Auditor Credibility Impairment Spillovers: Evidence from Three Andersen Engagements

Abstract:     
Does bad news about one auditor's conduct affect the credibility of all auditors? We examine auditee abnormal stock returns around twenty-five bad news events involving Arthur Andersen LLP's (Andersen) questionable audits of Waste Management, Sunbeam, and Enron. Of these twenty-five windows, twelve (including eight pre-Enron windows) exhibit significantly negative market-wide mean abnormal returns. Moreover, during these twelve windows, portfolios of low quality auditees are, on average, penalized significantly more than portfolios of high quality auditees. During windows related to SEC actions (probes, sanctions), Andersen, Other Big Five and non-Big Five auditees are strongly penalized. Disclosures about the details of accounting and auditing irregularities, on the other hand, more strongly affect Big Five auditees than non-Big Five auditees. Our study is the first to present systematic evidence that bad news about the conduct of one auditor can generate significant negative externalities (spillovers) to all auditors. Interestingly, all three events that show the strongest evidence of spillovers occur before Enron's financial troubles became public. During Enron-related events, by contrast, evidence for spillovers is mixed for both Andersen and non-Andersen auditees.

Keywords: Auditor Credibility, Spillovers, Agency Costs, Financial Statement Credibility

JEL Classifications: G12, L14, L15, M41, M49

Working Paper Series