The Ultimate Form of Mandatory Auditor Rotation: The Case of Former Arthur Andersen Clients
36 Pages Posted: 15 Feb 2005
Date Written: February 10, 2005
The collapse of Arthur Andersen provides a unique quasi-experimental setting to study the implications of mandatory auditor rotation for public firms. Consistent with the extant literature on mandatory auditor rotation, we hypothesize the selection of a new auditor is a function of agency and switching costs. Using a unique dataset identifying whether or not former Andersen clients followed their audit team to a new auditor, we are able to find support for both hypotheses. Further, we find firms with greater performance adjusted discretionary accruals were more likely to follow their Andersen audit team to a new auditor, consistent with these firms trying to mitigate the costs of switching auditors. However, tests of accruals in the subsequent year reveal the most aggressive firms who followed Andersen staff were no longer aggressive in the following year relative to the group who chose new non-Andersen auditors. This is inconsistent with mandatory auditor rotation directly improving financial reporting since we expect the non followers to exhibit the greatest degree of accrual correction. However, our results must be interpreted with caution since the rotation described in the paper is quite atypical. Further, whether the benefits outweigh the costs is still difficult to determine since we cannot empirically quantify these aspects.
Keywords: Mandatory rotation, audit quality, earnings quality, Arthur Andersen
JEL Classification: M41, M43, M44, M49
Suggested Citation: Suggested Citation