Auditor Ratification Research Articles

Auditor Ratification in Light of Shareholder Dissatisfaction with the Audit Committee—Evidence from Germany

SYNOPSIS Auditor ratification gives shareholders a voice in the auditor selection process. Although votes against auditor ratification primarily relate to the auditor, they also signal shareholder dissatisfaction with the audit committee that is responsible for recommending the auditor. In Germany, shareholders are required to separately vote on auditor ratification and, in addition, ratify the acts of the supervisory board (including the audit committee), allowing us to separately consider whether shareholder dissatisfaction is directed toward the auditor or the audit committee. We find that votes against audit committees’ acts (rather than votes against auditor ratification) are associated with a higher likelihood of subsequent auditor dismissal, suggesting that audit committees particularly respond to shareholder dissatisfaction when their own reputation is at stake. In addition, subsequent audit outcomes (i.e., audit report lag and modified audit opinions) appear to also be affected by shareholder dissatisfaction with the audit committee. Data Availability: Data are available from the sources cited in Appendix A. JEL Classifications: M4; M42; M48; G3; G39.

Do investors differentiate between types of component auditors? Evidence from auditor ratification voting

Do investors differentiate between types of component auditors? Evidence from auditor ratification voting

Do Shareholders Care about “Surprise” Internal Control Weakness Disclosures?

SUMMARY Prior research shows that many of the companies that disclose material weaknesses in internal control (MWs) do not disclose such weaknesses in earlier quarterly 10-Q filings for the same year—i.e., the year-end MW disclosures are “surprise” disclosures. We find that shareholders at accelerated filers with surprise MW disclosures are more likely to vote against auditor ratification (by a factor of about 1.4 times) than at companies with “no-surprise” MW disclosures. These findings suggest that shareholders may at least partly blame auditors and hold them responsible for the surprise MW disclosures. Internal control disclosures necessarily involve professional judgment, but the results indicate that for shareholders, earlier disclosure of such problems is preferable to waiting until the year-end (and perhaps hoping that the problems will be resolved).

Do Shareholder Ratification Votes Impact Subsequent Audit Outcomes?

SUMMARY The Securities and Exchange Commission (SEC) and the Public Company Accounting Oversight Board (PCAOB) have justified audit-related disclosure rules by asserting that such information would be relevant for shareholders in auditor ratification voting decisions. The underlying assumption, stated more explicitly by activists and others, is that such voting can influence auditors’ subsequent actions. A recent study by Tanyi, Rama, Raghunandan, and Martin (2020) tests this assumption. Using data from 10,326 auditor ratification votes, Tanyi et al. (2020) find that higher than expected shareholder dissatisfaction of their external auditors is associated with higher audit quality and higher audit fees in the subsequent period. The results suggest that auditors should pro actively engage with audit committees if there is higher than expected shareholder dissatisfaction. Auditors can also expect regulators to use such evidence in future rule proposals by the SEC and PCAOB, given past actions by regulators.

Shareholders’ Perception of Auditor Type and Timing of Auditor Engagement: Evidence from Auditor Ratification

AbstractMany companies present their selected auditor to shareholders for ratification. In this study, we use auditor ratification voting results to examine whether shareholders view the type of auditor and the timing of the engagement as indicative of audit quality. The auditor ratification literature has yet to explicitly examine these research questions. Our study is unique in that we focus on the auditor switch setting and test how shareholders view a newly hired auditor. We find that shareholders are less likely to approve a non‐Big N auditor than a Big N auditor. We also document that shareholders view late auditor engagements (i.e., during or after the fourth quarter) more negatively, consistent with the argument that late appointment of new auditors should be viewed with caution. The timing effect is particularly acute for non‐Big N firms; however, shareholders do not seem to mind late engagements of Big N auditors.

Voting on Auditor Ratification by Shareholder Type: Impact of Institutional Shareholder Dissent on NAS Fees and Audit Quality

Institutional investors have a better understanding of corporate performance than non-institutional investors, and their presence tends to improve the overall governance mechanism of a company and discipline top management against taking self-serving or myopic decisions. In this study, we examine shareholder voting patterns on auditor reappointments in Indian companies and examine whether institutional shareholder dissent on auditor reappointment acts as a disciplining mechanism on subsequent auditor actions and leads to improvement in audit quality. Our results indicate that institutional shareholder dissent on auditor reappointment is positively related to relative magnitude of non-audit services (NAS) fees in the previous year. More importantly, we observe that auditors are sensitive to institutional dissent and respond by charging a lower amount of NAS fees and providing superior audit quality in the subsequent year to signal increased independence and objectivity. Similar results are not observed in the case of retail shareholders. Our findings reinforce the role of institutional shareholders as important monitors in the corporate governance process and call for regulation to mandate the participation of shareholders in the auditor appointment process.

Passive Investors and Audit Quality: Evidence from the U.S.

The rise of index funds, or passive investing, in recent decades has caused heated debates over the efficacy of passive investors' stewardship role in corporate governance. Our study adds to this emerging line of literature by examining whether passive investors enhance the quality of financial statement audits, a key aspect of corporate governance mechanisms. We exploit the yearly Russell index reassignment, which provides us with an ideal setting to study the causal relation between passive institutional investors (i.e., index trackers) and firms' audit quality. Examining firms closely surrounding the Russell 1000/2000 cutoff line, we find that higher passive ownership leads to higher audit quality proxied by audit fees. To investigate the channel through which passive investors influence audit-related governance issues, our evidence from auditor ratification voting records suggests that passive investors do ‘voice’ their opinion on low-quality audits. Such effort also leads to a higher likelihood of auditor turnover in the following year. In the cross-sectional analysis, we also find that the positive effect of passive investors on audit quality is more pronounced in firms with higher agency costs. Thus, our study supports the view that passive investors play an active role in improving corporate governance.

Retail shareholders and the efficacy of proxy voting: evidence from auditor ratification

Retail shareholders and the efficacy of proxy voting: evidence from auditor ratification

Showcasing Audit Quality through Voluntary Public Disclosure of Audit Quality Indicators

SUMMARYPublic accounting firms continuously invest significant resources into enhancing audit quality. In this paper, we summarize Brown and Popova's (2019) key findings related to public disclosure of audit quality indicators (AQIs) and discuss important implications for audit practitioners. Specifically, we discuss the current landscape of AQI disclosure from a regulatory and practitioner standpoint, and we provide recommendations for audit practitioners to consider when developing their own framework for AQI disclosure. Finally, we discuss how important stakeholder groups such as individual investors are influenced by AQI disclosures when making significant decisions concerning the audit firm (e.g., making auditor ratification decisions) and the audit client (e.g., making investment changes). The insights provided in our summary inform audit practitioners on how to showcase their audit quality enhancement efforts through voluntary AQI disclosure.

Do seasoned industry specialists provide higher audit quality? A re-examination

The purpose of this paper is to re-examine the recent findings in Gaver and Utke (2019) (GU) who find that seasoned industry specialist auditors provide higher audit quality. We first illustrate how the magnitude of residuals from the accruals model can vary significantly by industry, thus highlighting the importance of including industry fixed effects when the dependent variable is discretionary accruals. We next replicate GU’s findings. We first attempt to replicate prior literature after including industry fixed effects in the audit quality (discretionary accruals) models. This is an important control, as the relevant benchmark for a firm with an industry specialist auditor is a peer firm in the same industry with a non-specialist auditor. We find that after including industry fixed effects, there is no association between seasoned industry specialist auditors and discretionary accruals. We also find that the association between industry specialization and discretionary accruals is very sensitive to the way in which the researcher calculates specialization. Our findings are informative for shareholders of public companies who vote on auditor ratification.

Does the Business Press Influence Equity Investors’ Perception of Big 4 Audit Quality?

We investigate whether the business press influences equity investors’ perception of the credibility of the Big 4 for providing high-quality audits. We find that the extent of audit-related negative business press coverage of a Big 4 is associated with lower earnings response coefficients (ERC) for clients, negative client abnormal returns on the days of the news release, and a higher percentage of votes against auditor ratification. Importantly, these results are robust to controlling for other information sources such as client news, audit quality indicators (restatements and auditor litigation), and regulator press releases. Also, the extent of Big 4 negative business press coverage is associated with a lower probability of gaining new clients and a greater probability of client misstatements, suggesting that coverage is diagnostic of audit quality. The effects for ERCs and abnormal returns are concentrated in clients with low dedicated institutional ownership and high earnings uncertainty. Overall, this evidence is consistent with the business press influencing investors’ perception of Big 4 audit quality.

Does auditor ratification matter to bondholders? Evidence from new bond issues

We investigate the relation between shareholder votes on auditor ratification and the client’s credit risk, using both parametric and nonparametric regression techniques. Using data from 2006 to 2016, we show that the proportion of shareholder disapproval for auditors heterogeneously impacts credit risk, as shown by bond spread and bond rating. The results suggest that higher shareholder disapproval of the auditor has an adverse effect on yield spread and bond ratings after controlling for firm characteristics associated with audit quality, such as auditor size and tenure.

Shareholder Dissatisfaction and Subsequent Audit Outcomes

SYNOPSIS This study examines the association between shareholder dissatisfaction, as proxied using auditor ratification voting, and subsequent auditor effort and audit quality. We document that increases in shareholder dissatisfaction are associated with (1) higher audit fees and longer audit report lags, and (2) lower abnormal accruals and reduced likelihood of financial statement misstatements, in the subsequent period. These findings inform the debate about auditor ratification voting, as governance activists and some regulators argue to increase the role of shareholders in auditor selection despite opposition from some firms and the staff of the Securities and Exchange Commission. We provide empirical evidence that increases in shareholder dissatisfaction with the auditor are associated with increases in subsequent auditor effort and audit quality. This suggests that shareholder action (even nonbinding) may potentially influence subsequent audit outcomes.

Why do firms seek shareholders ratification of the independent audit function? The case of foreign cross‐listed companies in the United States

Many factors influence why companies require routine auditor ratifications. In this study, we seek to examine factors that increase or decrease the likelihood of shareholders’ involvement in the ratification of the independent auditor's appointment for foreign cross‐listed companies in the United States. Foreign cross‐listed companies provide a unique opportunity to observe how country‐specific factors impact the auditor ratification vote decision and outcome. Our analysis shows that bank financing, the location of the cross‐listed firm's independent auditor (U.S.‐based vs. non‐U.S.‐based audit office), and non‐audit fee ratio as having the highest marginal effects on the probability of companies requiring their shareholders to ratify the auditor's appointment. We also examine how these factors influence the outcome of the vote. We find that several engagement and country‐specific factors also influence the outcome of the vote.

How Do Investors Respond to Disclosure of Audit Quality Indicators?

SUMMARYBoth U.S. and international standard setters have sponsored initiatives to develop a reliable portfolio of audit quality indicators (AQIs). We conduct two experiments to examine how investors respond to receiving auditor-disclosed AQIs. We find that investors experience a stronger negative affective reaction toward the auditors when receiving a negative-trending AQI portfolio compared to receiving a positive trend of AQIs or when no AQIs are disclosed. In turn, investors receiving a negative-trending AQI portfolio are less likely to support auditor ratification and choose to voluntarily decrease their investment in the company. Results also indicate that including additional qualitative context within the disclosure increases investor support for auditor ratification when accompanying a positive-trending AQI portfolio but has no additional effect on investor decision-making for a negative-trending AQI portfolio. Our findings help to advance the dialogue on AQIs and suggest a possible path forward for disseminating AQIs to interested stakeholders.JEL Classifications: M40; M41; M42.

Should Uninformed Shareholders Vote? Evidence from Auditor Ratification

We investigate the influence and implications of retail shareholder participation in the proxy voting process. Using the shareholder vote on auditor ratification – a setting which facilitates the identification of an informed vote – we find that, on average, shareholder votes against auditor ratification are not associated with audit failures but are strongly associated with investment performance. We next consider how these relations vary with the composition of a company’s voting base and find evidence that the auditor ratification vote is less informed (i.e., associated with factors that do not reflect auditor performance) when retail ownership is higher. In subsequent tests, we find that the probability of auditor dismissal is increasing in the proportion of votes against auditor ratification, regardless of the level of retail ownership. Collectively, our results suggest that some auditors are dismissed for factors not directly related to auditor performance. More generally, our results suggest that votes cast by retail shareholders can limit the efficacy of proxy voting as a corporate governance tool.

Do Auditor Ratification Results Matter to Auditors? First Evidence from a Mandatory Ratification Setting

This paper empirically examines the impact of shareholder ratification of auditors (SRA) voting results on audit fees in a mandatory and binding ratification setting (i.e., Germany). Motivation for our study comes from the widespread implementation of SRA in Europe. Furthermore, it addresses calls for research on the effect of mandatory SRA voting results and on SRA outside the US. We obtain three main findings: (i) Big 4 and Non-Big 4 auditors respond differently to large shareholder dissent, (ii) Big 4 audit fees are approximately 15 percent higher following an economically significant magnitude of negative votes on auditor ratification and (iii) respective audit fee increases are associated with higher audit report lag. Based on these results, we conclude that (i) the different response of Big 4 and Non-Big 4 auditors can be attributed to the relevance of shareholder dissent, (ii) Big 4 auditors try to remedy unfavorable SRA voting results by engaging in additional audit effort and (iii) this additional audit effort most likely relates to additional endeavors in audit service quality in order to meet the needs of the audit committee. Our study is, to the best of our knowledge, the first to examine how auditors respond to SRA voting results in a mandatory and binding ratification setting.

PCAOB Inspection Reports and Shareholder Ratification of the Auditor

ABSTRACT We examine the effect of unfavorable PCAOB inspection reports, which contain audit deficiencies related to GAAS and/or GAAP violations, on shareholder voting for the auditor ratification. We further investigate whether shareholders likely vote against ratification for the auditors receiving deficiency reports in a weak corporate governance environment. Overall, we do not find evidence that shareholders vote against auditor ratifications when their auditors receive unfavorable inspection reports. However, we find some evidence that shareholders cast their votes against the ratifications of auditors receiving unfavorable inspection reports when the corporate governance is weak, as proxied by CEO duality and a low level of board diligence. Our results suggest that shareholders seem not to incorporate inspection reports as a potential proxy for auditor quality in their vote decisions on auditor ratification. Data Availability: Data are available from public sources identified in the paper.

Market Reaction to Auditor Ratification Vote Tally

SYNOPSIS This paper provides empirical evidence that the proportion of shareholder votes against the ratification of the auditor is informative to investors' perception of the auditor-client relationship. We find that lower shareholder approval of the auditor is associated with a negative market reaction to the 8-K announcement of the auditor ratification vote. Additionally, we find that the market reaction is more negative when a high level of auditor dissatisfaction is likely a surprise to investors, such as when audit and auditor characteristics suggest that the auditor provides high audit quality. We provide confirming evidence that withheld votes are associated with a higher likelihood of a future auditor dismissal and that the market reaction to the dismissal is more positive for firms with lower shareholder approval of the auditor. JEL Classifications: G34; G30; M40.

Proxy Advisor Recommendations on Auditor Ratification: Who is Listening?

The auditor ratification vote provides shareholders with an opportunity to voice their opinions about the company’s choice of auditor, but historically, less than two percent of shareholders express dissent in their vote. Motivated by regulatory attention on the importance of shareholder involvement and the institutional power of proxy advisors on voting outcomes, I examine how proxy advisor recommendations affect shareholder voting for auditor ratification. Specifically, I examine whether low percentages of shareholder dissent in auditor ratification may be due to low levels of dissent expressed by proxy advisors. I find that proxy advisors have a significant influence over shareholder voting outcomes when they do recommend against auditor ratification, but the Against recommendation is rare. Proxy advisors are more likely to recommend against auditor ratification when based on signals in the DEF 14A proxy filing (e.g., the proportion of nonaudit fees), but rarely recommend against auditor ratification when using signals from other filings (e.g., restatements in 8-K filings). This may be due to bias given to readily available information or to underperformance in a credence goods scenario. I discuss the implications of these findings, which should be of interest to regulators, investors, public companies, and audit firms.