Did the Waste Management Audit Failures Signal Lower Firm-Wide Audit Quality at Arthur Andersen?

Posted: 19 Sep 2010 Last revised: 9 Feb 2012

See all articles by Steven F. Cahan

Steven F. Cahan

University of Auckland Business School

Wei Zhang

SUNY at Albany

David Veenman

University of Amsterdam - Amsterdam Business School (ABS)

Date Written: September 17, 2010

Abstract

This study investigates Arthur Andersen’s audit quality in the decade before the collapse of Enron. Andersen’s involvement in the Waste Management audit failures – which relate to audits of the company’s 1992-96 financial statements – led the SEC to accuse Andersen of issuing false and misleading audit reports and resulted in a permanent injunction that prohibited Andersen from further violating securities laws. We examine whether the Waste Management audit failures were symptomatic of widespread audit deficiencies at Andersen. Using three empirical measures of audit quality – discretionary accruals, clients’ propensity to meet or just beat analyst forecasts, and accounting misconduct identified by AAERs – we find no overall evidence suggesting lower average audit quality at Andersen relative to the Big 4 during the period 1992-2001 for a sample of S&P 1500 firms. Focusing on high litigation risk firms, however, we find larger absolute and income-increasing accruals and a greater propensity to meet or just beat analyst forecasts for Andersen clients relative to the Big 4 clients in the period August 7, 2000 to December 31, 2001 after Andersen’s divorce with Andersen Consulting. These findings provide some evidence that, after the divorce, Andersen was not able to constrain aggressive accounting where it may have mattered most, that is, among its clients with the highest litigation risk.

Keywords: Audit quality, Audit failure, Arthur Andersen, Waste Management

JEL Classification: M41, M42

Suggested Citation

Cahan, Steven F. and Zhang, Wei and Veenman, David, Did the Waste Management Audit Failures Signal Lower Firm-Wide Audit Quality at Arthur Andersen? (September 17, 2010). Contemporary Accounting Research, Vol. 28, No. 3, pp. 859–891, Fall 2011, Available at SSRN: https://ssrn.com/abstract=1678473

Steven F. Cahan

University of Auckland Business School ( email )

Faculty of Business & Economics
Private Bag 92019
Auckland
New Zealand

Wei Zhang

SUNY at Albany ( email )

School of Business
Department of Accounting and Law
Albany, NY 12222
United States

David Veenman (Contact Author)

University of Amsterdam - Amsterdam Business School (ABS) ( email )

Roetersstraat 18
Amsterdam, 1018WB
Netherlands

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