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    Forced Audit Firm Change, Continued Partner-Client...
    research summary posted April 23, 2012 by The Auditing Section, last edited May 25, 2012, tagged 02.0 Client Acceptance and Continuance, 02.04 Predecessor Auditor Factors, 03.0 Auditor Selection and Auditor Changes, 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers 
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    Title:
    Forced Audit Firm Change, Continued Partner-Client Relationship, and Financial Reporting Quality
    Practical Implications:

    The results of this study are important for regulators to consider when scrutinizing auditor changes and former audit partners. The evidence indicates that former audit partners may adopt a strategic approach to auditing follower clients by being more conservative in their audits in the first post-switch year when the level of scrutiny is high, but allowing more aggressive earnings management after the first post-switch year.

    Citation:

    Chen, C. J. P., X. Su, and X. Wu. 2009. Forced Audit Firm Change, Continued Partner-Client Relationship, and Financial Reporting Quality.  Auditing: A Journal of Practice and Theory 28 (2): 227-246. 

    Keywords:
    Forced audit firm change, former audit partner, financial reporting quality, auditor selection and auditor change, audit partner/audit firm switching.
    Purpose of the Study:

    The authors use a setting of forced auditor changes (e.g. the forced demise of Andersen resulting in partners and staff going to work for other firms) to examine whether clients follow their former audit partner, and the implications for earnings management.  Forced auditor changes following an audit failure scandal raise the level of perceived and/or actual regulatory risk to both former audit partners and the new audit firms that take on such partners. However, regulatory scrutiny of the new audit firm in subsequent years may not be as strong as in the first year following the partner switch to the new audit firm. This study investigates the financial reporting quality of Chinese listed firms following forced partner/audit firm changes. The main objectives of the study are to  determine whether: 

    • Former audit partners tend to be more conservative in the first post-switch year.
    • Former audit partners become less conservative after the first post-switch year.
    Design/Method/ Approach:

    The authors use data on publicly-traded companies in the Chinese stock market which faced forced partner/audit firm changes in 2001 to examine the financial reporting quality associated with audits performed by these audit partners with their new audit firm in the post-switch years.

    Findings:
    • The authors document that firms with greater earnings management activities are more likely to follow their former audit partners to a new audit firm.  
    • Follower clients with aggressive earnings management behavior who are audited by former partners do not report abnormally high earnings management in the first post-switch year. 
    • While new audit firms are more likely to assign brand new audit partners to follower clients in the first post-switch year, a large number of former audit partners return to their clients in subsequent years. 
    • The authors find that the financial reporting of aggressive follower clients audited by former partners becomes significantly more aggressive in the second and third post-switch years.
    Category:
    Client Acceptance and Continuance, Auditor Selection and Auditor Changes
    Sub-category:
    Impact of SEC Actions, Predecessor Auditor Factors, Dismissal Decisions – impact of restatements - disagreements - fees - mergers etc
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