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    Determinants and Market Consequences of Auditor Dismissals...
    research summary posted February 24, 2015 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers, 12.0 Accountants’ Reports and Reporting, 12.03 Restatements 
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    Title:
    Determinants and Market Consequences of Auditor Dismissals after Accounting Restatements
    Practical Implications:

    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.

    Citation:

    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.

    Keywords:
    restatements, auditor dismissals, corporate governance
    Purpose of the Study:

    Auditors play an integral role in assuring the integrity of financial reporting, and market participants continue to debate the ability of the audit market to self-regulate adequately. One of the challenges in evaluating audit performance is that audit quality is difficult to observe and measure. Restatements, however, provide a visible signal of poor audit quality that can impose significant costs on firms. Firms respond to restatements with a variety of corrective actions, including the possible reconsideration of the external auditor. The purpose of this study is to provide evidence on the circumstances under which boards dismiss auditors in response to restatements and to examine how the market responds to those dismissals. 

    Design/Method/ Approach:

    This study examines a sample of public-company restatements occurring between 1997 and 2010. The authors focus only on restatements where the incumbent auditor opined on at least one annual period prior to the restatement announcement. Firm and restatement characteristics and executive and auditor turnover data is gathered from publicly available information.

    Findings:
    • The authors find that auditors are more likely to be dismissed after more severe restatements but that the severity effect is primarily attributable to the dismissal of non-Big 4 auditors rather than Big 4 auditors.
    • The authors document that among corporations with Big 4 auditors, those that are larger and more complex operationally are less likely to dismiss their auditors.
    • The study also examines contemporaneous executive turnover and finds evidence that boards view auditor dismissals as complementary rather than substitute responses to restatements.
    • Lastly, the study documents that the market reaction to an auditor dismissal (with a contemporaneous engagement of a comparable-sized auditor) is significantly more positive following more severe restatements (5.9%) than less severe restatements (0.6%). 
    Category:
    Accountants' Reporting, Auditor Selection and Auditor Changes
    Sub-category:
    Dismissal Decisions – impact of restatements - disagreements - fees - mergers etc, Restatements