Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

research summary

    Auditor Switches in the Pre- and Post-Enron Eras: Risk or...
    research summary posted May 7, 2012 by The Auditing Section, last edited May 25, 2012, tagged 02.0 Client Acceptance and Continuance, 02.06 Resignation Decisions, 03.0 Auditor Selection and Auditor Changes 
    456 Views
    Title:
    Auditor Switches in the Pre- and Post-Enron Eras: Risk or Realignment?
    Practical Implications:

    This study provides a more complete analysis (compared to the GAO 2006 study) of how Big 4 firms responded to the supply and demand shocks to the audit market by Andersen and SOX Section 404, which is useful for audit firms and regulators to consider.

    Citation:

    Landsman, W. R., K. K. Nelson, and B. R. Rountree. 2009. Auditor switches in the pre- and post-Enron eras: Risk or realignment?  The Accounting Review 84 (2):  531-558. 

    Keywords:
    Auditor switching, client risk, client misalignment, Sarbanes-Oxley Act, auditor appointment
    Purpose of the Study:

    The major accounting scandals of the early 2000s affected the market for audit services in two ways: the demise of Andersen resulted in an increase in the number of clients available to other accounting firms, and Section 404 of the Sarbanes Oxley Act (SOX) increased demand for audit services by accelerated filers.  These events resulted in temporary capacity constraints resulting in Big 4 firms rebalancing their public client portfolios.  Big 4 firms issued press releases during this time period indicating that they responded to these market forces by dismissing a number of clients that exposed their public client portfolios to unacceptable levels of risk.  The General Accounting Office issued a 2006 report further suggesting that the Big 4 firms have become more selective regarding risky clients.  This study investigates Big 4 auditor switch decisions during the pre-Enron (1993-2001) and post Enron (2002-2005) time periods to determine whether: 

    • Big 4 firms increased their sensitivity to client risk during the post-Enron period and dismissed clients that presented increased risk to their public client portfolios.  OR
    • Big 4 firms were faced with a capacity constraint due to Section 404 demand and elected to dismiss smaller clients that were misaligned with their overall portfolio strategy of serving larger clients.  The authors define auditor/client misalignment as occurring when a client is predicted to engage a non-Big 4 audit firm but actually engages a Big 4 audit firm.
    Design/Method/ Approach:

    The authors use data on publicly-traded companies and compare measures of client financial risk, audit risk, and auditor/client misalignment pre-Enron (1993-2001) to post-Enron (2002-2005) for three categories of Big 4 clients (as well as comparing resignations versus dismissals): (1) Big 4 clients that continue with their auditor, (2) new clients that switch laterally or upward to a Big 4 audit firm, and (3) Big 4 clients that switch to a national, regional or local audit firm.

    Findings:
    • The frequency of clients switching from Big 4 audit firms to the non-Big 4 audit firms more than doubled during the post-Enron time period relative to the pre-Enron period. 
    • Clients switching from Big 4 audit firms to non-Big 4 audit firms were more likely to be “misaligned” (as defined in the study) with a Big 4 audit firm during the post-Enron time period; however, demonstrated less risk during the post-Enron time period.  Lateral/upward switches during the post-Enron period demonstrated less client financial and audit risk and were less likely to be “misaligned” with a Big 4 audit firm.
    • Big 4-initiated resignations present greater risk compared to client-initiated dismissals, but there is no change in the sensitivities of resignations or dismissals to client risk or auditor/client “misalignment” during the post-Enron time period.           

    The authors claim their findings suggest that realignment decisions of Big 4 firms post-Enron were mostly due to auditor/client misalignment that resulted from the capacity constraints caused by the increase in supply of former Andersen clients and increased demand for audit services resulting from SOX Section 404, and not a change in the Big 4 firms’ sensitivity to client risk. 

    Category:
    Client Acceptance and Continuance, Auditor Selection and Auditor Changes
    Sub-category:
    Resignation Decisions
    Home:
    home button