The Effect of Arthur Andersen's Demise on Clients' Audit Fees and Auditor Conservatism: International Evidence

Abstract

AbstractUsing samples from 12 non‐U.S.A. countries, we find that following Arthur Andersen's failure in the United States of America, successor Big‐N auditors charged an audit fee premium for ex‐Andersen clients compared to existing clients and non‐Andersen switch‐ins. We show that this audit fee premium is not attributable to the Andersen switch‐ins having lower prior earnings quality or lower bargaining power than non‐Andersen switch‐ins. We also show that ex‐Andersen clients exhibit higher earnings quality after the switch than do ongoing clients and other switch‐ins. These results suggest that the audit fee premium is attributable to auditor conservatism. Furthermore, we find that risk assessments for ex‐Andersen clients are higher in countries with weak legal and extra‐legal institutions. We interpret this result as suggesting that the effect of lost auditor reputation is stronger when objective evidence of earnings quality is uncertain because of weaker supporting institutions. This is the first study to document a direct effect of countrywide institutions on audit risk assessment.