical significance, implying that in the events with negative news on the auditors’ reputation, firms whose auditors

Table 8Fixed effect model multivariate regression results after correcting for heteroscedastic standard errors – CAR estimated using Fama–French three-factor model.

Variables Mean CAR – all six events (A) Mean CAR – FACTA events(Events 1–2) (B)

Mean CAR – Olympus events(Events 3–6) (C)

Mean CAR – negative news(Events 1–5) (D)

Mean CAR – neutral news(Event 6) (E)

Coeff. t-Value Pr(>|t|) Coeff. t-Value Pr(>|t|) Coeff. t-Value Pr(>|t|) Coeff. t-Value Pr(>|t|) Coeff. t-Value Pr(>|t|)

Panel A (without interaction variables)Olympus 0.0001 0.2100 0.8370 �0.0011 �0.9100 0.3644 0.0007 0.7800 0.4360 0.0001 0.1600 0.8700 0.0002 0.1100 0.9130Opinion 0.0007 0.5200 0.6020 0.0015 1.0400 0.3002 0.0003 0.1800 0.8590 0.0013 1.0600 0.2900 �0.0024 �0.6800 0.4950RoA �0.0175 �0.7900 0.4280 �0.0154 �0.7300 0.4628 �0.0186 �0.7400 0.4570 �0.0043 �0.2000 0.8400 �0.0835 �1.8400 0.0660*

Assets 0.0009 1.6800 0.0940* 0.0016 1.9500 0.0516* 0.0005 0.8900 0.3730 0.0001 0.2700 0.7900 0.0048 3.1000 0.0020***

Leverage 0.0031 0.6600 0.5120 �0.0064 �1.4500 0.1484 0.0078 1.2500 0.2100 0.0013 0.4000 0.6900 0.0117 0.7400 0.4580FreeFloatRatio �0.0005 �0.1400 0.8900 �0.0073 �1.0000 0.3195 0.0029 0.7200 0.4750 �0.0023 �0.5200 0.6000 0.0083 0.8500 0.3970Segments �0.0005 �1.2700 0.2040 0.0005 1.2400 0.2139 �0.0009 �2.0900 0.0370** �0.0003 �0.9400 0.3500 �0.0013 �1.3300 0.1840ForeignShareholders 0.0067 0.8400 0.4030 0.0026 0.3100 0.7530 0.0087 0.8600 0.3930 0.0091 1.3300 0.1900 �0.0056 �0.3200 0.7480OverseasSales 0.0172 7.6900 0.0000*** 0.0103 3.2700 0.0011*** 0.0207 7.3600 0.0000*** 0.0141 6.4600 0.0000*** 0.0328 4.4800 0.0000***

CrossListing �0.0012 �0.4800 0.6330 �0.0063 �2.6300 0.0087*** 0.0014 0.3600 0.7180 �0.0003 �0.1500 0.8800 �0.0056 �0.6700 0.5010

Observations 918 918 918 918 918Industry fixed effects Included Included Included Included Included

Total sum of squares 0.1670 0.2990 0.2820 0.1540 1.2800Residual sum of squares 0.1500 0.2830 0.2600 0.1440 1.1700R-squared 0.1010 0.0533 0.0790 0.0692 0.0818Adj. R-squared 0.0964 0.0510 0.0756 0.0662 0.0782p-Value 0.0000 0.0000 0.0000 0.0000 0.0000

Panel B (with interaction variables)Olympus 0.0002 0.3700 0.7107 �0.0008 �0.8200 0.4114 0.0007 0.8800 0.3780 0.0002 0.3300 0.7422 0.0001 0.0400 0.9690Opinion 0.0002 0.1700 0.8633 0.0012 0.8500 0.3939 �0.0002 �0.1200 0.9020 0.0009 0.6800 0.4939 �0.0030 �0.8200 0.4131RoA �0.0188 �0.9900 0.3244 �0.0183 �0.9500 0.3446 �0.0191 �0.8600 0.3890 �0.0060 �0.3400 0.7376 �0.0831 �1.8100 0.0703*

Assets 0.0009 1.8900 0.0591* 0.0016 2.2500 0.0247** 0.0005 0.7600 0.4490 0.0001 0.1700 0.8625 0.0048 3.1500 0.0017***

Leverage 0.0034 0.7600 0.4486 �0.0069 �1.5600 0.1192 0.0086 1.3700 0.1710 0.0017 0.5700 0.5712 0.0119 0.7400 0.4592FreeFloatRatio �0.0003 �0.0700 0.9480 �0.0074 �0.9500 0.3407 0.0033 0.7700 0.4410 �0.0021 �0.4600 0.6473 0.0091 0.9500 0.3417Segments �0.0005 �1.3400 0.1800 0.0005 1.1300 0.2569 �0.0009 �2.1900 0.0290** �0.0003 �1.0700 0.2847 �0.0011 �1.2300 0.2192ForeignShareholders 0.0069 1.0000 0.3152 0.0014 0.1700 0.8618 0.0096 1.0700 0.2860 0.0092 1.6100 0.1088 �0.0049 �0.3000 0.7605OverseasSales 0.0170 8.0800 0.0000*** 0.0104 3.3700 0.0008*** 0.0204 7.5100 0.0000*** 0.0141 6.5800 0.0000*** 0.0319 4.7100 0.0000***

CrossListing �0.0005 �0.2100 0.8303 �0.0065 �2.5000 0.0125** 0.0024 0.6200 0.5360 0.0002 0.1100 0.9114 �0.0042 �0.5100 0.6085Olympus * Opinion �0.0014 �0.6900 0.4880 �0.0022 �0.9900 0.3232 �0.0009 �0.4000 0.6930 �0.0033 �1.8000 0.0720* 0.0085 1.3400 0.1809Olympus * RoA �0.0480 �0.8900 0.3743 �0.1166 �2.3700 0.0181** �0.0137 �0.2000 0.8380 �0.0743 �1.7400 0.0816* 0.0831 0.4700 0.6397Olympus * Assets �0.0016 �1.0800 0.2823 0.0005 0.4100 0.6834 �0.0026 �1.4500 0.1460 �0.0013 �0.9600 0.3366 �0.0028 �1.0500 0.2930Olympus * Leverage 0.0155 2.0800 0.0383** 0.0001 0.0100 0.9886 0.0232 2.2100 0.0280** 0.0125 2.0500 0.0404** 0.0307 1.4300 0.1537Olympus * FreeFloatRatio �0.0145 �1.4800 0.1381 0.0070 0.4700 0.6358 �0.0252 �2.1100 0.0350** �0.0094 �0.9500 0.3414 �0.0396 �1.7300 0.0837*

Olympus * Segments �0.0006 �1.1700 0.2436 �0.0001 �0.1800 0.8573 �0.0008 �1.2200 0.2250 �0.0004 �0.7300 0.4635 �0.0015 �1.4200 0.1568Olympus * ForeignShareholders 0.0113 0.6800 0.4990 �0.0030 �0.1800 0.8538 0.0184 0.9700 0.3300 0.0103 0.6400 0.5209 0.0159 0.4400 0.6624Olympus * OverseasSales 0.0144 3.0800 0.0021*** 0.0140 2.7200 0.0066*** 0.0146 2.5500 0.0110** 0.0139 3.0700 0.0022*** 0.0171 1.3900 0.1649Olympus * CrossListing �0.0001 �0.0200 0.9817 0.0028 0.4400 0.6592 �0.0016 �0.2100 0.8310 0.0024 0.5000 0.6161 �0.0128 �0.7700 0.4426

Observations 918 918 918 918 918Industry fixed effects Included Included Included Included Included

Total sum of squares 0.1670 0.2990 0.2820 0.1540 1.2800Residual sum of squares 0.1460 0.2770 0.2540 0.1390 1.1600R-squared 0.1270 0.0756 0.1010 0.1010 0.0949Adj. R-squared 0.1200 0.0716 0.0955 0.0953 0.0898p-Value 0.0000 0.0000 0.0000 0.0000 0.0000



Frendy,D.H

u/Journal

ofContem

poraryA

ccounting&

Economics

10(2014)

206–224

221


were associated with Olympus that received a better audit opinion (unqualified) and had higher profitability (higher RoA)experienced more negative spillover effects. These findings imply that Japanese firms with better corporate governanceand profitability are more susceptible to negative news when their auditors are associated with fraud. The negative marketreaction represents a reversal of the high expectations that investors have for firms with good audit histories and financialperformance when they receive news with a potentially negative effect on the firms’ auditors. Firms with higher profitabilityare particularly more sensitive to negative news when the news source is unreliable. A statistically significant, negativeinteraction effect between the Olympus variable and the RoA variable is also observed for the news events published byFACTA (Column B).

Based on the results of Table 8 Panel B, we also find that the strongest statistically significant interaction effect betweenthe Olympus variable and the Leverage variable and between the Olympus variable and the OverseasSales variable wasobserved for the majority of the events (average of all six events (Column A), the Olympus-announced news events (ColumnC), and negative news content (Column D)). The positive signs for both estimates indicate that firms associated with theOlympus auditors experienced more positive abnormal reactions than firms whose auditors were not associated with Olym-pus when the firms have a higher level of leverage and overseas sales. Firms with a high level of leverage rely less on stockequity financing, while firms with a higher overseas sales ratio are less susceptible to shocks from the domestic market. Weconclude that, in the news announcement events affecting the firms’ auditor reputation, firms with less dependence onequity and the domestic Japanese market experienced better market price reactions even when their auditors’ reputationswere negative affected.

We also find a statistically significant, negative interaction effect on the FreeFloatRatio variable for news events publishedby Olympus (Column C). This result indicates that firms with higher stock liquidity were more vulnerable to negative marketreactions when news affecting their auditors’ reputation was officially published by Olympus. Firms with higher stockliquidity allow investors to have more influence in changing the stock price more rapidly to better match their expectations.This result was not observed for news announcements published by FACTA, suggesting that Japanese investors are moredependent on reliable news sources when trading liquid stocks in response to news affecting firms’ auditor reputation. Itshould be emphasized, however, that we do not find any differences in market reactions between firms whose auditors wereassociated and not associated with Olympus.

We also find that firms’ listing status is not a statistically significant predictor of investor reaction, suggesting that Jap-anese investors did not expect an audit assurance difference between domestic and foreign-listed companies when theyresponded to events affecting the Olympus auditors’ reputation. Although firms that are only listed on domestic exchangesrepresent the majority of stocks traded on the Tokyo Stock Exchange, we find that there are no differences in types of auditopinions, profitability or leverage level between domestic and foreign-listed Japanese companies. We argue that the similar-ities in these firms’ characteristics and the significant number of domestic-only listed companies negatively skew Japaneseinvestor expectations of audit quality. Although foreign-listed firms have a higher audit quality requirement compared withdomestic-only listed firms, the overall lower quality of Japanese audit institutions is associated with similar market reactionsbetween domestic and foreign-listed firms.

The first group of events (Events 1 and 2) identified in the event study covered the publication of investigative articles onthe Olympus fraud case published by a small Japanese business magazine. The publication time of those articles precededfollow-up articles by major Japanese media outlets by at least two months.13 We argue that the lack of investor reactionto the publication of the FACTA articles is attributable to insufficient media coverage by other major Japanese media outlets.14

In addition, the limited distribution of the FACTA articles—which were only available to subscribers—restricted the wide circu-lation and exposure of the news to Japanese market investors. Furthermore, the FACTA articles were published by a small mediacompany that is generally considered to publish less reliable and credible information. We argue that those two factorscomplement the Japanese market investor non-reaction observed during those first two events.

We also observe that clients of E&Y and KPMG did not experience reputational losses due to their association withOlympus, which includes both negative news announcements from Event 1 to Event 5 (Column D) and neutral news asrepresented by Event 6 (Column E). We argue that Japanese investors anticipated the Olympus event as an expectedcase of audit failure where auditors conducted the necessary audit procedures to achieve a reasonable level of assur-ance. In addition, the distinct characteristics of the audit market in Japan strongly indicate that Japanese investorsare more likely to expect a lower audit quality compared with audits performed in Anglo-American markets. In theabsence of legal penalties imposed by regulators on the auditors and given the influence of the aforementioned factors,Japanese investors considered the news to be insufficient and unreliable evidence to change their prior expectations ofthe Olympus auditors’ reputation.

13 We searched through the Nikkei Telecom 21 database for the earliest publication date of articles covering the Olympus fraud case. The database coverscitations of four major Japanese commercial newspapers: the Nikkei, the Nikkei Business Daily, the Nikkei Finance Journal, and the Nikkei Marketing Journal.The earliest Nikkei article referring to an indication of fraud was published in the October 18, 2011 edition of Nikkei Sangyo Shinbun, which reported thewhistleblowing action of Mr. Woodford.

14 Major Japanese general media outlets include the Nikkei, Yomiuri, Asahi, Mainichi, and Chunichi. Major business media outlets in Japan include the NikkeiBusiness Daily and the Nikkei Marketing Journal.


6. Conclusion

Our paper investigates the impact of news concerning the Olympus auditors’ potential involvement in the company’sfraud case on their reputation. Our study complements the findings of Numata and Takeda (2010) by providing evidenceof Japanese investor reactions to news of potential auditor involvement in a case of accounting fraud. Using event studyand multivariate regression analysis, we found no observed changes in the reputations of auditors affiliated with Olympussurrounding the publication of news affecting their reputation. Based on the interaction variables’ regression results, wefound that the market reacted more negatively to firms whose auditors were associated with Olympus when their stockhad higher market liquidity. Our study supplements existing empirical studies that have shown market non-reactions toother events with auditor reputation losses (Barbera and Martinez, 2006; Harris and Krishnan, 2012; Nelson et al., 2008).

We argue that Japanese investors reacted rationally by not responding to news affecting the Olympus auditors’ reputationdue to the following three factors. First, the articles published by FACTA magazine exposing the Olympus fraud case, whichshould have had a significant influence on the Olympus auditors’ reputation, did not capture sufficient investor attention dueto the publisher’s limited influence and exposure to a smaller audience of Japanese investors. Second, Japanese investors con-servatively responded to the release of official reports on the potential involvement of the Olympus auditors. Investors didnot have sufficiently reliable evidence to confirm their expectations of systematic substandard audits performed byOlympus’ auditors prior to the Olympus fraud case. Third, the Japanese audit institution is characterized by the government’ssignificant role in shaping accounting policy, a weaker role for CPAs, a high-leverage Japanese corporate financial structureand a non-litigious audit environment.

The non-reaction of Japanese investors observed in this study represents the rational expectation of investors concerningthe limits of financial statement auditing in relation to audit failure. In a standard unqualified auditor’s report, auditorsemploy the phrase ‘‘. . . to obtain reasonable assurance about whether the consolidated financial statements are free frommaterial misstatement’’ to express the objective of financial statement auditing. This statement implies that audit proce-dures require a considerable degree of materiality and risk judgment concerning management’s assertions, with a remoteprobability that auditors might overlook materially misstated financial statement accounts. When considering these auditmodel limitations, rational investors should expect that rare cases of audit failure do occur at a reasonably low frequencyin the market in the long run. Japanese investors are more likely to have a higher threshold for expected audit failurescompared with US investors such that Japanese investors do not react in the event of audit failures.

Acknowledgments

We would like to thank Dan Simunic (our paper’s discussant at the Journal of Contemporary Accounting and EconomicsSymposium 2014), Ferdinand A. Gul, Gordon Richardson, Janto Haman, Fumiko Takeda, Chong Wang, anonymous referees,and participants at the Journal of Contemporary Accounting and Economics Symposium 2014 held in Monash University –Malaysia, the 4th 2013 Japanese Accounting Review Conference hosted by Kobe University, and seminar participants atNagoya University for all their helpful comments and suggestions to improve previous versions of this paper.

References

Abe, S., 2011a. FACTAleaks – Open Letter to Olympus and Declaration of War. FACTA Online. <http://facta.co.jp/blog/archives/20110715001009.html>(retrieved 07.06.13) (in Japanese).

Abe, S., 2011b. FACTAleaks – Second Open Letter to Olympus. FACTA Online. <http://facta.co.jp/blog/archives/20110915001014.html> (retrieved 07.06.13)(in Japanese).

Akhigbe, A., Madura, J., Martin, A.D., 2005. Accounting contagion: the case of Enron. J. Econ. Financ. 29 (2), 187–202.Armitage, J., 2012. A Very Honourable Defeat: Ex-Olympus Boss Walks Away. The Independent, London.Asthana, S.C., Balsam, S., Krishnan, J., 2010. Corporate governance, audit firm reputation, auditor switches, and client stock price reactions: the Andersen

experience. Int. J. Audit. 14 (3), 274–293.Autore, D.M., Billingsley, R.S., Schneller, M.I., 2009. Information uncertainty and auditor reputation. J. Bank. Financ. 33, 183–192.Ball, R., 2009. Market and political/regulatory perspectives on the recent accounting scandals. J. Acc. Res. 47 (2), 277–323.Ball, R., Kothari, S.P., Robin, A., 2000. The effect of international institutional factors on properties of accounting earnings. J. Acc. Econ. 29 (1), 1–51.Barbera, C.F., Martinez, M.C.P., 2006. The stock market reaction to the Enron–Andersen affair in Spain. Int. J. Audit. 10, 67–85.Barton, J., 2005. Who cares about auditor reputation? Contemp. Acc. Res. 22 (3), 549–586.Boehmer, E., Masumeci, J., Poulsen, A.B., 1991. Event-study methodology under conditions of event-induced variance. J. Financ. Econ. 30 (2), 253–272.Brown, S.J., Warner, J.B., 1980. Measuring security price performance. J. Financ. Econ. 8 (3), 205–258.Brown, S.J., Warner, J.B., 1985. Using daily stock returns: the case of event studies. J. Financ. Econ. 14 (1), 3–31.Chaney, P.K., Philipich, K.L., 2002. Shredded reputation: the cost of audit failure. J. Acc. Res. 40 (4), 1221–1245.Corrado, C.J., 1989. A nonparametric test for abnormal security-price performance in event studies. J. Financ. Econ. 23 (2), 385–395.Corrado, C.J., Zivney, T.L., 1992. The specification and power of the sign test in event study hypothesis tests using daily stock returns. J. Financ. Quant. Anal.

27 (3), 465–478.Dee, C.C., Lulseged, A., Zhang, T., 2011. Client stock market reaction to PCAOB sanctions against a Big 4 auditor. Contemp. Acc. Res. 28 (1), 263–291.Dyck, A., Morse, A., Zingales, L., 2010. Who blows the whistle on corporate fraud? J. Financ. 65 (6), 2213–2253.Fama, E.F., French, K.R., 1993. Common risk factors in the returns on stocks and bonds. J. Financ. Econ. 33 (1), 3–56.Fama, E.F., French, K.R., 1996. Multifactor explanations of asset pricing anomalies. J. Financ. 51 (1), 55–84.Firth, M., 1990. Auditor reputation: the impact of critical reports issued by government inspectors. Rand J. Econ., 374–387.Francis, J.R., 2004. What do we know about audit quality? Brit. Acc. Rev. 36 (4), 345–368.Harris, E.E., Krishnan, J., 2012. The impact of tarnished auditor reputation on nonprofit income. Int. J. Audit. 16 (2), 130–146.

http://facta.co.jp/blog/archives/20110715001009.html

http://facta.co.jp/blog/archives/20110915001014.html

http://refhub.elsevier.com/S1815-5669(14)00025-3/h0015
























Hillison, W., Pacini, C., 2004. Auditor reputation and the insurance hypothesis: the information content of disclosures of financial distress of a majoraccounting firm. J. Manage. Iss., 65–86.

Huang, R.D., Li, H., 2009. Does the market dole out collective punishment? An empirical analysis of industry, geography, and Arthur Andersen’s reputation. J.Bank. Financ. 33, 1255–1265.

Huberman, G., Regev, T., 2001. Contagious speculation and a cure for cancer: a nonevent that made stock prices soar. J. Financ. 56 (1), 387–396.Jinnai, Y., 1990. The function of accounting: a Japanese perspective. Acc. Audit. Acc. J. 3 (2), 8–23.Khurana, I.K., Raman, K.K., 2004. Litigation risk and the financial reporting credibility of Big 4 versus Non-Big 4 audits: evidence from Anglo-American

countries. Acc. Rev. 79 (2), 473–495.Kolari, J.W., Pynnonen, S., 2011. Nonparametric rank tests for event studies. J. Empir. Financ. 18 (5), 953–971.Konishi, T., 2010. Fraud by certified public accountants in Japan and the United States. Asian J. Criminol. 5 (2), 99–107.Kothari, S.P., 2001. Capital markets research in accounting. J. Acc. Econ. 31 (1), 105–231.Kothari, S.P., Warner, J., 2007. The econometrics of event studies. In: Handbooks of Corporate Finance: Empirical Corporate Finance. Elsevier/North-Holland,

Amsterdam.Krishnamurthy, S., Zhou, J., Zhou, N., 2006. Auditor reputation, auditor independence, and the stock-market impact of Andersen’s indictment on its client

firms. Contemp. Acc. Res. 23 (2), 465–490.Kyodo News Service, 2011a. Olympus Dismisses Woodford as President, Demotes Him to Director. Japan Economic Newswire, Tokyo.Kyodo News Service, 2011b. Ousted Olympus President had Called for Chairman’s Resignation. Japan Economic Newswire, Tokyo.Kyodo News Service, 2011c. FOCUS: Olympus Mired in ex-CEO’s Accusations of Questionable Payments. Japan Economic Newswire, Tokyo.Linthicum, C., Reitenga, A.L., Sanchez, J.M., 2010. Social responsibility and corporate reputation: the case of the Arthur Andersen Enron audit failure. J. Acc.

Publ. Policy 29 (2), 160–176.Lorsch, J.W., Srinivasan, S., Durante, K., 2012. Case Study – Olympus (A). Harvard Business School.MacKinlay, A.C., 1997. Event studies in economics and finance. J. Econ. Liter. 35 (1), 13–39.Menon, K., Williams, D.D., 1994. The insurance hypothesis and market prices. Acc. Rev. 69 (2), 327–342.Miller, G.S., 2006. The press as a watchdog for accounting fraud. J. Acc. Res. 44 (5), 1001–1033.Nakamoto, M., 2012. Foreign CEOs Face Challenges in Japan. Financial Times, Tokyo.Nelson, K.K., Price, R.A., Rountree, B.R., 2008. The market reaction to Arthur Andersen’s role in the Enron scandal: loss of reputation or confounding effects? J.

Acc. Econ. 46 (2–3), 279–293.Nobes, C., Parker, R., 2012. Comparative International Accounting, 12th ed. Pearson Education Limited, Harlow.Non-Director Management Liability Investigation Committee, 2012. Investigation Report. Olympus Corporation, Tokyo.Numata, S., Takeda, F., 2010. Stock market reactions to audit failure in Japan: the case of Kanebo and ChuoAoyama. Int. J. Acc. 45 (2), 175–199.Olympus, 2011a. Company Response to Media Reports. Olympus Corporation, Tokyo.Olympus, 2011b. Notice Concerning Further Requests from Shareholder for Filing of Legal Action. Olympus Corporation, Tokyo.Olympus, 2012. Annual Report 2012. Olympus Corporation.Pacini, C., Hillison, W., 2003. Client-firm market reaction to regulatory action against a major accounting firm. J. Econ. Financ. 27 (3), 279–299.Piot, C., 2005. Auditor reputation and model of governance: a comparison of France, Germany and Canada. Int. J. Audit. 9 (1), 21–44.Porta, R.L., Lopez-de-Silanes, F., Shleifer, A., Vishny, R.W., 1998. Law and finance. J. Polit. Econ. 106 (6), 1113.Rauterkus, S.Y., Song, K., 2005. Auditor’s reputation and equity offerings: the case of Arthur Andersen. Financ. Manage. 34 (4), 121–135.Sakagami, M., Yoshimi, H., Okano, H., 1999. Japanese accounting profession in transition. Acc. Audit. Acc. J. 12 (3), 340–357.Skinner, D.J., Srinivasan, S., 2012. Audit quality and auditor reputation: evidence from Japan. Acc. Rev. 87 (5), 1737–1765.Tanimura, J.K., Okamoto, M.G., 2013. Reputational penalties in Japan: evidence from corporate scandals. Asian Econ. J. 27 (1), 39–57.Third Party Committee, 2011a. Investigation Report. Olympus Corporation, Tokyo.Third Party Committee, 2011b. Investigation Report Summary. Olympus Corporation, Tokyo.Weber, J., Willenborg, M., Zhang, J., 2008. Does auditor reputation matter? The case of KPMG Germany and ComROAD AG. J. Acc. Res. 46 (4), 941–972.West, M.D., 2001. Why shareholders sue: the evidence from Japan. J. Legal Stud. 30 (2), 351–382.Yamazaki, S., 1999. A Japanese way for 2000 beyond the bubble crash. Pac. Acc. Rev. 11 (2).Yoshimi, H., 2002. Auditing changes in Japan: from the minor to the major. Crit. Perspect. Acc. 13 (4), 533–544.





































Japanese stock market reaction to announcements of news …kotan/japanese_stock_market... ·...

Documents

Transcript of Japanese stock market reaction to announcements of news …kotan/japanese_stock_market... ·...