Abstract
The article presents information on the effect of auditor changes on security prices in both a mechanical decision rule and in the possibility that an adverse audit opinion may lead to dismissal. The analysis implies that the stock price response to the announcement of an auditor change depends on the preswitch audit opinion. The author contends that his research proves auditor switches can be good for investors and that even when they are costless, and there is no collusion between auditor and firm, market reaction can be negative.
Highlights
This paper analyzes the effect of auditor changes on security prices in two alternative regimes
If no new information arrives after an initial audit opinion and switching is costly, I show that an auditor change is good news to investors: only the lowest-value firms, which expect a qualification
I show that when an auditor follows a mechanical decision rule, an auditor switch can be good news for investors because the switch separates better firms which have been underassessed by the auditor from poorer firms
Summary
This paper analyzes the effect of auditor changes on security prices in two alternative regimes. If no new information arrives after an initial audit opinion and switching is costly, I show that an auditor change is good news to investors: only the lowest-value firms, which expect a qualification. I assume for the present that audit fees are the same across auditors, and can be ignored in the switch/retain decision LEMMA 1, 1, The probability of a clean opinion from the current auditor at date 1 and from a new auditor at date 2 is increasing in tbe gross value of tbe firm X^ and in y. Investors expect higher gross and net values after a clean opinion than after a qualified opinion at date 2, conditional on the date 1 opinion and the switch or retain event
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