Corporate Governance, Audit Firm Reputation, Auditor Switches, and Client Stock Price Reactions: The Andersen Experience

Abstract

The financial scandal surrounding the collapse of Enron caused erosion in the reputation of its auditor, Arthur Andersen, leading to concerns about Andersen's ability to continue in existence and ultimately to the firm's demise. In this paper we investigate the role of corporate governance on the timing of the auditor switch by former Andersen clients. After controlling for factors associated with switching costs, we find clients with strong corporate governance were more likely to switch early. We also find that clients switching from Andersen experienced positive abnormal returns during the three-day window surrounding the announcement of the switch. We attribute this positive response to the reduction in uncertainty associated with the cost of finding a new auditor.