An Examination of Auditor Changes Following Events Adversely Affecting External Auditor Credibility.

Abstract

This study examines auditor changes following events adversely affecting auditor credibility. Disciplinary actions against auditors by the Securities and Exchange Commission (SEC) are posited to be events damaging to auditor credibility. Agency theory and prior research are used to generate hypotheses about differences between client firms that switch auditors and client firms that do not switch auditors after an SEC action under Rule 2(e) against their auditor. A series of univariate and multivariate statistical tests are conducted on the sample firms. The sample is divided into a Switch group and a Non-Switch group. The sample as a whole is examined, as well as subgroups of clients of Big Eight auditors and clients of smaller auditors. The results indicate that smaller firms are more likely to switch auditors after an SEC Rule 2(e) action than larger firms. Among clients of Big Eight auditors, firms with a faster rate of sales growth are more likely to switch auditors. Contrary to expectations derived from prior research, firms with audit committees are less likely to switch auditors than firms without audit committees. Among clients of smaller auditors, firms with management bonus plans tied to audited accounting data are less likely to switch auditors than firms without such compensation plans, a result opposite that predicted by agency theory. Other than the differences noted between clients of Big Eight auditors and clients of smaller auditors, the most striking result of the study is the apparent failure of agency theory to predict the response of client firms to a decline in auditor credibility.