Abstract
This study investigates how the presence and power of labor unions are associated with auditor replacement, more specifically, external auditor tenure and the direction of auditor change. External auditor tenure and direction have been of great interest to stakeholders, as they are very likely associated with the financial reporting quality and corporate transparency, crucial factors for sustainable business. We are focusing on the role of the labor union, one of the key stakeholders involved in corporate governance and transparent operations, in external auditor selection processes. During the annual wage bargaining process, labor unions that rely on financial information face information asymmetry because financial statements are provided by the management. Therefore, labor unions have a high demand for independent and capable external auditors. This demand is likely to shorten auditor tenure and/or prompt changes to higher-quality auditors. Using a sample of 4568 firm-years listed in the Korean stock markets for the period of 2005 to 2008, we find evidence that the presence and power of labor unions significantly decrease external auditor tenure. We also find that the direction of auditor changes with the presence and power of labor unions is likely from non-industry specialist auditors to industry specialist auditors. This study contributes to the extant literature by extending the previous research on auditor selection and the governance role of labor unions.
Highlights
Corporate transparency is an important factor in maintaining the sustainable market economy in which business can operate
Among the various governance mechanisms, this study examines the role of labor unions in external auditor changes—it examines the association between the presence/power of labor unions and external auditor tenure and the direction of external auditor changes
We posit that if a labor union has a strong demand for high-quality audits and the firm reacts to this demand, the firm will change its external auditor more often, and the change will likely be to a high-quality auditor
Summary
Corporate transparency is an important factor in maintaining the sustainable market economy in which business can operate. Knowing that external auditors play a key role in reducing information asymmetry, labor unions, one of the most significant stakeholders of firms, are likely to demand high-quality audits. Influential labor unions are likely to push firms to change their long-term external auditors in order to ensure auditor independence This push will eventually reduce auditor tenure when labor unions play a significant monitoring role. The results indicate that the demands of labor unions for higher-quality external audits are considered when the auditor tenure is long and when firms change their auditors. By empirically examining how the presence of labor unions and the strength of their influence are associated with auditor tenure and the direction of auditor changes, this study provides useful implications for investors and regulators by showing that the role of labor unions must be considered in their decision making.
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