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research summary
This study sheds light on why auditors choose to resign from auditing particular clients. The authors find that public information about audit risk, business risk, and litigation risk as well as private information about audit risk and business risk all play a role in the auditor’s resignation decision. This is useful for audit firms and regulators to consider.
Ghosh, A. and C.Y. Tang. 2015. Auditor Resignation and Risk Factors. Accounting Horizons 29 (3): 529-549.
While prior research has suggested litigation risk as the main reason for auditor resignations, the competing explanations of audit risk and business risk have not been tested concurrently to discover their incremental importance. Furthermore, prior research has not been able to isolate the auditor’s private information from public information about these risks. The authors attempt to close this gap in the literature by studying whether and how much the auditor’s private information about future audit risk, business risk, and litigation risk impacts the auditor’s resignation decision.
The authors use data from publicly-traded companies that switched auditors during the 1999-2010 time period. First, they compare auditor resignations to auditor dismissals based on pre-switch audit risk, business risk, and litigation risk. Then they test whether auditor resignations predict post-switch audit risk (e.g. internal control problems), business risk (e.g. delisting from stock exchange), and litigation risk (e.g. class-action lawsuits).
- Compared to clients from which auditors have been dismissed, clients from which auditors resigned tend to have greater litigation risk, audit risk, and business risk before the change in auditors, but greater audit risk and business risk after the change.
- The litigation risk, business risk, and audit risk existing before an auditor chooses to resign from an engagement all impact the auditor’s resignation decision, with litigation risk having the largest impact and audit risk the smallest.
- Clients whose auditors have resigned are more likely to experience class-action lawsuits, internal control problems, and delisting from a stock exchange.
- Auditor resignations reveal no private information about future litigation risk.
- Auditor resignations reveal private information about future audit risk and future business risk, especially when one of the Big 4 audit firms resigned.