An Examination of Auditor Choice using Evidence from Andersen's Demise

Abstract

The Enron/Andersen scandal provides a unique opportunity to examine the role of signaling in auditor choice. Not surprisingly, many clients dismissed Andersen quickly after Enron declared bankruptcy – in some cases even before a replacement auditor was engaged – and lawsuits against the audit firm were mounted. However, many clients did not dismiss Andersen until its auditing practice was shut down by the court. This study investigates why some clients did not make a quick auditor switch, that is: was the timing of the switch a signal? Our predictions are based on the theory that those that switched early (compared to those that switched late) were sending a signal that they were high‐quality financial reporters. We test a sample of 711 companies from the final portfolio of Andersen auditees. Consistent with our hypotheses, we find that subsequent to the change of auditors, management of those companies that dismissed earlier was more likely to initiate the restatement of their financial statements than those that dismissed later. It appears as though the early switchers were attempting to distance themselves from Andersen and the financial reporting used with Andersen. In contrast, those clients that dismissed Andersen later had more restatements imposed on them than those that dismissed earlier, suggesting that their financial statements were of lower quality.