Auditor Dismissals After Accounting Restatements

Abstract:     
This study examines the conditions under which financial restatements lead corporate boards to dismiss independent auditors. We predict auditors are dismissed when restatements indicate sufficiently poor audit quality (i.e., poor auditor performance) and/or when the client deems it necessary to restore financial reporting credibility. Auditors are dismissed at higher than normal rates after restatements, but in contrast to prior research on CEO/CFO turnover, we find no evidence of differential dismissal rates across restatement types (i.e., irregularities vs. errors) for Big 4 auditors. For non-Big 4 firms, however, we do find that dismissal rates are higher for restatements resulting from irregularities as compared to errors. This evidence is consistent with the benefits from re-establishing reporting credibility outweighing the lower switching costs for smaller auditors after more damaging restatements. In addition, we test the market reaction to auditor dismissals to assess whether investors view them as a positive step toward restoring financial reporting credibility. Consistent with this, we find that the market responds positively to auditor dismissal announcements after restatements. The reaction to the dismissal is significantly more positive following restatements involving irregularities (7.6%) rather than errors (1.3%) when the client engages a comparably sized or larger successor auditor.

Number of Pages in PDF File: 48

Keywords: Corporate Governance, Restatements, Auditing, Dismissals

JEL Classification: G30, M41, M51

working papers series