The results of this study suggest that the auditor changes resulting from the demise of Andersen did not result in improved financial reporting quality and transparency for the former Andersen clients that parted ways with their former audit practice. This implies that the mandatory rotation of auditors may not yield an increase in financial statement quality. This result should be of interest to audit regulators and standard setters, as well as practitioners seeking to comment on proposed mandatory rotation regulations.
Additionally, the results indicate that switching costs in non-forced auditor change settings likely outweigh agency benefits of changing auditors in many cases. This result may be of interest to shareholders, managers, and audit committees in their respective roles related to auditor selection.
Blouin, J., B. M. Grein, and B. R. Rountree. 2007. An Analysis of Forced Auditor Change: The Case of Former Arthur Andersen Clients. The Accounting Review 82 (3): 621-650.
The authors use a sample of 407 Andersen clients. The authors classify companies as retaining their Andersen audit team if the audit report in the year after Andersen's collapse indicates the new auditor within a city acquired the Andersen audit practice in that same city. Companies that did not adhere to this were classified as having switched to a different auditor. In performing this analysis, the authors examine “Switching costs” (i.e. Andersen industry expertise, auditor tenure, auditee size, auditee complexity, and discretionary accruals) and “Agency Costs” (i.e. auditee size, auditee complexity and transparency, insider ownership, leverage, presence of a blockholder, and audit committee expertise and independence.
This study has practical audit client portfolio management implications for audit firms seeking to earn audit fee premiums for reputations of industry expertise. For example, auditors’ reputations for industry expertise are neither strictly national nor strictly local. One interpretation with practical implications for such firms is that national level or city level reputations for industry expertise are not individually sufficient to maximize fee premiums. Rather, auditors can most effectively earn fee premiums when they establish both city-level and national-level reputations for industry expertise.
Francis, J. R., K. Reichelt, and D. Wang. 2005. The Pricing of National and City-Specific Reputations for Industry Expertise in the U.S. Audit Market. The Accounting Review 80 (1): 113-136.
The purpose of this study is to examine the pricing of Big 5 industry expertise in the United States based on national and city level reputations for industry expertise.
Industry knowledge and expertise help auditors build reputations that auditors can use to negotiate fee premiums. Prior research suggests that industry knowledge and expertise is developed by investments in accounting professionals and their experiences in serving clients out of city-based practice offices. However, auditors can build national reputations for industry expertise that may enable them to negotiate audit fee premiums as well. The authors argue that the central issue in the “national” vs. “city” perspective on industry expertise is the degree to which office-specific expertise is transferrable throughout a firm. Specifically, the national perspective assumes accounting firms capture the industry expertise of its office-based professionals and distribute it throughout the entire firm. Conversely, the city perspective assumes that auditor expertise is indelibly tied to individual professionals and cannot be distributed throughout the firm. This study examines industry specialization audit fee premiums at the city level and national level to analyze how auditor reputations for industry expertise are viewed. Specifically, the authors use U.S. fee disclosures to investigate audit pricing in the U.S. audit market in order to determine:
The study uses data on U.S. non-financial publicly-traded companies with Big 5 auditors during the fiscal years 2000 and 2001. The authors investigate audit fee premiums resulting from:
The authors argue these findings suggest that an auditor’s reputation is priced into audit fees as if both firm-wide (national) and city-specific (local) reputations are jointly relevant.
This study provides an important implication for audit firms in maintaining their worldwide brand name reputation. The results suggest that, for global audit firms, the damage to auditor reputation in one country may spill over and cause concern among investors about the quality of their services in other countries. Further, the damage to reputation is greater where the demand for auditing and assurance is higher.
Cahan, S. F., D. Emanuel, and J. Sun. 2009. Are the Reputations of the Large Accounting Firms Really International? Evidence from the Andersen-Enron Affair. Auditing: A Journal of Practice and Theory 28 (2): 199-226.
The Big 4 accounting firms market themselves as global firms that deliver a uniform level of service across countries. While such a global reputation helps build worldwide demand for high-quality audits, it also creates risks if service quality becomes questionable in one of the countries in which a firm operates. Questionable audit practices in one of the countries, especially in the home jurisdiction, may raise doubts as to whether sub-standard audits also occur in other countries.
This study examines whether the damage to the name brand of Arthur Andersen following the Andersen-Enron scandal in the U.S. spilled over into other countries. The study focuses on two key event dates leading up to Andersen’s demise: (1) January 10, 2002, when Andersen announced it had shredded documents related to the Enron audit, and (2) February 4, 2002, when Enron’s board released the Powers report that was critical of Andersen and when Andersen announced the establishment of an Independent Oversight Board (IOB) to investigate the firm’s audit policies and procedures. This study investigates the market reaction to Andersen’s clientele base around these two dates to determine whether:
The authors use data on publicly-traded companies audited by Arthur Andersen in 2001 to examine whether there is a negative market reaction to Andersen’s non-U.S. clients around the two event dates discussed above.
The results of this study confirm the importance of management reputation issues in auditor change decisions, while also extending our understanding of nonprofit organizations. For nonprofits, a change in auditor is more likely when the organization’s operational structure changes. As the organization grows and becomes more reliant on federal funding, the likelihood of changing auditors, particularly to bigger audit firms, increases.
Tate, S. L., 2007. Auditor changes and auditor choice in nonprofit organizations. Auditing: A Journal of Practice & Theory 26 (1): 47-70.
Accounting frauds of the early 2000’s coupled with the passage of the Sarbanes-Oxley Act of 2002 (“SOX”) resulted in increased focus on the role of the independent auditor in monitoring public companies. Although the new SOX rules were not directed at nonprofit organizations, the public support of these organizations suggests that adequate levels of monitoring are also important in this sector. This study specifically evaluates the auditor choice decisions of nonprofit organizations.
The author uses publicly available data for the years 1998 through 2002 to examine the effects of operational structure, management reputation and contracting, and audit fees on a nonprofit organization’s choice of auditor and decision to change auditors.
This study offers an important implication for audit firms that industry specialization, in addition to brand name, is perceived as valuable by investors. The results are also useful for regulators when examining auditor switching by firms. Finally, the results are useful to investors in that they show significant market reactions to various types of auditor switching.
: Knechel, R. W., V. Naiker, and G. Pacheco. 2007. Does Auditor Industry Specialization Matter? Evidence from Market Reaction to Auditor Switches. Auditing: A Journal of Practice and Theory 26 (1): 19-45.
Accounting regulators are interested in auditor switching by client companies because of a concern over opinion shopping. However, companies may also switch auditors in order to search for a higher-quality level of assurance provided by the audit. Prior research indicates that auditor brand name represents an audit quality differentiation and that investors recognize this differentiation, as reflected in market reactions to changes to or from a brand name auditor.
Knowledge of a client's industry is one of the essential components of auditor expertise. Besides brand name, audit firms employ industry specialization as a method to differentiate their services and structure themselves along industry lines. This study examines whether:
The authors use data on publicly-traded companies from 2000 to 2003 to investigate the market reaction to firms switching to (from) industry specialist auditors.