Auditor switch, analysts forecasts and executives' stock options

Abstract

This paper shows that companies tend to switch auditors when audit opinions are inconsistent with those in the previous period, financial performances are worse, and both stock and option values fall. We find no evidence that, during the switching year, option values and firm performance affect the exercise of executives’ stock options, possibly because the exercise of stock options often occurs before switching auditors in order to prevent the SEC from investigating insider trading in the switching year. The changes in holdings of executives’ stock options are positively correlated with the degree to which analysts’ earnings forecasts deviate from previous periods; the announcements of analysts’ earnings forecast errors have no influence on the value of executives’ options, since that signaling effect has already reflected on the stock price. Furthermore, accruals are unrelated to the changes in holdings of executive stock options, possibly because investors often have negative beliefs about auditor switches, so executives do not tend to take advantage of this opportunity to manipulate earnings. Key words: Auditor switch, analyst forecast, executive stock option, earnings management.