Opaque Auditor Dismissal Disclosures: What Does Timing Reveal that Disclosures Do Not?

Abstract

Auditor resignations provide a clear signal of accounting problems or heightened audit risk; however, registrants label the vast majority of auditor changes as dismissals, which carry more ambiguity. Motivated by the opacity of current dismissal disclosures, this study explores the usefulness of these disclosures compared to an alternative signal – the timing of the dismissal within the reporting year – for inferring the causes and implications of dismissals. Dividing the reporting year into key periods, we find that the probabilities of future restatements, material weaknesses, and delistings following a dismissal generally increase within the reporting year while negative circumstances disclosed do not. Analyses suggest that the timing patterns are caused by burgeoning, yet undisclosed, conflicts between the client and the outgoing auditor, rather than by transition difficulties involving the new auditor (as prior literature claims). The timing patterns strongly persist after controlling for negative circumstances that registrants disclose in the dismissal filing, suggesting that the disclosures are not fully revealing. In fact, disclosed negative circumstances have no incremental predictive power for future restatements and delistings. Our results suggest a severe lack of informativeness of current disclosures and support previous calls for improvement of dismissal disclosure regulation.

Paper is available at: https://www.sciencedirect.com/science/article/pii/S0278425421000880

Note: This study was formerly entitled, "Auditor Dismissals: Opaque Disclosures and the Light of Timing".

Keywords: auditor dismissal, auditor resignation, restatement, material weakness, delisting

JEL Classification: M40, M41, M42, M48