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A study was conducted to examine auditors' responses to first-time debt covenant violations and to assess whether these responses can be employed to forecast financial distress. Data were drawn from a sample of 159 companies traded on the NYSE/AMEX or NASDAQ that had initial default dates ranging from 1978 to 1988. The findings reveal that auditors are more likely to need debt reclassification when the violations are not waived by lenders. However, the waiver decision does not seem to significantly affect the auditor's qualification decision. For companies experiencing technical default, the audit option is an important determinant of future financial distress, even after controlling for factors usually associated with bankruptcy.


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