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    Auditor Resignation and Firm Ownership Structure
    research summary posted October 29, 2013 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.06 Resignation Decisions, 13.0 Governance, 14.0 Corporate Matters, 14.09 CEO Tenure and Experience 
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    Title:
    Auditor Resignation and Firm Ownership Structure
    Practical Implications:

    The audit profession operates in a highly legal environment, and because of this, audit firms must find ways to manage their risk exposure. One way to reduce the risk of litigation against the firm is to manage the client portfolio and resigning from high risk clients. According to the study, family owned firms are less of a litigation risk to the auditor than non-family owned firms, especially when the CEO of the family-owned firm is not a family member. However, if an auditor does resign from auditing a family-owned firm managed by a non-family CEO, the investing public reacts less negatively to this than if the firm were not family owned.


    For more information on this study, please contact Samer K. Khalil.
     

    Citation:

    Khalil, S., J. Cohen, and G. Trompeter. Auditor resignation and firm ownership structure. Accounting Horizons 24 (4): 703-727.

    Keywords:
    family firms; auditor resignations; corporate governance; market reactions
    Purpose of the Study:

    In order to manage risk exposure, audit firms can choose to resign from high risk clients. Auditor resignations can bring very negative outcomes to the discharged client because of the audit search and startup costs incurred and the investors’ interpretation in the information signaled by the auditor resignation. This study investigates whether the likelihood of auditor resignations and the subsequent stock market reaction in family firms differs significantly from that in non-family firms. Additionally, this study examines whether the identity of the CEO that manages the family firms has an effect on the aforementioned associations. The identity of the CEO refers to whether the CEO is a founder, a descendant, or a non-family CEO.

    Design/Method/ Approach:

    The evidence for this study was gathered using auditor resignations reported on the Audit Analytics database in the U.S over five calendar years, 2004-2008. Sample firms were matched with control firms that did not switch their auditors using four different attributes: firm size, firm industry, auditor type, and auditor tenure to serve as one benchmark.  A random sample of control firms that did not switch their auditors and had publicly available data on their corporate governance was used as a second benchmark.

    Findings:
    • The primary findings of this study were that: 1) auditors of family firms are less likely to resign than those of non-family firms and that 2) auditor resignations are less likely to occur in family firms managed by a founder or non-family CEO. These imply that auditors appear to attribute lower litigation risk to family firms because the family’s concern to preserve their reputation and contribute family wealth to future generations reduces the risk of misappropriation of assets and/or earnings management.
    • Another primary finding was that abnormal return following auditor resignations in family firms are significantly less negative than those in non-family firms. Furthermore, the findings suggest that the investing public places a lower weight on the bad news associated with auditor resignation in family firms managed by a non-family CEO as opposed to non-family firms. The public’s reaction to a resignation did not vary based on whether a family firm was managed by a founder or descendant CEO.
    • Secondary finding indicate that the following variables also have an impact on auditor resignation:
      • Firm audit reports modified for going concern reasons
      • Firms that report weaknesses in internal control over financial reporting
      • Firms that report a loss in the year preceding auditor resignation
      • The presence of an auditor-client mismatch
      • Firms with large variance in abnormal returns
      • Firms with higher likelihoods of bankruptcy and acquisition
      • Corporate governance mechanisms such as number of audit committee meetings, percentage of financial experts serving on the audit committee, and one or more institutional block holders.
         
    Category:
    Client Acceptance and Continuance, Corporate Matters, Governance
    Sub-category:
    CEO Tenure & Experience, Resignation Decisions