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    Do Financial Restatements Lead to Auditor Changes?
    research summary posted March 9, 2015 by Jennifer M Mueller-Phillips, tagged 12.0 Accountants’ Reports and Reporting, 12.03 Restatements, 12.05 Changes in Reporting Formats 
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    Title:
    Do Financial Restatements Lead to Auditor Changes?
    Practical Implications:

    Since the reasons for auditor changes are rarely publicly revealed, the authors acknowledge that this study only shows an association, and not a causal relationship, between restatement announcements and subsequent auditor changes. While the authors attempt to control for all known determinants of auditor changes in the empirical testing, it is possible that the results are biased due to omitted variables.

    For more information on this study, please contact Vivek Mande.

    Citation:

    Mande, V. and M. Son. 2013. Do Financial Restatements Lead to Auditor Changes? Auditing: A Journal of Practical & Theory 32 (2): 119-145. 

    Keywords:
    restatement; auditor switch; dismissal; resignation; abnormal market returns
    Purpose of the Study:

    This study examines whether financial restatements are associated with subsequent auditor changes. A financial restatement represents a breakdown in a company’s financial reporting, but, importantly, also of its audit. The paper argues that in response to pressure from capital markets, restating firms will dismiss their auditors to increase audit quality and restore reputational capital lost when the restatements are announced to the investing public. 

    Design/Method/ Approach:

    The sample includes 3,492 auditor changes. The authors model the likelihood of an auditor change as a function of one-period lagged restatements and a set of predetermined lagged control variables used by previous studies. The research relates auditor changes to restatements in the previous year rather than the current year to rule out the possibility that the restatements may have occurred at the urging of the new auditor.

    The first set of control variables relates to auditor characteristics. It is expected that auditor changes occur more frequently when: audit opinions are not clean, auditor tenure is either short or long, audit fees are high, and the auditor does not have industry expertise. The study also includes controls for clients’ financial risks and mergers and acquisitions (M&A). Year and industry dummies are included as controls in the model.

    Findings:

    Using a large sample of restatements and auditor changes, the study finds that the likelihood of auditor-client realignments increases after firms announce restatements. It is also found that the positive association between restatements and auditor turnovers is more pronounced when restatements are more severe and the quality of corporate governance is high. Finally, the study finds that stock market returns surrounding auditor changes increase as the severity of restatements increases. 

    Category:
    Accountants' Reporting
    Sub-category:
    Changes in Reporting Formats, Changes in Reporting Formats, Restatements