The results of this study are important for audit firms to consider given interest from regulators on the role of shareholder ratification on auditor selection. The evidence indicates that while shareholders, through auditor ratification voting, are not responsible for the acceptance or dismissal of a firm’s auditor, subsequent auditor dismissals do appear to be influenced by increased shareholder resistance. A one percent increase in shareholder votes against auditor ratification is associated with a four percent increase in the likelihood of auditor dismissal within the following year.
Abhijit Barua, K. Raghunandan, and Dasaratha V. Rama (2017) Shareholder Votes on Auditor Ratification and Subsequent Auditor Dismissals. Accounting Horizons: March 2017, Vol. 31, No. 1, pp. 129-139.
This study offers insights into how restatements by one client may impact an auditor’s other clients. The authors find evidence suggesting that when an auditor’s clients restate their financial statements, the auditor’s reputation for audit quality suffers. Non-restating clients experience a small negative market reaction around the restatement date and a higher likelihood of dismissing that auditor. These findings may inform audit firms and their clients about the potential negative consequences of restatements by other clients.
Irani, A.J., S.L. Tate, and L. Xu. 2015. Restatements: Do They Affect Auditor Reputation for Quality. Accounting Horizons 29 (4): 829-851.
The results of this study are important to audit regulators and auditors as the PCAOB considers disclosure of additional audit quality indicators. The results of this study indicate that clients do respond to publicly available indications of audit quality as they avoid audit firm offices that are associated with restatements. Additionally, auditors may be interested in the findings of this study as it relates to the economic implications of contaminated offices. The findings of this study provide evidence about the importance of local office reputation as client retention and new client additions decrease when offices are associated with audit failures.
Swanquist, Q.T. and R.L. Whited. 2015. Do Clients Avoid “Contaminated” Offices? The Economic Consequences of Low-Quality Audits. The Accounting Review 90(6): 2537-2570.
The results of this study are consistent with the idea that auditor reputation has an effect on analysts’ forecasts. The authors specifically examine on the collapse of Andersen, an event that was unprecedented in terms of its scope and scale. By focusing on analysts’ forecasts for this time period, audit quality concerns are the most plausible explanation for the results produced. The evidence found in this study extends upon prior research and contributes to the research on forecast revision frequency and forecast properties, as well as on the collapse of Andersen.
Cahan, S. F., P. K. Chaney, D. C. Jeter, and Wei Zhang. 2013. Damaged Auditor Reputation and Analysts’ Forecast Revision Frequency. Auditing 32 (1).
The results of this study are important for regulators and audit committee members who are concerned with the ability of the audit market to self-regulate. Specifically, the evidence suggests that firms with higher switching costs and fewer replacement auditor choices are less likely to dismiss their auditors after a restatement. This evidence informs the debates about the costs of mandatory auditor rotation and the limited competition in the audit market. Additionally, the evidence of a positive market reaction to dismissals after severe restatements is consistent with firms restoring financial reporting credibility by replacing their auditors, and this should be of interest to audit committee members considering various corrective actions after a misstatement.
Hennes, K., A. Leone, and B. Miller. 2014. Determinants and Market Consequences of Auditor Dismissals after Accounting Restatements. The Accounting Review 89 (3): 1051–1082.
The results of the study strongly suggest that initial-year audit discounts are quite common and substantial in the post-SOX period. Although the existence of lowballing seems to be a threat to independence, at least in appearance, the existing research on lowballing provides mixed results on its impact on audit quality. The findings will likely be of interest to the PCAOB as it searches for ways to bolster auditor independence and other regulators because many, including the GAO, believe that without non-audit service fees, auditors are less likely to offer ‘‘loss-leader’’ fees for audits.
For more information on this study, please contact Rosemond Desir.
Desir, R., J. R. Casterella, and J. Kokina. 2014. A Reexamination of Audit Fees for Initial Audit Engagements in the Post-SOX Period. Auditing: A Journal of Practice & Theory 33 (2): 59-78
The objective of this study is to determine whether PCAOB inspection reports of triennially inspected auditors are used as audit quality signals. The study was based upon the premise that the reports may serve as a publicly-available proxy of perceived audit quality. Clients were found to react differently to the PCAOB inspection reports contingent upon their severity with GAAP-deficient reports are more likely to trigger an auditor dismissal than a clean or GAAS-deficient report. The results suggest that clients of non-Big 4/non-national auditors are using certain PCAOB inspection reports as a publicly-available signal of audit quality and not as a means of procuring more favorable audit reporting or audit fees.
Abbott, L., K. A. Gunny, and T. C. Zhang. 2013. When the PCAOB Talks, Who Listens? Evidence from Stakeholder Reaction to GAAP-Deficient PCAOB Inspection Reports of Small Auditors. Auditing 32 (2).
This objective of this study is to determine whether auditor quality and audit committee financial expertise are associated with improved restatement disclosure timeliness as reflected in reduced dark periods. Recent actions by regulatory agencies suggest that the timeliness of financial reporting remains a top priority of investors and regulators. This study finds evidence that both the auditors and audit committees can provide significant value to clients and improve timely disclosure of restatement details.
Schmidt, J., and M. S. Wilkins. 2013. Bringing Darkness to Light: The Influence of Auditor Quality and Audit Committee Expertise on the Timeliness of Financial Statement Restatement Disclosures. Auditing 32 (1).
Restatements are an important determinant of auditor resignation. Severe restatements affect new auditor choice. Auditor resignations are another significant cost imposed on restatement companies since companies tend to hire a lower-quality auditor.
For more information on this study, please contact Ying Huang.
Huang, Y. and S. Scholz. 2012. Evidence on the Association between Financial Restatements and Auditor Resignations. Accounting Horizons 26 (3): 439-464.
This study displays the many outcomes and reasons for those outcomes that could occur when a company decides to switch auditors or when auditor decide to leave a client. Although this study did not find consistent evidence to support the idea that auditor downgrade leads to greater discretionary accruals and possible audit deterioration only highlights the complexities of the client-auditor relationship. Both client companies and audit firms could benefit from the findings of this study by considering the wide range of effects of auditor switching on financial reporting before deciding to switch.
For more information on this study, please contact Brian T. Carver.
Carver, B.T., C.W. Hollingsworth, and J.D. Stanley. 2011. Recent auditor downgrade activity and changes in clients’ discretionary accruals. Auditing: A Journal of Practice and Theory 30 (3): 33-58.