Japanese Stock Market Reaction to the Announcements of News Affecting
Auditors’ Reputation: The Case of Olympus Fraud
Frendy, Nagoya University
HU Dan, Nagoya University
ABSTRACT

Revelation of accounting fraud in Olympus Corporation gave rise to Olympus’
shareholders’ allegation of audit failure against Olympus auditors — Ernst & Young
ShinNihon LLC and KPMG AZSA LLC in 2011. However, there is currently noliterature investigating the effect of news announcements on Olympus auditors’
reputation. In this study, we investigate whether auditors’ affiliation with Olympus
contributes to divergent perception of audit quality in the events of news announcements
affecting reputation of Olympus auditors. First, we use nonparametric generalized rank
event study methodology on 810 sample firms of the First Section of Tokyo Stock
Exchange (TOPIX) to observe whether investors’ perception of audit quality as proxiedby abnormal returns are observed on events affecting Olympus auditors’ reputation.
Second, we perform linear regression on firms’ abnormal return after controlling forconfounding variables. We found that Japanese investors do not respond to negative or
neutral reputational information arising from news announcements concerning
Olympus auditors for firms with and without affiliation to Olympus auditors. Based onthese results, we conclude that Japanese investors do not regard news announcements
affecting Olympus auditors’ reputation as convincing evidence to change their
expectation on reputation of audit firms affiliated with Olympus fraud.
1. Introduction
Accounting fraud perpetrated by Olympus management in 2011 provides a unique opportunity
for assessing the impact of news announcements surrounding potential involvement of Olympus
auditors on their reputation. During investigation of the fraud in last quarter of 2011, Olympus
shareholders request independent investigation to confirm whether Olympus independent
auditors (Ernst & Young ShinNihon LLC and KPMG AZSA LLC; hereafter referred to as E&Y
and KPMG respectively) are legally responsible for the fraud (Olympus, 2011a). Their request
suggests that investors believe that Olympus auditors have failed to fulfill their duty in issuing
proper audit opinion on Olympus financial statements. This case illustrates another instance ofaudit failure, which can be defined as a circumstance when an auditor fails to issue a modified
or qualified audit report in the appropriate circumstances (Francis, 2004). Inverse relationshipwhich exists between the extent of audit failure and audit quality signals investors that audit
quality performed by Olympus auditors is below expectation. As auditors’ reputation is thefunction of audit quality, the release of new information that signals change to expected audit
quality contributes to adjustment in auditors’ economic value.

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Relationship between audit quality and its economic value is generally described by twocompeting hypotheses in accounting literature: the insurance hypothesis and the reputation
hypothesis. Insurance hypothesis assumes that the main role of auditors is for taking
responsibility in case of investor suffering loss from management misrepresentation of financial
statements. However, reputation hypothesis denotes that auditors derive value from providing
reliable assurance services by certifying the reasonability of management’s assertion offinancial information presented to stakeholders.
The validity of insurance hypothesis is less justifiable compared to reputation hypothesis due tospecific characteristics of Japanese corporate setting which provides better relevance for testing
reputation hypothesis. Japan is categorized as a low-litigation country where shareholders andother third parties have had difficulties winning lawsuits against auditors (Numata & Takeda,
2010). Consequently, the possibility for Japanese shareholders to successfully indict auditorsand demand compensation for negligence in performing financial statements audit in case ofmanagement fraud is low. We argue that events surrounding announcement of Olympus fraud
provide an opportunities to test whether publication of news affecting auditors’ reputation has
an observable impact on share price of other Japanese public firms audited by the auditors
affiliated with Olympus.
This study will provide additional empirical evidence on the impact of press release to clients
audited by auditors alleged to be involved in corporate fraud in Japanese capital market. To thebest of our knowledge, this paper represents the first attempt to detect the effect of potential
auditors’ reputation loss resulting from publication of news surrounding the Olympus fraud.

2. Literature Review and Hypotheses Development
2.1. Auditor Reputation and Value of Audit
The provision of external audit by professional auditors has a long history as a provider ofvaluable service for their clients. External auditors represent an essential element of network
together with management, internal auditors and audit committee who are collectively
responsible for ensuring accurate representation of management assertion (Kueppers & Sullivan,
2010). The argument for the inherent value of audit to its client precedes the statutory
requirements to report audited financial reports for government agencies. Prior research
provides evidence of voluntary audit by British merchant guilds since the beginning of 13th
century and proliferated during the establishment of joint stock companies in Europe during
16th century (Watts & Zimmerman, 1983). Owing to the absence of any statutory requirements,
auditors’ service has been employed as an efficient means for maintaining the enforcement ofcontractual agreement between management and shareholders. In this setting, success of audit
firms largely depends on maintaining their reputation as providers of providing high quality2

audit. This argument maintains that auditors’ reputation represents the main source of value inaudit service.
Alternative rationale for the value proposition of audit service is provided by Menon &Williams (1994), who provided empirical evidence on the validity of “deep pocket or insurance”
hypothesis. Their research found that negative market reaction from auditors’ client wasobserved during the dissolution of their auditors due to litigation charge, while no positive stock
price recovery is observed during the appointment of new auditors. This evidence leads Menon& Williams to conclude that the value of audit service is mainly derived from auditors’ role ofproviding their clients with additional buffer against litigation claim in the event of clients’business failure. In that case, auditors were frequently viewed as a party with a “deep pocket”
able to absorb the litigation charge.
Both of these reputation and insurance hypotheses attempt to provide plausible explanations on
the value of audit and the market reaction following the failure of auditors to uphold those ideal.
However, considerable overlap in explaining the market reaction resulting from loss of audit
value observed in previous empirical studies makes it difficult to clearly differentiate which
hypothesis is explaining the true causal factor of the market reaction (Ball, 2009). In certain
circumstances however, preferential treatment between reputation and insurance hypotheses ispreferable. Piot (2005) investigated the determinants of auditors’ reputation in three distinct
capital market and legal framework: Canada, France, and Germany. Piot concluded that
evidence of insurance hypothesis is more evident in Canada (higher risk litigation environment)
and France (higher shareholder-debt holder conflict potential) when compared to Germany
where there is a maximum legal cap on the litigation against auditor.
In their research on market reaction resulting from KPMG-ComROAD AG scandal; Weber,Willenborg, & Zhang (2008) applied reputation hypothesis rationale to conclude that there isevidence for abnormal negative return on KPMG clients following disclosure of the event.
Japan shares many similar features with Germany regarding legal environment on auditor
litigation. Shareholders plaintiffs in Japan are generally characterized by low win percentage,
few settlements of lawsuits, low monetary amount of settlements, and low correlation between
stock price and law suits (West, 2001). Since our paper discusses the impact of Olympus fraud
in Japanese capital market environment, we consider reputation hypothesis as the most suitable
explanatory factor in analyzing the effect of audits failure in Olympus fraud.

2.2. Audit Failure and Fraud Detection
Although financial statements audit is not specifically designed to detect fraud, investors
nevertheless expect auditors to protect their investments from management fraud. The widening
expectation gap between auditors and investors mainly results from the failure of auditors to3

design audit program that properly identify high-risk areas of fraud and modify audit proceduresin light of those risks (Hogan, Rezaee, Riley, & Velury, 2008). Investors need to rely on an
independent third party opinion on the fairness of financial statements; a responsibility which isfulfilled by mandating independent audit for all publicly listed companies.
If auditors fail to conduct proper audit by releasing unqualified opinion for fraudulent financial
reports; their reputation will suffer. Francis (2004) classified audit failure into two maincategories: failure to detect the misuse or neglect of GAAP by clients (GAAP failure) andauditor failure to issue timely qualified or modified audit report in proper situation expected by
the users of those audit report (audit report failure). Empirical research on audit failure occurredin US capital market from 1980 to 2004 suggested that the occurrence of audit failures is lessthan 1% of total annual financial report filings (Francis, 2004). However, audit failure caused byfraud invites greater concern since clients are able to systematically misrepresent financial
statements to investors and deliberately withhold key information to keep auditors in the dark.
Consequently, the inability of Olympus’ auditors to expose Olympus accounting fraud provides
a rationale for investors to downgrade the financial statements’ quality of firms audited by
Olympus’ auditors and degrade auditors’ reputation. Both of those factors will cause negative
stock price pressure for firms whose auditors are affiliated with Olympus.

2.3. Influence of News Announcement and Press Coverage
Efficient market hypothesis indicates that share price should only responsive to new information
released to public. However, no new-news contents of news publication can results in moresignificant share price reaction and industry spillover effect compared to the release of theoriginal news which was published earlier (Huberman & Regev, 2001). Huberman shows thatthe act of publishing news without any new-news content could result in market reaction. Thisfinding represents an anomaly in the efficient market hypothesis.
Market also has asymmetric response depending on whether the news contains good or bad
news. Chan (2003) argues that stock price of firms exposed to bad news exhibits stronger drift
behavior (slow stock price reaction) compared to stocks that experienced good news show.
Chan attributes the drift behavior to investors’ biased self-attribution in which investors are
overconfident in their own information while dismissing public information.
Among various sources of capital market information providers, press plays an important role indisseminating new information to capital market by performing original investigative articles.
Journalists are in good position to expose high profile corporate fraud due high reputational
incentives (Dyck, Morse, & Zingales, 2010). The propensity for press to publish investigative
articles on firms committing accounting fraud are directly related to the degree of public

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visibility that the article will produce (Miller, 2006). Consequently, corporate fraud case withsignificant magnitude or social cost has more likely chance to get covered in press.
Business media who regularly publish investigative articles on potential fraud case generally
have access to relevant information from other external sources (analysts, short sellers, or key
employees) and can confirm the validity of the information (Dyck et al., 2010). Since thosemedia are also exposed to risk of losing their reputation by publishing false positive
information; media generally only publish articles that they are certain to reflect the facts. Aman
(2013) demonstrated that publication of original news by media in Japanese market is more
likely to induce stock price jump.

2.4. Capital Market Reaction on Auditors Reputation Loss
Theoretical framework for informational value of securities prices is formalized in the efficient
market hypothesis (Fama, 1970). In his study of existing empirical literature on efficient market
model, Fama conceptualized three forms of tests for efficient market hypothesis that reflects
different assumptions for information in influencing securities prices. Subsequent research
however has provided evidence of investor irrationality that challenged the informational valueof securities prices in efficient market hypothesis. Dreman & Lufkin (2000) investigatedinvestor overreaction on stocks in their relation with fundamental variables of business growth.
They found that changes in growth fundamentals do not account to stock market return
differences between stocks with best and worst fundamentals.
Langevoort (1997) argues that market demand of constant high earnings put high pressures for
managers to employ aggressive accounting and distort disclosures. When the companies present
truthful but negative earnings results, inherently optimistic market expectation results inexcessive negative market reaction. Investor overreaction on publication of adverse news is also
observed in the substantial negative price reaction after auditors disclose going concern opinion
that is followed by reverse positive price changes that offset the majority of prior loss (Schaub,2006).
Investors’ reaction in response to adverse news related to auditors performance and opinions
have been widely documented. In particular, auditors’ inspection by capital market regulators
usually triggers negative investor reaction. Auditors report investigation by U.K. Department ofTrade negatively affect auditors’ reputation in providing high quality service that in turnnegatively impact their clients market value and loss of audit clients and fee (Firth, 1990). When
California State Board of Accountancy threatened to revoke Ernst & Young (E&Y) practicelicense due to possibility of audit failure however, E&Y clients only exhibit moderate negative
reaction following the event (Pacini & Hillison, 2003). Public announcement of PublicCompany Accounting Oversight Board (PCAOB) financial penalty against Deloitte audit failure5

of Ligand also resulted in negative market reaction to Deloitte clients, where financiallydistressed clients are more susceptible to the negative news (Dee, Lulseged, & Zhang, 2011).
Observation of market response following publication of non-standard audit opinion is anothermethod for explaining the informational value of audits. Soltani (2000) analyzed qualified audit
reports on French public companies from 1986-1995 and concluded that the evidence suggests
significant negative abnormal return around the announcement of audit report. Inclusion ofgoing concern modification in audit report can also trigger unfavorable investor reaction.
Herbohn, Ragunathan, & Garsden (2007) observed substantial negative market reaction prior to
the announcement of going concern modification. This evidence suggests that audit report fulfill
the role of attesting previously available information rather than signaling the availability of
new information.
Negative rumors on auditors circulating in capital market also play an important role in shaping
investors expectation on auditors’ reputation and audit quality. Hillison & Pacini (2004)
investigated stock price effect on audit clients following rumor on bankruptcy litigation facing
Ernst and Young in late 2000 and subsequent effort to restore credibility by self-advertising.
They reported evidence that investors reacted negatively after the release of adverse informationand self-advertising fails to restore investor confidence. Linthicum, Reitenga, & Sanchez (2010)
also showed that social responsibility measures performed by Arthur Andersen clients during
the uncovering of Enron fraud do not mitigate the negative market response. Instead, good
corporate governance measures better mitigate the negative impact of adverse rumors.
Following the negative reaction on Elan aggressive accounting practice in Wall Street Journal,
the number of independent boards of directors in Ireland companies is positively related withthe companies’ ability to mitigate the contagious effect of negative news on their stock return(Donnelly, 2008).
Accounting restatements can also be considered as attempts from managements to voluntary
amend and disclose their historically inappropriate application of accounting standards. Thereare evidence of negative return and changes of stocks’ return residual in the event of accounting
restatement (Cox & Weirich, 2002). Furthermore, company size is considered to contribute
more to the probability of accounting restatements compared with the choice of auditors(Eisenberg & Macey, 2004). Their finding suggests that there is no notable difference of audit
quality among auditors. Restatements that results in loss of stock value can also affect othernon-restating firms in the same industry (peer companies). Gleason, Jenkins, & Johnson (2008)
concluded that accounting restatement of large companies causes investor/analyst to scrutinize
the reliability of peer companies’ financial statements that might results in the decrease of theirconfidence in audited financial statements. In addition, they observed that companies with high6

accrual, low operating cash flow and high capital market pressure are more vulnerable to thenegative contagious effect.
Enron accounting fraud and the subsequent failure of Arthur Andersen (AA) have prompted
many researchers to investigate market reaction in the event of auditor failure. Multiple research
papers observed the evidence of negative market reaction particularly on Andersen clients
audited by Houston office (Chaney & Philipich, 2002; Huang & Li, 2009); adverse contagious
effect to peer firms (Akhigbe, Madura, & Martin, 2005); negative reaction to Andersen clients’secondary equity offering (Rauterkus & Song, 2005) and susceptibility of companies withhigher information ambiguity to the adverse news of Andersen failure (Autore, Billingsley, &Schneller, 2009). Other research studied the auditor switch timing of Andersen clients following
the investigation of the fraud. The evidence suggests that clients with more visibility in capital
market are more likely to switch sooner to other Big 5 auditors (Barton, 2005) and investors
react positively for clients that switch auditors earlier (Krishnamurthy, Zhou, & Zhou, 2006).
Further study suggests that clients with stronger corporate governance are more likely to switch
auditor earlier and public disclosure of auditors switching lead to positive investors reaction(Asthana, Balsam, & Krishnan, 2010).
In addition, several researchers indicated evidence of absence of market reaction in the event ofauditors’ reputation decline. Arthur Andersen failure did not trigger negative market reaction on
their clients in Spain despite their audit market share dominance (Barbera & Martinez, 2006).
After controlling for global macroeconomic confounding factor and industrial structure of AAclients; Nelson, Price, & Rountree (2008) demonstrated that there is no sufficient evidence tosupport the influence of auditors’ reputation loss on the negative market reaction. Contrary tonegative stock return observed in AA clients, AA nonprofit clients did not experience negativechange in their income despite the perceived importance of auditors reputation in securing
donation (Harris & Krishnan, 2012).
The profession of independent Certified Public Accountant (CPA) in Japan was first introduced
after the end of World War II (Jinnai, 1990). Consequently, professional and independent
character of Japanese CPA profession has not reached the same level of sophisticationcompared to their Western counterparts. Dual accounting regulation that is derived from bothSecurities and Exchange Law and Commercial Code often results in conflict of interest andcomplicated bureaucracy that weakens enforcement of capital market regulations (Oguri & Hara,
1990). Japanese capital market itself is characterized by the absence of litigation risk against
auditor even in case of corporate failure (Sakagami, Yoshimi, & Okano, 1999). The
combination of these institutional and legal complexities further limits the explanatory power of
insurance hypothesis in explaining investors’ reaction in Japanese capital market. Following thisrationale, Numata & Takeda (2010) investigate Japanese investors market price reaction due to7

loss of ChuoAoyama PricewaterhouseCoopers reputation during Kanebo scandal using
reputation hypothesis. They concluded that the negative market reaction results from perceived
low audit quality following their failure to prevent or detect Kanebo fraudulent accounting.

2.5. Chronological Summary of Olympus Fraud
On October 14, 2011, Japanese business world was shocked with the sudden dismissal of
Olympus CEO, Michael C. Woodford. Even as Olympus cited the problem of incompatible
management style as the reason of Woodford dismissal (Kyodo News Service, 2011a), thisunexpected news is negatively responded by investor, as evidenced by the loss of the company’s
stock by 24% at the next trading day (Kyodo News Service, 2011b). The ensuing days revealed
more light on much deeper problem behind the Olympus corporate governance, as Woodford
questioned the rationality of acquisitions moves done in 2008 and regarded his removal due tohis critical inquiry on the issue. After only one week after the event, Olympus stock value has
decreased around 50% from 2,482 yen on October 13, the day before Woodford’s dismissal to1,231 yen (Kyodo News Service, 2011c).
Olympus utilized tobashi (improper transfer of losses) to hide losses from its investment infinancial assets when the bubble economy burst in 1990. Using specified money trusts andspecified fund trusts (tokkin) to recover their losses, the amount of unrealized investment loss asof 1995 has grown to tens of billions of yen (Third Party Committee, 2011). However, revisionin Japanese accounting standard No. 10 “Accounting Standards for Financial Products” which iseffective in fiscal year 2000 requires major financial assets to be marked at fair value.
Consequently, accounting scheme to hide unrealized losses that occurred in the bubble economy
period through tobashi to fund trust accounts and non-consolidation of affiliates will no longer
be viable (Yamazaki, 1999).
In order to avoid recognizing unrealized valuation losses on financial assets which have grown
to 95 billion yen in 1998, Olympus executives arranged the establishment of “receiver funds”
entities in Cayman Islands that would not be consolidated with Olympus (Third Party
Committee, 2011). The “receiver funds” were then financed by financial institutions using
bonds owned by Olympus as collateral. Those entities then purchased financial instruments withunrealized losses from Olympus through the tokkin at book value. Since the purchase price isequal to the total unrealized losses of those instruments, Olympus does not record losses fromthose transactions.

However, the financial assets kept in “receiver funds” have to be eventually repaid. Using
acquisition transactions as a cover up, Olympus paid the “receiver funds” a huge amount ofconsulting fees resulting from corporate acquisitions which will be recognized as goodwill.
KPMG was the designated independent auditor of Olympus from fiscal year ending in March

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2003 to March 2009, until E&Y replaced KPMG from fiscal year March 2010. Investigation
report published by Olympus in December 2011 acknowledged that although both auditors wereinvolved in approving the fraudulent transactions, Olympus management was able to withholdessential information from auditors, preventing them to raise any red flag.

2.6. Problem Statements & Hypotheses Development
In the event of audit failure, public expect that audit report produced by auditors associated withaudit failure will provide lower level of assurance to the users of financial statements.
Consequently, clients of auditors with history of audit failure are more likely to overstate theirearnings and book values without being identified by auditor (Chaney & Philipich, 2002). The
extent of auditors’ reputation loss caused by the exposure of financial statements fraud are
expected to be more severe for clients of alleged firms as financial statements audited by them
are more likely to be subjected for stricter scrutiny by investors and analysts.
Accordingly, the revelation of Olympus fraud which was started by circulation of media rumor
from the middle of 2011 and ended by publication of official investigation report in the
beginning of 2012 provides a unique opportunity to investigate change of Olympus auditors’
reputation in Japanese stock market and its market effect on other public companies audited byauditors associated with Olympus.
The purpose of this study was to identify market reaction of clients of auditors whose reputation
is affected by publication of news that imply their active role on Olympus fraud. This paper
investigates the market effect of key events surrounding news announcements with potential
adverse auditors’ reputational effect for clients of accounting firms associated with Olympus.
We examine whether Japanese public companies audited by E&Y and KPMG are affected by
the announcement of news and whether the extent of the market reaction are more severe forclients audited by audit firms associated with Olympus compared to clients audited by auditors
not affiliated with Olympus.
We proposed the following hypotheses in alternative forms:
H1: Abnormal share returns of publicly listed clients of auditors associated with Olympus (E&Y
and KPMG) have direct relation to news publication affecting reputation of auditors associatedwith Olympus.

9H2: The extent of market reaction observed during the news publication affecting reputation ofauditors associated with Olympus (E&Y and KPMG) is more pronounced compared to otherfirms whose auditor is not associated with Olympus.

3. Methodology and Data
3.1. Determination of Event Days and Samples
In this section, we assess whether news announcements which negatively affects reputation ofauditors associated with Olympus fraud generates negative reaction from clients of alleged audit
firms. As shown in Table 1, we determined six events that have the largest possibility to alter
the investors’ perception on reputation of Olympus auditors. The event date (𝑡0 ) is based on thedate when news were made available to public. We investigate whether abnormal investors’

reaction on clients of auditors alleged to be involved in the fraud was observed around these
events.
Out of six events identified, the first two events (Event 1 and Event 2) cover the initial publicity
of suspicious acquisitions transactions by a Japanese financial magazine, FACTA, prior to thestart of official investigations by Olympus. The rest of the events (Events 3, 4, 5 and 6) cover
the announcement date of official press releases published by Olympus and investigation reports
results from independent committees commissioned by Olympus to investigate the fraud case.
Event 1 to Event 5 covers news publication that contains negative implication on reputation of
Olympus auditors; while Event 6 has a neutral implication on their reputation.
Event 1 included the earliest public press publication that raised doubt on the fairness of
Olympus acquisition on Gyrus in 2008 (Abe, 2011a). Although the article did not contain directreference of potential involvement of Olympus auditors on the acquisition, we argue thatinvestors might react to such information. Event 2 involved a publication of follow up article
from FACTA that reported no official response from Olympus regarding FACTA’s initialinquiry in July 2011 (Abe, 2011b). We assume that Event 2 will gave rise to negative perception
on Olympus auditors’ audit quality if investors associate the non-reply from Olympus asindication of inappropriate transaction.
Event 3 covered the period where Olympus published official press release in response of media
report that reported the reason why Olympus changed auditor in fiscal year 2010 from KPMG to
E&Y is due to KPMG withdrawal from auditing Gyrus, a subsidiary alleged to be involved in
improper acquisition transaction (Olympus, 2011b). Instead, Olympus stated that the motivation
for the change in auditor is reasonable as KPMG’s audit contract has expired and KPMG
reported unqualified audit opinion for fiscal year 2009 consolidated financial statements. We
argue that this press release was announced in response to FACTA inquiries in Event 1 and 2
and we will investigate whether Olympus response generates investors’ reaction.

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Event 4 covered the announcement of Olympus shareholders’ request to investigate whether
Olympus independent audit firms since 1999 (KPMG and E&Y) were negligent on their duties
of care owed to report to the board of auditors (Olympus, 2011a). If such breach of duties exists,
Olympus will be required to file legal action against those audit firms for such breach ofnegligence. In response of this request, Olympus commissioned Non-Director Management
Liability Investigation Committee to issue a report that was published in January 2012 toinvestigate parties that can be held legally responsible for the fraud (Event 6). On further note,
this is the first occasion where Olympus press release explicitly mentioned independent auditors
as potential suspects who took part in the fraud.
On December 6, 2011, Third Party Committee released results of its investigations on
inappropriate acquisitions transactions (Event 5). The report contained chronological summaryof transaction schemes, institutions, and individuals involved in hiding deferral losses andimplementation of the acquisition transactions. Specifically, the report documented Olympus
independent auditors’ rationale and opinion on accounting treatments for transactions schemes
designed by Olympus executives and their role in Olympus internal control and corporate
governance system (Third Party Committee, 2011). However, there is no any reference to legal
responsibility directed to any parties as this is not the objective of the report. Event 1 to event 5
summarizes news announcements with negative reputational effect on Olympus auditors.
Event 6 covered the release date of Non-Director Management Liability Investigation
Committee Investigation Report whose objective is to assess the possibility for Olympus to filelegal suit to pursue liability against non-director parties involved in the fraud. In relation to theinvolvements of Olympus independent auditors, the report investigated whether violations ofduty of care exist and whether auditor succession from KPMG to E&Y in 2010 and E&Y
decision to accept accounting treatment of goodwill are appropriate ((Non-Director
Management Liability Investigation Committee, 2012). The report concludes that both Olympus
audit firms were not held legally liable for the fraud. Event 6 represents news announcementwith neutral reputational effect on Olympus auditors.
Table 1
News Announcements Affecting Olympus Auditors’ Reputation
Publication Date of FACTA Articles on Olympus Fraud
Event 1
Jul. 15, 2011
FACTA, a Japanese financial magazine, published an article questioning
suspicious M&A activities in Olympus.
Event 2
Sep. 15, 2011
FACTA published a second article reporting no response from Olympus
regarding FACTA’s initial inquiry and investigation on Olympus' suspicious
acquisitions in July.
Official Olympus Press Releases and Investigation Reports
Event 3Oct. 24, 2011
Olympus released press release denied that the reason for auditor change is due
to KPMG’s withdrawal to audit subsidiary of Olympus.
Event 4
Nov. 25, 2011
Olympus received requests from its shareholders to investigate whether
Olympus independent auditors (KPMG and E&Y) were negligent in their duty.
Event 5
Dec. 6, 2011
Investigation report was issued by Olympus Third Party Committee that11

Event 6

Jan. 17, 2012

mentioned potential role of Olympus audit firms in the fraud.
Olympus Corporation Non-Director Management Liability Investigation
Committee Investigation Report was released. It concluded that no legal
liability will be charged against Olympus independent auditors.

We sample all firms listed in the First Section of the Tokyo Stock Exchange (TOPIX) during theperiod of observed events. Stock information, industry classification and financial variables data
were obtained from fiscal year 2011 Japanese securities filings information (YukashokenHokokusho) extracted from NEEDS (Nikkei Economic Electronic Database Systems)
FinancialQuest database. From 1,751 firms that were initially sampled, we adjusted final
samples by excluding firms with missing stock price and financial variables and firms withqualified or disclaimer audit opinion, finance and insurance companies, and firms who changed
auditors between fiscal year 2010 and 2011 to control for audit quality variability due to auditor
change in initial years of audit. Description of the samples selection process and auditors
distribution of final samples is provided in Table 2.
Table 2
Samples Selection
Firms listed on First Section of TOPIX in 2011 (excluding Olympus)
Less: Missing data or firms with qualified or disclaimer audit opinion
Firms that change auditor between fiscal year 2010 and 2011
Finance and insurance companies
Final samples

1,751
512
309
120
810

Distribution of final samples categorized by auditors
ShinNihon (E&Y)
AZSA (KPMG)
Tohmatsu (Deloitte)
Aarata (PwC)
Non Big-4
Final samples

323
12
251
39
185
810

3.2. Event Study Methodology
We employ nonparametric generalized rank (GRANK) test methodology for multiple event
windows (Kolari & Pynnonen, 2011) to evaluate whether abnormal price reaction are observedwith events associated with news with information content related to Olympus auditors’
reputation as described in Hypothesis 1. This test procedure improves on nonparametric rank
testing approach of Corrado (1989) and Corrado & Zivney (1992), where the GRANK test isable to measure cumulative abnormal returns (CAR) on multiple days.
This study utilizes daily stock and excess return for an individual security which exhibits
substantial departures from normality that are not observed with monthly data (Brown &Warner, 1985). Therefore, distribution free characteristic of nonparametric GRANK test
procedure makes it less sensitive to distributional assumption of parametric tests (Kolari &Pynnonen, 2011). Kolari & Pynnonen (2011) demonstrated that empirical properties of GRANK
test is better compared to popular parametric tests (e.g., ordinary t-test, Patell (1976) t-test, and12Boehmer, Masumeci, & Poulsen (1991) t-test) as well as existing nonparametric rank tests (e.g.,
Corrado & Zivney (1992) rank test and cumulated ranks test of Cowan (1992) and Campbell &Wesley (1993)). GRANK test also exhibits robustness to event-induced cross-sectional
volatility, autocorrelation of abnormal returns, and cross-correlation caused by event day
clustering (Kolari & Pynnonen, 2011).
The accuracy of event study’s findings are highly dependent on the existence of any
confounding events (e.g., a simultaneous dividend and earnings announcement) which concurwith the events of interest to the researcher (Kothari, 2001). The importance to isolate
confounding events is demonstrated by Nelson et al. (2008) who challenge results of Chaney &Philipich (2002) and Krishnamurthy et al. (2006) research that attribute the negative market
reaction of Andersen clients to Andersen’s reputation decline. Nelson et al. (2008) argue that
abnormal negative returns are mainly observed in firms from technology sector negatively
affected by sharp decline in oil price around the Andersen event. Those firms form adisproportionate share of Andersen clients compared to other Big 5 firms which contributed tohigher degree of negative returns for Andersen clients.
In order to control for adverse news announced during the event window which could
disproportionately affect sample firms from different industry sectors; we examined news
announcement around event window from Wall Street Journals, Financial Times, New YorkTimes, Nikkei Business, Yomiuri Shinbun, and Japan Times extracted from LexisNexis
database. From our observations, we did not identify global macroeconomic news during theevent window that could disproportionately result in systematic return differences acrossdifferent industries.
If an event is unanticipated by market and incomplete prior information exists, abnormal returnobserved during the event measures shareholders' reaction on the impact of the events (Brown& Warner, 1980). This observation is consistent with market efficiency hypothesis. We denotethe 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) in order toguarantee robust measure of price reaction (Numata & Takeda, 2010). CAR that covers multiple

days window are calculated to capture price effects of announcements which occur after thestock market closes on the announcement day. Price reaction 1 day prior to event is also
included to observe possibilities of information leaked prior to event day (MacKinlay, 1997).
The estimation window is set at 250 trading days before the event window of the first event.
We use Fama-French 3 factors models rather than market model to estimate abnormal return
because 3 stock market factors (overall market, firm size and book-to-market equity) factors can
explain the differences in common variation and cross section of average stock returns (Fama &French, 1993). Since the purpose of event studies is to isolate incremental impact of an event on

13

security price performance; Fama-French 3 factors model is more capable of isolating
performance associated with the event from those 3 known factors of performance determinants(Kothari & Warner, 2007). From statistical power perspective, multifactor model reduces
variance of the abnormal return by explaining more variation in the normal return (MacKinlay,
1997). Using returns data from this study, we found that R2 value of expected return estimatedby Fama-French 3 factors model is higher than market model.
Expected returns for each sampled firms using the following Fama-French 3 factors returns
model as illustrated in Equation (1) (Fama & French, 1996) 1. Stock and market returns data
used to estimate Fama-French model are transformed into their natural logarithm value.
𝑅𝑖,𝑡 − 𝑅𝑓,𝑡 = 𝛼 + 𝛽𝑖,𝑚 �𝑅𝑚,𝑡 − 𝑅𝑓,𝑡 � + 𝛽𝑖,𝑠𝑚𝑏 𝑆𝑀𝐵𝑡 + 𝛽𝑖,ℎ𝑚𝑙 𝐻𝑀𝐿𝑡 + 𝑢,𝑡(1)

𝐴𝑅𝑖,𝑡 = (𝑅𝑖,𝑡 − 𝑅𝑓,𝑡 ) − [𝛼 + 𝛽𝑖,𝑚 �𝑅𝑚,𝑡 − 𝑅𝑓,𝑡 � + 𝛽𝑖,𝑠𝑚𝑏 𝑆𝑀𝐵𝑡 + 𝛽𝑖,ℎ𝑚𝑙 𝐻𝑀𝐿𝑡 ](2)

Excess (abnormal) return is then estimated using the following equation:

where:

𝑅𝑖,𝑡𝑅𝑓,𝑡𝑅𝑚,𝑡 − 𝑅𝑓,𝑡
𝑆𝑀𝐵

stock daily returnmarket risk-free rate
stock excess return on a broad market portfolio (TOPIX)
the difference between the return on a portfolio of small stocks and the return on a portfolioof large stocks (SMB, small minus big)the difference between the return on a portfolio of high-book-to-market stocks and thereturn on a portfolio of low-book-to-market stocks (HML, high minus low)
estimated abnormal return

𝐻𝑀𝐿
𝐴𝑅𝑖,𝑡

We then calculated standardized abnormal return (SAR) for each stock over estimation window:
𝑆𝐴𝑅𝑖𝑡 =

𝐴𝑅𝑖𝑡
𝑆𝐴𝑅𝑖

(3)

where 𝑆𝐴𝑅𝑖 is the standard deviation of the regression prediction errors in abnormal returns

defined in (MacKinlay, 1997).

Cumulative abnormal return (CAR) and standardized abnormal return (SCAR) are computed foreach stock in event window:𝑡2

𝐶𝐴𝑅𝑖 (𝑡1 , 𝑡2 ) = � 𝐴𝑅𝑖,𝑡𝑆𝐶𝐴𝑅𝑖,(𝑡1 ,𝑡2) =𝑡=𝑡1

𝐶𝐴𝑅𝑖 (𝑡1 , 𝑡2 )𝑆𝐶𝐴𝑅𝑖 (𝑡1,𝑡2 )

(4)
(5)

where 𝑆𝐶𝐴𝑅𝑖 (𝑡1 ,𝑡2 ) is the standard deviation of prediction errors in cumulative abnormal returns

as defined in (MacKinlay, 1997).

1

Fama-French factors data for Japan stock market are obtained from Prof. French’s website(http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html). Monthly return value of Fama-French
factors is then adjusted to daily return.

14

Next, we compute re-standardized SCAR (SCAR*) to account for possible event-induced
volatility (Boehmer et al., 1991):
𝑆𝐶𝐴𝑅𝑖∗ =𝑆𝐶𝐴𝑅𝑖,(𝑡1,𝑡2)
𝑆𝑆𝐶𝐴𝑅(𝑡1,𝑡2)

(6)

where
𝑛

1
𝑆𝑆𝐶𝐴𝑅(𝑡1,𝑡2) = �
�(𝑆𝐶𝐴𝑅𝑖,(𝑡1,𝑡2 ) − ��������������
𝑆𝐶𝐴𝑅(𝑡1,𝑡2 ) )2
𝑛−1

(7)

𝑖=1

is cross-sectional standard deviation of 𝑆𝐶𝐴𝑅𝑖 .

The generalized standardized abnormal return (GSAR) is computed as:
𝑆𝐶𝐴𝑅𝑖∗ , 𝑓𝑜𝑟 𝐶𝐴𝑅 𝑤𝑖𝑛𝑑𝑜𝑤 (𝑡1 , 𝑡2 )𝐺𝑆𝐴𝑅𝑖𝑡 = �
𝑆𝐴𝑅𝑖𝑡 , 𝑓𝑜𝑟 𝑜𝑡ℎ𝑒𝑟 𝑡𝑖𝑚𝑒 𝑝𝑒𝑟𝑖𝑜𝑑(8)

where 𝑆𝐶𝐴𝑅𝑖∗ is defined in Equation (6), and 𝑆𝐴𝑅𝑖𝑡 is defined in Equation (3).
The demeaned standardized abnormal ranks of the GSAR are then calculated following thefollowing formula:𝑅𝑎𝑛𝑘(𝐺𝑆𝐴𝑅𝑖𝑡 )− 1⁄2(𝑇 + 1)
where T is equal to length of estimation period (250 days) plus 1 CAR event day which
𝑈𝑖𝑡 =

(9)

represents total number of observation.

Given the null hypothesis of no mean event effect:
𝐻0 : 𝜇(𝑡1 ,𝑡2) = 0

where 𝜇(𝑡1 ,𝑡2 ) is the expected value of the CAR over the period of event window (𝑡1 , 𝑡2 ).

The generalized rank t-statistic (GRANK-T) for testing H0 is defined as:12
𝑇−2
𝑡𝑔𝑟𝑎𝑛𝑘 = 𝑍 �
�
2
𝑇−1−𝑍

where

�0
𝑈
𝑍=
𝑆𝑈�

(11)

(10)

with

�𝑡 =
𝑈

𝑛𝑡

1
� 𝑈𝑖𝑡
𝑛𝑡
𝑖=1

1
𝑛𝑡 2
�
𝑆𝑈� = � � 𝑈
𝑇
𝑛 𝑡

(12)

(13)

𝑡∈𝑇

15

𝑛𝑡 is the number of valid 𝐺𝑆𝐴𝑅𝑖𝑡 available at time point t, T is the number of observations and�0 is the mean 𝑈
�𝑡 at t = 0 (the cumulative abnormal return). Asymptotic distribution of𝑈
GRANK-T follows Student t-distribution with T−2 degrees of freedom.

3.3. Cross-Sectional Analysis
We perform cross-sectional analysis to analyze firms specific variables that influence mean
CAR observed in six observed events. The following multivariate regression models are
estimated using fixed effect model after correcting for heteroskedastic standard errors (Equation
14). Fixed effect model is utilized to control for samples heterogeneity across different
industries.
𝐶𝐴𝑅𝑖 =

𝛽1 + 𝛽2 𝑂𝑙𝑦𝑚𝑝𝑢𝑠𝑖 + 𝛽3 𝑂𝑝𝑖𝑛𝑖𝑜𝑛𝑖 + 𝛽4 𝑅𝑜𝐴𝑖 + 𝛽5 𝐴𝑠𝑠𝑒𝑡𝑠𝑖 + 𝛽6 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒𝑖 + 𝛽7 𝐹𝑟𝑒𝑒𝐹𝑙𝑜𝑎𝑡𝑅𝑎𝑡𝑖𝑜𝑖 +𝛽8 𝑆𝑒𝑔𝑚𝑒𝑛𝑡𝑠𝑖 + 𝛽9 𝐹𝑜𝑟𝑒𝑖𝑔𝑛𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠𝑖 + 𝛽10 𝑂𝑣𝑒𝑟𝑠𝑒𝑎𝑠𝑆𝑎𝑙𝑒𝑠𝑖 + 𝑢𝑖

(14)

where

CAR
Olympus
OpinionRoA
AssetsLeverage
FreeFloatRatio
Segments
ForeignShareholders
OverseasSales

mean cumulative abnormal return (%)
dummy variable for clients audited by Olympus auditor (ShinNihon or AZSA) (1 = true, 0= otherwise)
dummy variable for audit opinion (1 = unqualified, 0 = unqualified with explanatory
paragraph)
return on assets (net income divided by total assets (%)
natural logarithm of total assets
total liabilities divided by total assets (%)
ratio of listed shares available for trading in the market (number of floating shares divided
by total number of shares owned by shareholders) (%)
number of distinct divisions for which shares of total sales are reported
ratio of listed shares owned by foreign corporations (number of shares owned by foreign
corporations divided by total number of shares owned by shareholders) (%)
ratio of sales outside Japan to total sales (%)

The control variables are drawn from previous research on stock market reactions which include
audit opinion, leverage, return on assets, total assets, free float ratio, ratio of foreign
shareholders, overseas sales ratio, and number of segments (Numata & Takeda, 2010; Skinner& Srinivasan, 2012). Dummy variable Olympus is included as main independent variable for the
purpose of testing Hypothesis 2. The variable takes a value of 1 if firms were audited by
Olympus auditor (ShinNihon or AZSA) and 0 if otherwise. We predict that the estimatedcoefficients should be insignificant when there is no difference in market reaction between firms
audited by Olympus auditors and firms not affiliated with Olympus auditors. Conversely, we
estimate negative and significant coefficient for the variable if Olympus auditors’ clients
experienced more negative market reaction compared to clients of other auditors.
Opinion variable is a dummy variable which we use to control for difference in audit opinion. It
takes a value of 1 if audit opinion for each firm in fiscal year 2011 is unqualified and 0 if the16

opinion released is unqualified with explanatory paragraph. Variable RoA controls forprofitability performance for each firms which is affected by earnings management. The next
two balance sheet variables, Assets and Leverage, control for size effects and risk of debt
insolvency respectively. Variable FreeFloatRatio controls for trading liquidity for each stock.
Stocks with higher free-float ratio imply that shareholders can trade their stocks more easily
compared to stocks with lower free-float ratio. In addition, we use Segments variable as a proxy
to control firms’ business operation complexity. Firms with higher number of business segments
require more complex audit procedures which in turn involves the need for higher audit quality
and more dependence on auditors’ reputation. The last two variables, ForeignShareholders andOverseasSales, control for the degree of influence of foreign stockholders on sampled Japanesefirms from the equity and income perspective respectively.

4. Analysis Results
4.1. Descriptive Statistics
Industry distribution of samples across auditors is provided in Table 3. We classified thesamples’ industry distribution by auditor’s affiliation to Olympus and auditor size. Firms inGroup I denote sample firms audited by E&Y and KPMG who are affiliated with Olympus. On
the other hand Group II consists of sample firms audited by other auditors not affiliated with
Olympus which includes other Big 4 and non-Big 4 auditors.
We observe that 810 sample firms in this study are diversely distributed across 29 industries.
For each group of samples classified by their affiliation with Olympus, we found that there is no
single industry which comprises of more than 12% of total samples. The diversified samples
across industries makes the samples less susceptible to cross-industries confounding factors.

17

Table 3
Industry Distribution Categorized by Auditors’ Affiliation with Olympus
Industry

Air Transportation
Chemicals
Construction
Electric Appliances
Electric Power & Gas
Fishery, Agriculture & Forestry
Foods
Glass & Ceramics Products
Information & Communication
Iron & SteelLand Transportation
Machinery
Marine Transportation
Metal Products
MiningNonferrous Metals
Oil & Coal Products
Other Products
Pharmaceutical
Precision Instruments
Pulp & Paper
Real Estate
Retail Trade
Rubber Products
Services
Textile & Apparels
Transport Equipment
Warehousing and Harbortransportation
Wholesale Trade

Group I
(Clients of Auditors Affiliated with
Olympus)
Freq.
%

Group II
(Clients of Auditors Not Affiliated with
Olympus)
Freq.
%

1
38
30
30
2
3
11
6
14
5
9
30
3
4
4
10
2
5
9
3
4
10
29
5
15
10
14
3

0.30%
11.34%
8.96%
8.96%
0.60%
0.90%
3.28%
1.79%
4.18%
1.49%
2.69%
8.96%
0.90%
1.19%
1.19%
2.99%
0.60%
1.49%
2.69%
0.90%
1.19%
2.99%
8.66%
1.49%
4.48%
2.99%
4.18%
0.90%

0
38
18
50
6
1
15
8
28
11
9
45
3
14
1
5
1
19
9
11
2
16
46
1
31
9
27
5

0.00%
8.00%
3.79%
10.53%
1.26%
0.21%
3.16%
1.68%
5.89%
2.32%
1.89%
9.47%
0.63%
2.95%
0.21%
1.05%
0.21%
4.00%
1.89%
2.32%
0.42%
3.37%
9.68%
0.21%
6.53%
1.89%
5.68%
1.05%

26
335

7.76%
41.36%

46
475

9.68%
58.64%

Table 4 presents descriptive statistics for variables used for cross-sectional analysis as describedin Equation 14. We classified descriptive statistics results according to sample firms’ auditors
name, auditors’ size and auditors’ affiliation to Olympus (Group I consists of clients of auditors18

affiliated with Olympus (E&Y and KPMG) while Group II comprises of clients of auditors notaffiliated with Olympus).

19

Table 4
Descriptive Statistics
AuditorVariables

CAR

Olympus

OpinionRoA

AssetsLeverage

FreeFloatRatio

Segments

ForeignShareholders

OverseasSales

Observations

Statistics

Mean
MedianSt. Deviation
MeanMedianSt. Deviation
MeanMedianSt. Deviation
MeanMedianSt. Deviation
MeanMedianSt. Deviation
MeanMedianSt. Deviation
MeanMedianSt. Deviation
MeanMedianSt. Deviation
MeanMedianSt. Deviation
MeanMedianSt. Deviation

E&Y-0.0029-0.00470.01541
1
00.78301
0.41300.06290.05130.054611.7400
11.5600
1.34000.53400.53400.18500.19500.17400.11565.030052.77000.13440.1064
0.1086
0.1951
0.04220.2420323

KPMG-0.0109-0.0079
0.01701
1
00.91701
0.28900.0901
0.06560.101010.7100
10.8800
1.21000.43400.46500.16500.22500.23200.08823.920053.00000.07290.07050.05000.090300.220012Deloitte-0.0058-0.0068
0.01340000.86501
0.34300.06820.06000.052011.4900
11.3200
1.36000.47000.47000.20100.16600.14700.09954.350053.06000.14160.11640.11860.179600.2480251

Auditor Size
PwC
-0.0008
0.00040.01240000.69201
0.46800.06600.05690.0651
11.7100
11.4100
1.42000.45300.44200.16200.14400.12100.10254.410063.33000.13830.1103
0.09640.29120.32240.244039

Non Big-4-0.0044-0.0053
0.01290000.69701
0.46100.05320.04350.0537
11.2000
11.1300
1.15000.50500.49500.19300.20800.17600.12324.680052.76000.11160.0746
0.11230.156900.2080185

Big 4-0.0041-0.0057
0.01450.53601
0.49900.813010.39000.06570.05500.0555
11.6200
11.4500
1.36000.50100.50700.19300.18000.16000.10904.700052.94000.13600.10890.11100.193000.2460625

Non Big-4-0.0044-0.0053
0.01290000.69701
0.46100.05320.04350.0537
11.2000
11.1300
1.15000.50500.49500.19300.20800.17600.12304.680052.76000.11200.0746
0.11200.157000.2080185

Auditor Affiliation with Olympus
Group IGroup II
(Clients of Auditors Affiliated(Clients of Auditors Not
with Olympus)
Affiliated with Olympus)-0.0031-0.0048-0.0049-0.0058
0.01550.013210
10000.78800.78501
10.40900.41100.06380.06220.05220.05280.05680.0542
11.7100
11.4000
11.5500
11.2300
1.35001.29000.53000.48300.52900.47700.18500.19500.19600.18000.17500.15700.11500.11204.99004.4900552.78002.97000.13200.13000.1054
0.09650.10800.11500.19100.1800000.24200.2350335
475

20

4.2. Event Study Results
Table 5 presents GRANK-T statistics results of null hypothesis that there are no abnormal
returns observed for firms categorized by their auditor’s affiliation with Olympus for each
events described in Section 3.
Table 5Results of GRANK tests of Abnormal Returns Observed around Olympus Events

Event 1

Event 2

Event 3

Event 4

Event 5

Event 6

Observations

Group I
(Clients of Auditors Affiliated with
Olympus)GRANK t statistics
p-valueGroup II
(Clients of Auditors Not Affiliated with
Olympus)GRANK t statistics
p-value(0,1)

0.35270.72460.29320.7696(0,2)-0.17210.8635-0.1806

0.8568(0,3)-0.57120.5684-0.6832

0.4951(-1,3)-0.6927

0.4892-0.6175

0.5375(0,1)

0.24920.80340.16530.8689(0,2)-0.0187

0.9851-0.0495

0.9605(0,3)-0.9974

0.3196-0.82110.4124(-1,3)-1.2933

0.1971-0.8879

0.3754(0,1)

0.32820.74300.36690.7140(0,2)

0.36290.71700.36080.7185(0,3)-0.7096

0.4786-0.6924

0.4893(-1,3)-0.3956

0.6928-0.32880.7426(0,1)-0.39100.6961-0.64480.5197(0,2)-0.79310.4285-0.8956

0.3713(0,3)-1.05220.2937-1.17540.2409(-1,3)-0.91310.3621-0.9334

0.3515(0,1)

0.11080.91190.09140.9272(0,2)-0.1338

0.8937-0.32030.7490(0,3)

0.71410.47580.45190.6518(-1,3)

0.81030.41850.55490.5795(0,1)

0.15740.87510.13580.8921(0,2)-0.91450.3613-0.94700.3446(0,3)-1.5743

0.1167-1.5785

0.1157(-1,3)-1.31370.1902-1.34290.1805335

475*, ** and *** represent statistical significance at 10%, 5%, and 1% level, respectively.

The results show that from 6 events observed, we found that there is no abnormal market
reaction observed with across two groups of firms categorized by their auditors’ affiliation to
Olympus. Therefore, we cannot reject H1 null hypothesis that news publication affecting
reputation of auditors associated with Olympus do not contribute to abnormal share returns ofpublicly listed clients of auditors associated with Olympus (E&Y and KPMG). To conclude
whether there is observed market reaction difference attributable to clients’ auditors association
with Olympus and controlling for firm specific characteristics, we perform cross-sectional
regression analysis for abnormal returns observed in Event 6 in the next section.

21

4.3. Cross-Sectional Results
Table 6 presents multivariate regression estimation results from Equation (14) with dependent variables of mean CAR categorized by events.
Table 6
Fixed Effect Model Multivariate Regression Results after Correcting for Heteroskedastic Standard Errors – CAR Estimated Using Fama-French 3 Factors Model
Mean CAR -FACTA Events(Event 1-2)

Mean CAR - All 6 Events

Variables
Coeff.

t-value

Pr(>|t|)Coeff.

t-value

Pr(>|t|)Mean CAR - Olympus Events(Event 3-6)
Coeff.

t-value

Mean CAR - Negative News
(Event 1-5)

Pr(>|t|)Coeff.

t-value

Pr(>|t|)Olympus0.001215

1.12

0.262

-4.25E-05

-0.03

0.978

1.84E-03

1.27

0.2

1.05E-03

0.92

0.358

Opinion0.002234

1.5

0.134

2.26E-04

0.17

0.868

3.24E-03

1.7

0.09

*

2.29E-03

1.87

0.062

RoA

-0.017708

-1.41

0.16

1.10E-02

0.55

0.581

-3.21E-02

-2.17

0.03

**

-3.76E-03-0.35

Assets0.001291

1.95

0.052

2.25E-03

2.22

0.027

8.12E-04

1.39

0.16

4.08E-04

0.62

Leverage

0.001298

0.32

0.746

-5.96E-03

-1.28

0.2

4.93E-03

0.91

0.36

4.57E-04

FreeFloatRatio-0.003142

-0.7

0.482

-9.23E-03

-1.19

0.236

-9.92E-05

-0.02

0.99

Segments-0.000122

-0.66

0.509

-1.36E-04

-0.62

0.534

-1.15E-04

-0.46

0.65

ForeignShareholders-0.001773

-0.28

0.78

-3.86E-03

-0.51

0.609

-7.31E-04

-0.1

0.92

0.01204

6.06

2.20E-09

4.49E-03

1.49

0.138

1.58E-02

5.4

8.90E08

OverseasSales

***

**

***

Mean CAR - Neutral News
(Event 6)
Coeff.

0.85

0.395270.001936

0.44

0.66155

0.724-0.08742-2.57

0.01023*

0.532

0.005704

4.97

8.40E-07

***

0.14

0.889

0.0055030.390.70032-5.41E-03

-1.19

0.233

0.008186

0.75

0.4562-7.44E-05

-0.5

0.615

-0.00036-0.68

0.49528

1.79E-04

0.03

0.976

-0.01154-1.04

0.29812

9.59E-03

5.46

6.30E-08

0.024286

3.89

0.00011

***

810

810

810

810

810

Industry Fixed Effects

Included

Included

Included

Included

Total Sum of Squares

0.144

0.28

0.241

0.128

1.16

Residual Sum of Squares

0.133

0.269

0.225

0.122

1.06

R-Squared

0.075

0.0391

0.06760.0441

0.081

Adj. R-Squared

0.07150.03720.06440.042

0.0772

1.08E-09

0.000307

1.70E-08

6.07E-05

1.14E-10

p-value

Pr(>|t|)0.002035*

Included

Observations

t-value*, ** and *** represent statistical significance at 10%, 5%, and 1% level, respectively.

22

***

The regression results for Olympus variable in Table 6 yield statistically insignificant coefficientwhich suggest that for all instances of CAR observed in this study, there is no difference in market
reaction between firms audited by Olympus auditors and firms not affiliated with Olympus auditors.
These results suggest that we are unable to reject H2 null hypothesis that the extent of market
reaction observed during the news publication affecting reputation of auditors associated with
Olympus (E&Y and KPMG) is no different from other firms whose auditor is not associated with
Olympus.

5. Discussion of Results
Event study and multivariate regression analysis results presented in the previous section indicatethat there is no observed change in Olympus auditors’ reputation surrounding the news
announcements of their potential involvement in the fraud. Our research mirror results of previous
study conducted in US which shown weak observed relation between public news announcement
and market activity (Mitchell & Mulherin, 1994). Investor non-reaction which is observed forevents that include news announcements with both neutral (Event 6) and negative contents (Event
1-5) on auditors’ reputation indicate that Japanese investors do not regards changes of Olympus
auditors’ reputation as a significant contributor to the quality of financial statements audited by
Olympus auditors.
The first group of events (Event 1 and 2) identified in the event study covered the publication of
investigative articles on Olympus fraud published by a small Japanese business magazine. The
publication time of those articles preceded follow-up articles by major Japanese media by at least
two months 2. We argue that lack of investors’ reaction during the publication of FACTA articles is
attributable to insufficient media coverage by major Japanese media 3. In addition, limited
distribution of FACTA articles — only available to subscribers — restrict the circulation of thenews in the market. Furthermore, major media networks also possess higher public credibility when
they expose high-profile corporate fraud compared to smaller media, which is publisher of FACTA
in this case. We argue that the combination of aforementioned factors contributes to Japanese
investors’ non-reaction to publication of relevant news on Olympus auditors’ reputation. Our
results confirm that the observed non-reaction of Japanese investors to publication of FACTA
articles represents an anomalous case of efficient market where publication of relevant news
2
We searched Nikkei Telecom 21 database for the earliest publication date of articles covering Olympus fraud. The
database covers citations of four major Japanese commercial newspapers: The Nikkei, the Nikkei Business Daily, theNikkei Finance Journal, and the Nikkei Marketing Journal. The earliest Nikkei article pointing to indication of Olympus
fraud is published in 18th October edition of Nikkei Sangyo Shinbun on whistleblowing action of Mr. Woodford.
3
Major general Japanese media include the Nikkei, Yomiuri, Asahi, Mainichi, and Chunichi. Major business media inJapan includes Nikkei network which includes the Nikkei Business Daily and the Nikkei Marketing Journal.

23

affecting auditors’ reputation does not necessarily result in change of investors’ perception of audit
quality due to the press’s limited news coverage and exposure to broader Japanese investors.
We observe that E&Y and KPMG did not experience reputational loss due to their association with
Olympus in the second group of events (Event 3 and 6) which covers negative news contents on
Event 3, 4 and 5 and neutral news content on Event 6. There have been no recent history of E&Y
and KPMG Japanese clients who are involved in accounting scandal prior to Olympus fraud. Thereis limited evidence which suggest the existence of persistent low audit quality of Olympus auditors.
Therefore, news of potential involvement of Olympus auditors in the fraud do not provide sufficientconfirmation value for investors to change their prior expectation of Olympus auditors’ reputation
and audit quality. This circumstance is significantly different from the case of Arthur Andersen
reputational loss in the Enron fraud. Other major client of Arthur Andersen (Waste Management)
was also involved in a major accounting fraud prior to Enron. Further revelation of Arthur Andersen
active participation in Enron fraud confirmed investors expectation of Arthur Andersen’s
substandard audit quality which explained the negative contagion effect observed on their clients.
However, assuming Japanese investors behave rationally; our findings suggest that Japanese
investors consider news surrounding potential involvement of Olympus auditors to be notsufficiently significant to justify changes of their perception of Olympus auditors’ reputation.

6. Conclusions
Our paper investigates the impact of news indicating Olympus auditors’ potential involvement in
Olympus fraud case on their reputation. Our study complements previous research by (Numata &Takeda, 2010) by providing additional evidence on Japanese investors’ reactions on news ofpotential auditors involvements in an accounting fraud. We identified a series of events covering
news announcements with reputational effects on both Ernst&Young Shin Nihon LLC and KPMG
AZSA as Olympus auditors. Using event study and multivariate regression analysis, we found noobserved changes in reputation of auditors affiliated with Olympus during publication of news
affecting their reputation.
We argue that a number of factors contributed to Japanese investors’ non-response on news
announcements which affect Olympus auditors’ reputation. First, articles exposing Olympus fraud
which should have significant influence on Olympus auditors’ reputation did not capture sufficientinvestors’ attention due to limited public credibility and exposure to wider Japanese investors.
Second, Japanese investors conservatively respond to release of official reports on potential
involvements of Olympus auditors. There is a lack of prior evidence which can confirm investors’
expectation on low audit quality of Olympus auditors prior to the Olympus fraud. Lacking this24

evidence, our study shows that Japanese investors reacted rationally by not responding to release ofnews on potential Olympus auditors’ involvement in the fraud.

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