Quality Levels of Predecessor and Successor Auditors: Evidence from the Reasons Reported by Managers for Changing Auditors

Abstract

In this study we investigate relations between the quality levels of successor and predecessor auditors for a sample of client-initiated auditor switches. We use reasons reported by managers for changing auditors to investigate whether those reasons are differentially related to changes in the quality levels of successor and predecessor auditors. Based on prior evidence on auditor realignments, we classify the reasons from managers into three categories that appear to summarize the motivating factors surrounding client-initiated changes. The three categories relate to structural changes of the company, audit fees, and accounting disagreements. In this study we introduce a three-level auditor quality proxy that suggests and allows future researchers, to consider auditor quality as other than a binary variable (i.e., Big 6 versus non-Big 6). We find that the quality level of the successor auditor is related to the quality level of the predecessor auditor irrespective of the reason for the change. Our results suggest that auditor quality levels are, on average, unchanged following a client-initiated change. However, an investigation of any changes in auditor quality subsequent to our classification of client-initiated changes into the three categories suggests that managers' reasons are differentially related to the change in quality of the auditor. Managers who cite structure reasons move up in quality, confirming prior literature. Managers who cite fees as a reason tend to move down in quality, which is different from findings in prior papers. Finally, we find that clients who cite accounting disagreement as the reason for changing also move down in quality, which is consistent with managers searching for less conservative auditors. Our evidence offers additional insights into possible reasons that managers change auditors and may suggest the need for financial reporting regulators to consider increased or improved disclosures related to the reasons for changing auditors particularly in the case of client-initiated changes.