Journal Articles

Determinants and Market Consequences of Auditor Dismissals after Accounting Restatements

2014, forthcoming The Accounting Review

Karen Hennes, Andy Leone, Brian Miller

Abstract

This study examines the conditions under which financial restatements lead corporate boards to dismiss external auditors and how the market responds to those dismissal announcements. We find that auditors are more likely to be dismissed after more severe restatements but that the severity effect is primarily attributable to the dismissal of non-Big 4 auditors rather than Big 4 auditors. We also document that among corporations with Big 4 auditors, those that are larger and more complex operationally are less likely to dismiss their auditors. Combined, this evidence suggests that firms with higher switching costs and fewer replacement auditor choices are less likely to dismiss their auditors after a restatement, which is informative to the debates about the costs and benefits of mandatory auditor rotation and limited competition in the audit market. Additionally, we examine contemporaneous executive turnover and find evidence that boards view auditor dismissals as complementary rather than substitute responses to restatements. Finally, we investigate the market reaction to auditor dismissals after restatements. The market reaction to the dismissal is significantly more positive following more severe restatements (5.9%) relative to less severe restatements (0.6%) when the client engages a comparably sized auditor. This positive market reaction is consistent with firms restoring financial reporting credibility by replacing their auditors and highlights the important role that auditors play in the financial markets.

Citation

Hennes, K,. A. Leone, and B. Miller (2014), “Determinants and Market Consequences of Auditor Dismissals after Accounting Restatements,” The Accounting Review, forthcoming.