DO INVESTORS CARE ABOUT AUDITOR DISMISSALS

AND RESIGNATIONS? WHAT DRIVES THE RESPONSE?

By

Paul A. Griffin* and David H. Lont**

Version of

January 31, 2010***

Comments Welcome

UC Davis GSM MRN No. 03-10

* Professor of Management, Graduate School of Management, University of California, Davis,

Davis, California 95616 USA (pagriffin@ucdavis.edu).
** Associate Professor, School of Business, University of Otago, Dunedin 9054 New Zealand, and
corresponding author (david.lont@otago.ac.nz).
***We thank G. Bhabra, K. Ellis, S. Rajgopal, D. Segal, T. Shevlin, P. Theivananthampillai, M.
Yetman, and two reviewers for this journal for their useful comments. Earlier versions were
presented at the National Meetings of the American Accounting Association, Anaheim, 2008, and
at the seminars in 2007-2009 at the Australian National University, Louisiana State University,
U.C. Davis, University of Otago, and Victoria University of Wellington. Any remaining errors and
omissions remain the responsibility of the authors. This version updates
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1079243.

Electronic copy available at: http://ssrn.com/abstract=1079243

 Do
Investors
Care
About
Auditor
Dismissals

and
Resignations?
What
Drives
the
Response?



Abstract



This paper uses market response tests to document key factors that help explain why investors find

some auditor change announcements informative and others not. We find that the key drivers of investor

response relate more to economic fundamentals than to the auditor change attributes in mandated auditor

change disclosures. Investors react most negatively to resignation announcements (and much less for

dismissals), and this response increases for companies with prior securities litigation and higher bankruptcy

risk. Once we control for these factors, mandated auditor change disclosures other than an indication of

resignation, while significant, have only limited ability to explain the price drop around an auditor change

announcement.


Data:


Please contact the corresponding author.


Keywords:

Dismissal, resignation, investor response, economic fundamentals, event study, Form 8-K, Item 4.01

changes in registrant’s certifying accountant.

JEL
Classification:

C20, G14, G18, K22, M42


 ii


Electronic copy available at: http://ssrn.com/abstract=1079243

 Do
Investors
Care
About
Auditor
Dismissals

and
Resignations?
What
Drives
the
Response?



1. Introduction


This study uses market reaction tests to document key factors that help explain why investors find some

auditor change announcements informative and others not. The key drivers of response that emerge from our

investigation relate more to economic fundamentals than to the auditor change attributes in the mandated

disclosures.1 This result offers new insights for investors and regulators about the relevance of these

mandated dismissal and resignation disclosures. The Securities and Exchange Commission (SEC) has

shown much interest in this topic for several decades, mostly in an effort to provide information to investors

about auditor-company conflicts and events that might threaten auditor independence. Yet, despite this

interest, prior studies (reviewed in section 2) document varying results and reasons about why such auditor

change events might be newsworthy. The earlier results, for example, tend to explain investors’ response as

mostly conditional upon mandated auditor change disclosures and not fundamental factors that might be

coincidental with or mirrored by the auditor change itself. We examine a large sample of auditor changes

before and after the passage of the Sarbanes-Oxley Act of 2002 (SOX) (July 25, 2002) to shed further light

on this issue, specifically, to understand whether the investor response to an auditor change is explained

better by fundamental factors such as litigation and bankruptcy risk and profitability rather than by the

auditor change attributes in the mandated disclosures.2

As a backdrop to our primary objective, we first document a negative response to resignation

announcements (and a mostly insignificant response to dismissals). This response increases negatively when

we restrict our analysis to filings that follow the auditor change event date within the required filing period



























































1
SEC Release 33-8400 (SEC 2004a) and earlier releases 33-6766 (SEC 1988) and 33-6822 (SEC 1989) govern the
mandated auditor change disclosures. These releases require a Form 8-K filing in the event of an auditor change
disagreement if it occurs within 18 months of the engagement of a new auditor. SEC Release 33-6766 (FRR 31)
mandates the timely disclosure of auditor-company disagreements and certain reportable events relating to internal
control and financial statement reliability as outlined in Item 304(a)(1)(iv) and (v) of Regulation S-K (17 CFR 229.304,
Item 304). SEC Release 33-6822 reduced the Form 8-K due date from 15 to within five business days following the
event; and SEC Release 33-8400 (FRR 34) reduced the lag to within four business days, effective August 23, 2004.
2
Turner et al. (2005) comment on the different factors that might be associated with the stock price effects of an auditor
change, and note that “further research is warranted.” (p. 12).


 1


Electronic copy available at: http://ssrn.com/abstract=1079243

(timely filings).3 Based on a research design from prior research, we also document that such negative

response varies with certain reportable event disclosures mandated under SEC Regulation S-K, Item 304

(a)(1)(iv) on an auditor-client disagreement and Item 304(a)(1)(v)(A) through (D) on other reportable events

(hereafter, mandated auditor change disclosures or variables). That research design (and other similar

approaches), however, does not include proxies for economic fundamentals as additional explanatory factors.

When we condition investors’ response to an auditor change on economic fundamentals such as litigation

and bankruptcy risk and change in expected company profitability, our ability to explain investors’ response

to an auditor change increases significantly. The inclusion of mandated auditor change variables also adds

significant incremental ability to explain the response to an auditor change beyond the more fundamental

factors, although the effect is more limited and explained mostly by two relatively infrequent reportable

event disclosures (auditor-client disagreement and non-reliance on management). We interpret our findings

to suggest that in reacting to an auditor change, while investors do not ignore certain reportable event

disclosures, they also pay close attention to and condition their response on the basis of the economic

fundamentals coincident with an auditor change.

Section 2 discusses the literature and motivates the need for additional research. Section 3 describes the

sample and data. Section 4 presents the results, and section 5 describes supplementary analyses and

robustness tests. The final section summarizes the results and states conclusions and suggestions for future

research.

2. Literature
and
Research
Issues


Most investor response studies contend that an auditor change should convey significant information to

investors, and test for a positive or negative excess stock return around a specified date (against the null

hypothesis of no response). Many earlier studies lacked the data to distinguish between a dismissal and a



























































3
While the SEC has since 1989 (SEC 1989) required an auditor change report to be filed within five business days (four
days after August 23, 2004) of the triggering event, the SEC also provides limited safe harbor from the consequences of
a late Form 8-K filing. Such consequences include ineligibility to use a short form registration statement such as the
Form S-3.


 2

resignation.4 Rather, they tested and found–with the exception of Nichols and Smith (1983), Johnson and

Lys (1990), Klock (1994), and Joher et al. (1999), who report no reaction–a negative market response to

auditor changes with adverse disclosures (e.g., auditor-company disagreement, Fried and Schiff 1981, Smith

1988, and Eichenseher et al. 1989, auditor-company disagreement and adverse financial situation, Dhaliwal

et al. 1993). Johnson and Lys (1990) conclude that an auditor change announcement has little information

content “because the realignment is a predictable consequence of earlier changes in the client’s operations

and activities.” (p. 304).

The distinction between a dismissal and a resignation is important, however, as each may signal a

different kind of information (Schwartz and Soo 1995; Krishnan and Krishnan 1997). While a dismissal

should convey positive (or at least non-negative) news to the extent that managers act in shareholders’ best

interests regarding a company-initiated auditor change (Johnson and Lys 1990), given the many reasons for a

dismissal, some dismissals may also transmit offsetting, adverse information. Based on the post-1988 (FFR

No. 31) SEC rules (described in note 1), most studies report no significant response to a dismissal (e.g.,

Whisenant et al. 2003, -1.24 percent for filing days -1 to 1), possibly because dismissals and replacements

(e.g., realigned services, fee reductions) confer minor benefits compared to company market value, and/or

because of offsetting costs and benefits.

On the other hand, from an economic standpoint, a resignation should occur when audit fees are

insufficient to price-protect the auditor from the additional effort and audit risk, including litigation liability

(Bockus and Gigler 1998), or when the client exceeds risk thresholds in auditing regulations (e.g., refusal to

accept a qualified audit opinion, PCAOB non-registration) or professional codes of conduct (e.g., illegal act,

impaired independence). Shareholders in such situations face higher litigation risk and may raise questions

about controls and governance. Also, a company may pay more to the replacement auditor because of new

effort and liability thresholds such as those imposed by SOX.5 Wells and Loudder (1997), DeFond et al.



























































4
For example, SEC Release 33-6766 (SEC 1988), which requires separate disclosure of a change in certifying
accountant as a resignation or dismissal (Item 4.01 of Form 8-K), became effective for SEC registrant reports after April
1988 (53 FR 12929, April 20, 1988, as amended at 54 FR 9774, March 8, 1989).
5
Auditing Standard No. 2 (PCAOB 2004), the applicable standard during the study period, in fact, sets an unusually


 3

(1997), Shu (2000), and Whisenant et al. (2003) test these notions and document significant negative excess

return around resignations but not dismissals: -0.6 percent for filing days 0 and 1 (Wells and Loudder 1997),

-10.2 percent from event day 0 to filing day -1 (DeFond et al. 1997), -3.11 percent for filing days 0 to 2 (Shu

2000), and -4.48 percent for filing days -1 to 1 (Whisenant et al. 2003). Shu (2000) also finds that the

negative reaction to an auditor resignation increases in litigation risk.

To place our results in context, we first build upon the literature on investors’ response to dismissals and

resignations by examining a more recent sample, since the prior work of which we are aware mostly covers

auditor changes in the 1990s. For instance, investors’ response may have changed following SOX because

the 2002 Act changed auditors’ thresholds and risk of litigation (note 5). This change may have heightened

investors’ interest in auditor changes, particularly resignations. We also examine investors’ response to a

delay in engaging the replacement auditor. Our data show an increase in companies that delay such

announcement and report it later in a separate Form 8-K, Item 4.01 reportable event. While there is no

requirement to announce simultaneously the outgoing and incoming auditor, without adequate disclosure, a

delay may prompt some investors to downgrade the stock (Smith 1988).

A related strand of the literature examines the response to mandated auditor change disclosures

coincident with an auditor change. These papers show a negative response at the filing date when the

auditor’s letter is delayed (Krishnan 2002) and when an adverse disclosure such as a disagreement or

reportable event (e.g., about reliability) accompanies the auditor change filing (Whisenant et al. 2003,

Beneish et al. 2005). These papers also contend that it is the interaction of a resignation and a reportable

event that mostly drives the negative announcement return, not the reportable disclosure per se (Whisenant et

al. 2003, note 6), and that investors find uninformative a resignation announcement absent a reportable event

disclosure (Beneish et al. 2005). Some reportable events, however, may have limited news value, for



























































low risk threshold by requiring the auditor to evaluate all controls that address the possibility of fraud that could have a
material impact on the financial statements. This standard imposes higher costs on auditors regarding “significant
deficiencies” in internal controls and “reasonable assurance” that “no material weaknesses” exist by defining a
deficiency as significant and a weakness as material if there is “more than a remote likelihood” that a material
misstatement will not be prevented or detected. Also, SOX Section 103 requires higher engagement quality review
standards than before. The number of auditor changes, particularly resignations, increased after SOX (table 1; also,
Ettredge et al. 2007).


 4

example, nuanced descriptions of the underlying issues designed specifically to minimize information for

investors (Dunn and Stewart 1999, Dunn and Sikka 1999). Additionally, many SEC registrants–72 percent

in 2005 according to Glass Lewis (2006)6–provide no reason for an auditor change, and some actual

reportable events may be hidden in an unrelated filing (Turner et al. 2005) or just not reported. In one case,

Computer Associates, Inc. reported no disagreement or reportable event at the time of the auditor change but

revealed later, in litigation, that there had been a significant disagreement about accounting for employee

compensation (SEC Litigation Release No. 18891, SEC 2004b).

In short, while the literature examines certain additional considerations that may drive investors’

response to an auditor change, it also tends to emphasize relations between investors’ response and mandated

auditor change disclosures rather than the incremental explanatory power of those attributes to explain

investors’ response after controlling for factors such as litigation and bankruptcy risk, change in expected

profitability, and other variables. We, therefore, contend that what drives investors’ response is still not

sufficiently well documented in the literature. For example, while Beneish et al. (2005) report that investors

do not respond to resignations not accompanied by a reason for the auditor change, a more complete analysis

should also consider relevant outside (non-mandated) information that may condition investors’ ability to

interpret the underlying circumstances.

The balance of our paper, therefore, examines the explanatory power of the mandated auditor change

disclosures and certain key fundamental economic factors that might jointly condition the stock price

response to an auditor change. If investors’ reaction to an auditor change is driven primarily by fundamental

economic factors, and less by mandated auditor change variables, then those attributes studied in the prior

research may be relegated a secondary or more coincidental role.



























































6
Whisenant et al. (2003, p. 192) report similarly, that 85.71% of their sample of auditor change reportable event
disclosures report only the fact of an auditor change.


 5

3. Sample
and
data


Our sample of 2,524 auditor changes consists of all those available from Form 8-K reports in the Audit

Analytics database between January 8, 2001 and May 25, 2005 (the cutoff date)7 with CRSP security returns

from 100 days prior to and following the auditor change filing date.8 Audit Analytics also provided data on

the occurrence of an Item 304(a)(1) auditor-client disagreement or related event disclosure. We merge these

data with financial statement information from Compustat and prior class action securities litigation data

from Institutional Shareholder Services (acquired by RiskMetrics Group in 2007), defined as litigation

within 10 years of the auditor change year. ISS/RiskMetrics maintains comprehensive coverage of federal

securities class actions, and so we are reasonably sure that our auditor change sample is complete with regard

to prior class action securities litigation.

Table 1, panel A, reports the distribution of auditor changes by type and SIC industry code. A

comparison of the last two columns of panel A shows an industry composition of dismissals and resignations

similar to companies on the CRSP/Compustat merged data base.9 Panel B reports the distribution across

time and shows that, as a percentage of the total over all years, more resignations relative to dismissals occur

after 2002. Once we adjust for the 2002 Andersen dismissals, the percentages of dismissals and resignations

each year are more similar, although more resignations still occur after 2002, possibly as a result of SOX

(note 5). We also observe from panel B that companies file relatively more untimely resignations compared

to untimely dismissals, which also seems to increase after 2002. Additionally, panel C shows that dismissals

and resignations occur disproportionately more in the second quarter; as if the auditor change decision

follows (rather than precedes) the SEC due date, in this case, for calendar year filers. For example, for the

auditor change sample excluding 2002 Andersen dismissals, 38 percent of December 31 fiscal year



























































7
Audit Analytics also collects auditor change data from Form 6-K (foreign private issuer) and N-SAR (registered
investment company) filings. We exclude these from the analysis.
8
We use 100-day return periods to examine the impact of changes in systematic risk on our excess return measures.
9
Comprises all industrial and financial companies in the CRSP/Compustat merged data base for the same time period
as the auditor change observations without missing data for total assets and shareholders’ equity (to ensure corporate
form), SIC code, and auditor identification.


 6

companies (66 percent of that sample) announced an auditor change in the second quarter of the following

year.

Panel D of table 1 shows other sample characteristics. Regarding the continuous variables (definitions

in table 1), resignation companies relative to dismissal companies on average are smaller (TOTA, MCAP),

and reflect lower mean audit fees (LAFE) (mostly because of smaller size), lower systematic risk and market

model R2 (BETA and MMR2, respectively), and higher mean number of reportable events (RE#).10 Column 6

shows the significance of a t-test of the difference in the dismissal mean less the resignation mean for each

continuous variable. For the nominal variables (definitions in table 1), resignation companies reflect more

instances of RE (=1 for at least one reportable event, 0 otherwise), GCRN, and LOSS, and fewer instances of

BIGN (= 1 if Big 4 or 5 incumbent auditor–Andersen through 2002, Deloitte, Ernst & Young, KPMG,

Pricewaterhouse Coopers, 0 otherwise). Also, consistent with prior research, the overall percentage of the

sample with at least one RE event is quite low (6.82 percent), making such event a relatively infrequent news

item for investors. Column 6 uses a test of differences in proportions to assess the significance of the

difference for each nominal variable. To the extent that such characteristics might help explain investors’

response to an auditor change announcement beyond the auditor change attributes, we include them as an

economic or control variable in our analysis (section 3).11

Finally, we examine the distribution of auditor change filing dates relative to the closest Form 10-Q

earnings release date (QERD) (up to 45 calendar days in either direction). Unreported results show a

reasonably even distribution of auditor change filing dates across time relative to the QERD, other than a

small spike approximately every seven days. Our Form 8-K filing dates do not, therefore, cluster noticeably

around earnings release dates, which concentrate mostly around the Form 10-Q due date (Griffin 2003),

which might otherwise influence the results.



























































10
The result that mean BETA and MMR2 from the market model are lower for resignation companies versus dismissal
companies is consistent with a positive relation between a resignation announcement and unsystematic risk (1-MMR2);
another reason why investors might interpret a resignation announcement worse than a dismissal announcement.
11
The fact that a variable in panel D of table 1 does not differ significantly across dismissals and resignations (e.g.,
LITG, ZSCR, EGRW) does not imply that such a variable might not explain investors’ response to an auditor change
announcement.


 7

 In brief, the industry mix of our sample appears representative of the broader population, we see no

obvious signs of event clustering, and the differences between the dismissal and resignation subsamples are

as we would expect and consistent with earlier studies. Also consistent with prior work, the fiscal year

distribution of auditor changes shows higher resignation frequencies after 2002, presumably due to SOX.

4. Results


4.1 Univariate analysis

Table 2 summarizes the mean daily excess stock return from days -5 to 5 relative to the auditor change

filing date on the basis of key partitions of the sample.12 The table also reports cumulative mean excess

return (a) around the auditor change filing date (filing days -1 to 1), (b) around the auditor change event date

(event days -1 to 1), and (c) from event day -1 to filing day 1 (event -1 to filing 1), a varying number of days.

We calculate these return metrics for the following partitions: (a) all dismissal and resignation, (b) timely

dismissal and resignation, (c) reportable event disclosure, (d) company size, (e) Big N incumbent auditor (f)

delay in engagement, (g) reduced earnings growth, (h) prior litigation, and (i) bankruptcy risk. Given our

earlier discussion (section 2), we expect that excess stock return should be negative (or at least non-positive)

conditional upon disclosure of an auditor change for companies with resignations (especially timely

resignations), delayed engagement, reduced growth, prior litigation, and higher bankruptcy risk. Investors

should respond to such auditor change information at or around the filing date, or earlier if significant

information leakage occurs.

Table 2 (column 4) shows a mean excess return of -2.196 percent for filing days -1 to 1 for companies

with a timely resignation, significant at less than one percent versus a null hypothesis of zero excess return

(see row Sig. vs. 0) and also significant relative to the mean price response to a timely dismissal of -0.074

percent (column 3) (see row Sig. vs. prior col.). Table 2 uses one-tailed tests of significance. In contrast, the



























































12
We define excess return as market-adjusted return for company i for day t, i.e., XRit = Rit – Rmt, where Rit is the stock
return for company i for day t and Rmt is the CRSP daily NYSE/AMEX value-weighted market index. We also examine
our results based on excess return estimated from a market model in section 5.


 8

mean excess return for timely resignations for event days -1 to 1 of -0.244 percent is insignificant.13 Figure 1

graphs the cumulative mean excess return for filing days -10 to 10 for timely dismissals and resignations.

Unlike timely dismissals, we observe a steep drop in cumulative mean excess return for timely resignations

for filing days -1 to 3 of -3.202 percent. Figure 1 also shows an equivalent cumulative mean excess return

for filing days -1 to 3 for timely resignations in the post-SOX sub-period of -4.200 percent.14

Overall, the excess return measures in table 2 mostly confirm what we know from previous research.

Investors respond negatively to resignation announcements (and more negatively to resignations versus

dismissals) and more strongly for timely resignation announcements aligned to the filing date rather than the

event date.15 Investors do not seem to respond to dismissals at the filing date. However, we do observe a

small but significant response of -0.288 percent for all dismissals (but not timely dismissals) for event days

-1 to 1 (column 1), possibly related to small firms (column 8) with prior litigation (column 16) or higher

bankruptcy risk (column 18). Table 2 also shows no difference in mean excess return for an auditor change

with or without a reportable event (columns 5 and 6), although in later analysis we do find, consistent with

previous research (e.g., Whisenant et al. 2003), that investors’ response to an auditor change varies for

specific kinds of reportable event, in particular, an auditor-client disagreement and a disclosure of non-

reliance. Investors also act as if they condition their response on more fundamental factors. Auditor change

announcements involving smaller companies, Big N auditors, reduced earnings growth, prior litigation, and

higher bankruptcy risk all reflect a significant negative price response on filing day 0, and such response is

also significant for filing days -1 to 1 for companies with reduced earnings growth, prior litigation, and

higher bankruptcy risk.16 Table 2, thus, supports the notion that more fundamental factors may drive



























































13
Unreported analysis shows the equivalent adjusted price change for a timely resignation around filing days -1 to 1 in
the period after SOX passage is -3.053% (significant at <1% ), and -0.467% around the event date (not significant).
14
Unreported analysis shows the equivalent adjusted price change for a timely dismissal around filing days -1 to 1 in
the period after SOX passage is 0.172% (not significant), and 0.234% around the event date (not significant).
15
This is not to suggest, however, that an untimely resignation announcement is not newsworthy, rather that investors’
response decreases in delay because the resignation news has more chance to dissipate over the longer interval between
event date and the date of eventual public disclosure.
16
Unreported analysis shows that the mean expected earnings growth rate for resignation companies declines by 153
basis points over months -2 to 1, whereas the mean earnings growth rate for dismissal companies remains flat. In other
words, relative to dismissals, security analysts decrease their growth expectations for resignation companies within one


 9

investors’ response to an auditor change announcement. But lack of control for the mandated auditor change

disclosures renders such univariate results unreliable. We, therefore, conduct a multivariate analysis.

4.2 Multivariate regression analysis

This sub-section summarizes the results of multiple regression analyses to examine the extent to which

litigation and bankruptcy risk, future profitability, and other factors might significantly explain investors’

reaction to auditor changes, especially to resignations, after controlling for the mandated auditor change

disclosures studied in prior research. Given the results in table 2 (and figure 1), our analysis focuses on

timely auditor change announcements.

Table 3 presents the results of estimating the following cross-sectional model for companies with a

timely auditor change (without company or time subscripts for convenience):

XR_FLG-1,1 = α + ∑jβjAUDCj + ∑kφkECONk + ∑jkλjkAUDCj.ECONk + ∑mηmCNTLm + ε, (1)

where XR_FLG-1,1 = cumulative excess stock return for days -1 to 1 relative to auditor change filing date;

AUDCj = mandated auditor change disclosure j; ECONk = economic characteristic k that might condition

investors’ response; AUDCj.ECONk = interaction of auditor change disclosure j and economic attribute k;

CNTL = other control variable m; and ε = random error.

We expect the following coefficient signs for the AUDC and ECON variables: (a) negative coefficients

for AUDCj because investors’ response should be more negative for resignations (RSGN = 1 for a

resignation, 0 for a dismissal), auditor changes with reportable events (RE = 1 for at least one reportable

event, 0 otherwise; DIS = 1 for an auditor-client disagreement, 0 otherwise; RE_IC = 1 for an internal control

reportable event (Item 304a(1)(v)(A)), 0 otherwise; and RE_REL = 1 for a management reliability reportable

event (Item 304a(1)(v)(B)), 0 otherwise), a prior going concern audit opinion (GCRN = 1 if a going concern



























































to two months of an auditor change. Such a shift in earnings growth rate, however, does not imply that analysts
anticipate or even respond to auditor changes but, rather, that analysts’ forecasts more likely reflect one or more of the
economic factors that condition investors’ response to an auditor change. Also, these growth rate trends for dismissals
and resignations are not noticeably more or less pronounced conditional on the proximity of an auditor change to the
quarterly earnings announcement date. Unreported analysis shows a mean excess return for filing days -1 to 1 of
-6.22% for resignations with high litigation risk versus -2.19% for dismissals with high litigation risk.


 10

opinion in auditor change year t-1, 0 otherwise), and engagement delay (ENGD = 1 if no concurrent

disclosure of replacement auditor, 0 otherwise); (b) negative coefficients for the ECON variables litigation

risk (LITG = 1 if class action securities litigation, late Form 12b-25 (NT) filing, or restatement prior to year t,

0 otherwise) and bankruptcy risk (ZSCR = Altman measure of bankruptcy risk at the end of year t-1 times

minus one); (c) a positive coefficient for the ECON variable expected earnings growth (EGRW = 1 if change

in expected earnings growth from month -2 to 1 relative to auditor change month rate less than median

change in IBES growth rate, 0 otherwise); (d) negative coefficients for the interactions of auditor change and

litigation risk and bankruptcy risk (RSGN.LITG and RSGN.ZSCR); and (e) a positive coefficient for the

interaction of RSGN.EGRW.17

Model 1 also includes additional control variables (CNTL), namely, other factors that prior research has

shown to influence the significance of an auditor change. As control variables, however, we do not predict

the signs of the coefficients. The variables are: SIZE (natural log of total assets at the end of t-1), AA02 (= 1

if auditor change an Andersen dismissal in 2002, 0 otherwise), BIGN (= 1 if Big 4 or 5 incumbent auditor–

Andersen through 2002, Deloitte, Ernst & Young, KPMG, Pricewaterhouse Coopers, 0 otherwise), and

MKBK (market to book ratio at the end of t-1). We also include XR_FLG-5,-2 (cumulative excess return for

filing days -5 to -2) and XR_EVT 0 (excess return for event day 0) in the regressions to control for possible

information received by investors in days -5 to -2 relative to filing date and day 0 relative to event date that

might influence filing day -1 to 1 excess return. To the extent that these prior excess return variables might

capture some anticipation of an auditor change, our tests based on a three day event window should be more

conservative. However, as robustness tests, we also estimate model 1 without these return variables (with no

change in the results, see section 5), and, alternatively, we check for the effects of other information around

the auditor change announcement by estimating model 1 for a reduced sample of “uncontaminated”



























































17
The expected signs of the coefficients capture the effect of investor’s response around an auditor change filing date
conditional on the economic variable. For example, we expect a negative coefficient for LITG because investors can be
expected to condition their response to a resignation or dismissal on company litigation risk, among other attributes, and
a negative coefficient for RSGN.LITG because litigation risk should condition a resignation more than a dismissal,
although some companies may choose to report a resignation as a dismissal in an attempt to manage the expected
adverse price consequence of a resignation. Turner et al. (2005) report that client-initiated auditor changes (dismissals)
“occur more frequently over disagreements about such issues as internal control weaknesses and the reliability of
financial reporting.” (p.12).


 11

observations, defined as an auditor change filing date with no earnings or dividend announcement and no

other Form 8-K filing within plus or minus five days of the auditor change filing date.

The columns in table 3 estimate different versions of model 1 depending on the independent variables

included. Columns 1-4 estimate model 1 with all AUDC, ECON, and CNTL variables and with zero, one

(RSGN.LITG), two (RSGN.LITG, RSGN.ZSCR), and three (RSGN.LITG, RSGN.ZSCR, RSGN.EGRW)

interaction variables, respectively. Columns 5, 6, and 7 use only mandated auditor change disclosures

(AUDC) as the independent variables and, hence, follow the research design in Whisenant et al. (2003).18

Column 8 uses RSGN, all ECON and CNTL variables, and three RSGN.ECON interactions. We use this last

regression to test the incremental explanatory power of the mandated auditor change attributes other than

RSGN, that is, RE, DIS, RE_IC, RE_REL, GCRN, and ENGD, over the fundamental and control variables

(ECON and CNTL) and the three RSGN.ECON interaction variables.

Table 3 offers the following results. First, with regard to the AUDC variables, regression 1 shows

significantly negative coefficients for a resignation versus a dismissal (RSGN), a related event disclosure

about the reliability of management (RE_REL), and a prior year going concern audit opinion (GCRN). The

signs of the remaining AUDC coefficients are also negative, but not significant. In addition, regression 1

shows significantly negative coefficients for LITG and ZSCR and a positive coefficient for EGRW (not

significant). Also significant in regression 1 are BIGN (negative) and the controls for market response other

than during filing days -1 to 1. Regression 1, therefore, evidences that both the AUDC and the ECON

variables drive investors’ response to an auditor change announcement.

Second, regressions 2, 3, and 4 add the RSGN.ECON interaction variables to the model and, therefore,

test whether investors condition their response to a resignation on ECON variables, in addition to the main

effects of the ECON variables in the regression, and they do. Consistent with our research expectations, each

regression shows significantly negative coefficients for RSGN.LITG and RSGN.ZSCR and a positive

coefficient for RSGN.EGRW (not significant). The coefficients for the main effects of the ECON variables



























































18
We include ENGD as an AUDC variable because Form 8-K filing instructions require a registrant to either report the
incoming audit firm at the time of resignation or dismissal, or if not, report it in a later filing.


 12

remain predictably significant as before. The coefficients for RE_REL and GCRN also remain significantly

negative. On the other hand, the coefficient for RSGN in regressions 2, 3, and 4 is insignificant, though

negative. These findings suggest that the market response to an auditor resignation takes on primary

importance to an investor only when conditioned by other information, which in this case are the ECON

variables in model 1.

Third, regressions 1-4 also show consistent results for the CNTL variables. Companies with a Big N

incumbent auditor (BIGN) experience lower returns around an auditor change announcement. Company

assets (SIZE), growth expectations (MKBK), and the Andersen dismissals in 2002 (AA02), on the other hand,

do not influence the multivariate results. Lastly, we note that the market response around filing days -1 to 1

relates negatively to news during filing date days -5 to -2 (XR_FLG-5,-2) and positively to news around the

event date (XR_EVT 0) (consistent with some leakage of auditor change information around such date). We

also estimate all the regressions in table 3 without the two controls for stock return outside of the filing event

window. Untabulated analysis indicates no qualitative difference in the coefficients for the main and

interaction effects of the ECON variables under this alternative (discussed further in section 5).

Fourth, we comment on regressions 5-7, which essentially replicate equations 1 and 2 of Whisenant et

al. (2003, table 4) on our sample. We labeled our variables equivalently for convenience. Regressions 6 and

7 show a significantly negative response to a resignation (RSGN) and an auditor-client disagreement (DIS)

but not to reportable events in general (RE) and, thus, we only partially confirm the results for equation 1 of

Whisenant et al. (2003, table 4, panel A).19 In addition, regressions 6 and 7 show a significantly negative

coefficient for REL_RE and DIS but not for REL_IC, which is fully consistent with the results for equation 2

of Whisenant et al. (2003, table 4, panel B). Unlike the earlier study, however, regressions 5-7 of table 3

show a significantly negative coefficient for RSGN. We conjecture that two important considerations may



























































19
This results differs from Whisenant et al. (2003, table 4, panel A), who show a significantly negative coefficient for
RE, whereas we show an insignificantly negative coefficient. This could be due to differences in time periods (2000-
2005 versus 1993-1996), methods of obtaining the data (Audit Analytics versus manually collected), our partition on
timely announcements, and possibly the investor/auditor environment. However, they are unlikely caused by a
difference in the type of events analyzed, as we applied the same Item 304(a)(1)(v) classifications to the reportable
events data.


 13

explain this difference: one, we partition our sample on timely auditor change announcements (table 2 shows

a more negative response to timely versus untimely announcements) and, two, we examine several years

following SOX, which we contend because of changed audit risk thresholds may have made resignation

announcements more newsworthy (section 2). We examine differences in investor response for the pre-SOX

and post-SOX sub-periods (before and after July 25, 2002) in the next section.

The final step tests whether the explanatory power of the ECON and CNTL variables as a group

significantly exceeds the explanatory power of the auditor change variables as a group (AUDC), and whether

the AUDC variables as a group contribute to the regression incremental to the ECON and CNTL variables.

We examine this using an F-test of the difference in regression R2 (Kmenta 1997) between regression 4 and

the other regressions in table 3. We observe the following. First, each incremental R2 is significant for

regressions 1-3. Thus, the addition of one, two, or three RSGN.ECON interaction variables as a group adds

significantly to the explanatory power of model 1. Second, each incremental R2 is significant for regressions

5-7. In other words, the ECON, RSGN.ECON, and CNTL variables as a group add significantly to model 1

beyond the explanatory power of the included AUDC variables alone. Note that the increase in adjusted R2

is substantial–from less than one percent in regressions 5-7 to more than 10 percent in regressions 2-4.

Third, the incremental R2 for regression 8 shows that the AUDC variables other than RSGN also add

significantly to the regression. This occurs primarily because of the importance of RE_REL and DIS. To

summarize, these tests of incremental explanatory power support the view that investors’ reaction to an

auditor change announcement, apart from the control variables, is driven by three influences: (1) underlying

economic factors, (2) the interaction of those underlying factors with the event of an auditor resignation and,

to a lesser degree, (3) the mandated auditor change disclosures as documented in the prior research. The

underlying economic factors and the interactions are important because they condition investors’ response to

a resignation in a significant and predictable way. This is not to say, though, that the mandated auditor


 14

change disclosures are unimportant, rather that, as a group, they simply add less statistical power to the

overall regressions relative to the economic variables.20

5. Additional
tests


5.1 The impact of SOX on the regression analysis

One consequence of SOX was to lower risk thresholds for auditors, thereby making an audit more

costly and risky due to increased audit effort and litigation exposure (discussed in note 5 and section 2). As a

result, some auditors chose to resign rather than increase fees to price-protect themselves from the higher

exposure induced by SOX (Owens-Jackson et al. 2008). Under such circumstances, a resignation

announcement after SOX could signal additional information about client risk heretofore not disclosed in a

pre-SOX auditor change disclosure. We, therefore, replicate our results on the incremental explanatory

power of the ECON (and CNTL) variables over the AUDC variables split by pre- and post-SOX observations.

Table 4 presents the results for the same regressions as in table 3 for post-SOX auditor changes (results for

pre-SOX changes available on request). First, table 4 indicates that the post-SOX coefficients are mostly

unchanged from table 3. The incremental R2s for the ECON and RSGN.ECON variables are significant as a

group and, the individual coefficients are mostly significant in the predicted direction as per table 3. The

main difference is that the post-SOX RSGN coefficient increases negatively. In addition, the adjusted R2s for

regressions 5-7 are higher, and the incremental R2 for regression 8 is significant at less than one percent,

indicating that both RSGN and the other AUDC variables contribute significantly to the regression in the

post-SOX sub-period. Unreported analysis, on the other hand, shows that the equivalent incremental R2 for

regression 8 for the pre-SOX observations is insignificant. That is, the non-RSGN auditor change variables



























































20
We also examined the correlation matrix of the explanatory variables in the table 3 regression models. While some
variables are correlated, unreported analysis indicates that none of the correlations exceeds conventional thresholds for
significant collinearity, as per the criteria in Judge et al. (1988). None of the collinear variables should, thus, threaten
our tests based on model 1; for example, our F-tests of the excess of R2 with the AUDC and ECON variables over R2
without the ECON variables. The relative stability of the signs and significance of the ECON coefficients in the table 3
regressions with and without the control variables is also consistent with the absence of significant collinearity as a
factor that could affect our tests.


 15

in the pre-SOX sub-period have no incremental ability to explain investors’ response once we include for the

ECON, RSGN.ECON, and CNTL variables.

This shift in the coefficient for RSGN could be an indication that a post-SOX resignation announcement

signals more information about client risk than an equivalent announcement prior to SOX, which might

otherwise be captured better by more fundamental risk factors such as LITG and ZSCR. We test for the

significance of a possible shift in the coefficient for RSGN by adding to model 1 an indicator variable SOX

(SOX = 1 for auditor change announcements after July 25, 2002, 0 otherwise) and an interaction variable

SOX.RSGN. Given the preceding, we should observe negative coefficients for SOX and SOX.RSGN.

Unreported results show that the regression coefficients for SOX and SOX.RSGN are indeed negative, but

they are not significant at conventional levels. We also find that, despite such possible shift in the RSGN

coefficient in the post-SOX sub-period, our overall conclusion about the explanatory role of the ECON

variables does not change; that is, the addition of the ECON and RSGN.ECON variables to the model adds

significantly to explaining investors’ response to an auditor change announcement after controlling for SOX.

But, contrariwise, the variables to reflect the mandated auditor change disclosures including SOX and the

SOX interaction as a group add no significant explanatory power to the ECON variables to explain investors’

price response, despite the fact that the simple regressions with the AUDC variables, SOX, and the

SOX.RSGN interaction but excluding the ECON variables show significant coefficients for some of the

AUDC variables.

5.2 Concurrent information

Investors’ response to an auditor change filing could also be affected by (a) information from other

sources in the event window such as an earnings or dividend announcement or (b) other information in the

auditor change Form 8-K filing. To check for the effect of concurrent (or contaminating) information, we

first re-estimated the regressions in tables 3 and 4 excluding from the sample those observations within plus

or minus five days of the auditor change filing date with an earnings release, a dividend declaration or

dividend record date, or another Form 8-K filing. We chose an 11-day (versus a three-day) window to

include both the auditor change filing date and event date associated with a timely filing. This reduced the

number of dismissal (resignation) observations by 417 (66) or 19.3 (18.1) percent of the overall sample.


 16

Unreported analysis shows that when we restricted the sample to uncontaminated timely observations (i.e.,

no earnings or dividend announcements and no other Form 8-K within +/- 5 days of auditor change filing

date), in none of the tests in tables 3 and 4 did the sign or significance of the models’ coefficients or the

significance of the increase in the regression R2s with and without the ECON and RSGN.ECON variables

change qualitatively. Our conclusion about the role of the economic fundamentals in explaining investors’

response to dismissals and resignations is, thus, robust to this alternative analysis.21 Second, we examined

the sensitivity of our results to other Form 8-K disclosures made concurrently with the auditor change filing.

Based on an analysis of the Form 8-K filing event tags (SEC 2004a), we found that 23 percent of our sample

made an auditor change disclosure only (Item 4.01), 71 percent combined an auditor change disclosure with

a financial statement exhibit disclosure (Item 9.01), and six percent combined an auditor change disclosure

with one or more non-Item 9.01 disclosures (change in articles of incorporation, change in control,

completion of acquisition).22 When we based the regressions on auditor change filings with or without a

concurrent Form 8-K disclosure, the signs or significance of the models’ coefficients and the significance of

the increase in the regression R2s did not change qualitatively.

5.3 Other tests

In unreported analysis, we found no qualitative difference in the regression results in tables 3 and 4

when we subjected our results to the following sensitivity tests. First, we calculated XR_FLG-5,-2 and

XR_EVT 0 based on market model residuals, where we estimated market beta and alpha cross-sectionally for

each day from before to after the auditor change date for dismissal and resignation companies separately.

Second, we included industry dummy variables in model 1 to check if any one industry, e.g., technology

companies, dominated the results, and when we excluded the Arthur Andersen dismissals in 2002 from the



























































21
We also found in unreported analysis that the negative reaction to a timely resignation increased for the
uncontaminated sub-sample, although the increase was not significant. For example, the coefficient for RSGN in
regression 5 of table 3 dropped from -1.50% (p-value < .05) to -1.56% (p-value < .05) when estimated for the
uncontaminated sub-sample only, but the difference in the coefficients was not significant.
22
Inspection of the actual Item 9.01 disclosures showed that such disclosures were almost exclusively (with one
exception) a statement of confirmation by the auditor of the change in accountants.


 17

sample (and excluded AA02 from the regression model).23 Third, we defined RE (and RE_IC or RE_REL) as

the number of reportable disclosures associated with an auditor change event. Fourth, we estimated model 1

including a dummy variable to indicate whether a dismissal or resignation occurred within the Big N or non-

Big N tier (a lateral change) or whether it involved a change of tier (a non-lateral change). Fifth, we

replicated the regressions for all available observations for each regression rather than using 1,096

observations common to all regressions in table 3, and 478 common observations in table 4. Sixth, we

replicated the analysis by defining a timely filing change as one based on the filing dates extracted from an

alternative data source (in this case, Direct Edgar).24

Seventh, we replicated the analysis adding PRED and PRED.RSGN to model 1, where PRED was

assumed to proxy for whether the auditor change announcement in year t might not have been predictable

from t-1 information. Johnson and Lys (1990) reason that an auditor change announcement has little

information content because most of the underlying data are predictable. We defined PRED = 1 if the

auditor change were unanticipated, 0 otherwise, and based such unanticipated change on an estimate of

unexpected audit fee, that is, the difference between actual and expected audit fee in year t-1 from an audit

fee model (Hay et al. 2006). Following Ettredge et al. (2007), we assumed that an unanticipated auditor

resignation occurs in year t when the t-1 audit fee is higher than expected and resignation occurs, and an

unanticipated dismissal occurs in year t when the t-1 audit fee is lower than expected and dismissal occurs.

In unreported results, we found that the addition of PRED and PRED.RSGN to the regressions in tables 3 and

4 did not change our overall conclusion about the incremental explanatory power of the economic variables

relative to the auditor change variables.

As a final check on the results, we also estimated the regressions in tables 3 and 4 based on the full

sample of timely and untimely auditor change events. Consistent with the univariate results in table 2,



























































23
Studies of investors’ response to the 2002 Andersen dismissal announcements show a positive effect (Krishnamurthy
et al. (2006) for Big N replacement auditors), no effect (Chaney and Philipich 2002), and a negative effect
(Krishnamurthy et al. (2006) for non Big N replacement auditors). These studies do not, however, control for auditor
change attributes or other company information that may condition such response.
24
Unreported analysis also showed that while some Audit Analytics filing dates reflect a later, amended filing or the
announcement of the replacement auditor, most untimely filings remained “untimely” when subjected to such
alternative data source (and manual inspection of the later Form 8-Ks).


 18

unreported analysis showed insignificant coefficients for RSGN when we estimated the regressions using the

full sample. Yet, the ECON and RSGN.ECON variables continued to significantly explain investors’

reaction. Also, the addition of the AUDC variables, other than RSGN, generated no incremental change in R2

beyond the ECON and CNTL variables. In other words, our conclusion about the explanatory role of the

ECON variables is robust to the timeliness of an auditor change announcement.

6. Summary
and
conclusions


This study builds upon prior findings and documents that investors’ negative response to an auditor

change depends mostly on economic fundamentals and, more specifically, on how these fundamental

variables condition investors’ response to a resignation. Dismissal announcements generate no reliable

investor reaction. The negative response to a resignation persists when we control for mandated disclosures

about reportable events and auditor-company conflicts that may accompany auditor change filings. When

we further control for fundamental factors that may condition the news value of an auditor change such as

litigation and bankruptcy risk and change in expected earnings growth, our ability to explain investors’

response to an auditor change increases significantly. However, we also find that mandated auditor change

disclosures as a group (other than knowledge of a resignation) have significant ability to explain investor’s

response beyond the fundamental variables. This occurs primarily because of two relatively infrequent

reportable event disclosures, namely, disclosure of an auditor-client disagreement and a statement of non-

reliance on management’s representations. Our results are robust to alternative definitions and procedures,

for example, we draw the same conclusions when we control for contemporaneous earnings and dividend

announcements and partition the sample based on auditor changes before and after SOX.

In closing, we interpret our results to suggest that investors’ response to a resignation is driven primarily

by company attributes such as litigation and bankruptcy risk and other factors not required as mandated

disclosures. While prior research has documented the explanatory role of reportable events and conflict

disclosures conditional upon an auditor change announcement, our results should be of special interest and

relevance for investors because so many companies choose not to report disagreements and other reasons for

an auditor change, and when they do they may disclose such reasons in a way so as to minimize their news

value. On the other hand, investors can be expected to interpret an auditor change conditional on all


 19

generally available information, and not just information in a particular disclosure or filing, and this is

consistent with what we find. Indeed, it is difficult to imagine an investor attempting to interpret and

respond to an auditor change–dismissal or resignation–devoid of information beyond the filing per se. Under

this interpretation, while mandated auditor change disclosures may sometimes be relevant, in general, it

appears that from an investor standpoint, when available, they may also partially serve as proxies for the

more fundamental factors, such as those that we find to condition investors’ response.

While the prior literature and accounting professionals may have alluded to the role of mandated auditor

change variables as proxies for more fundamental factors or early warning signals, our study is the first of

which we are aware to document with appropriate statistical reliability that this is in fact so. As with any

empirical study, our results are conditional on the data, models, and analytical techniques. We use a recent

and comprehensive sample, and the auditor change events are well distributed over the study period; so, an

event study approach is reasonable and appropriate. Additional research could test whether the price

response we observe to a resignation announcement differs from the price response to a matched sample of

companies with similar disclosures about earnings expectations and risk but without a resignation, although

such study would also have to control for information transfer.


 20

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 22

Figure
1

Cumulative
Mean
Excess
Return
Around
Auditor
Change
Filing
Date




1.00
Cumulative Mean Excess Return (%)

0.00

-1.00
Timely
Dismissal
-2.00
Timely
-3.00 Resignation

-4.00 Timely
Resignation:
Post-SOX
-5.00
-10
-9
-8

-6
-5
-4
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
-7

Day Relative to Filing Date

This figure plots the cumulative mean excess return (%) around the auditor change filing date (day 0)
cumulated from day -10 to 10. A timely auditor change filing occurs when the SEC filing date follows the
auditor change event date within five business days (four after 2004).


 23

Table
1

Sample
Characteristics


Panel A: Auditor Changes By Type and SIC Group

CRSP/
Auditor Change Category Dismissal1 Resignation All1 Dismissal1 Resignation All1 Comp.2
SIC
Industry Group Count Count Count Percent Percent Percent Percent
0000-
Agriculture, Fishing, Forestry 0999 5 0 5 0.20% 0.00% 0.20% 0.30%
1000-
Mining, Construction 1999 156 15 171 7.20% 4.10% 6.77% 4.80%
2000-
Manufacturing-I 2999 263 44 307 12.20% 12.10% 12.16% 12.90%
3000-
Manufacturing-II 3999 523 93 616 24.30% 25.60% 24.41% 22.40%
Transport, Communications 4000-
Electricity, Gas 4999 171 18 189 7.90% 4.90% 7.49% 8.50%
5000-
Wholesale Trade, Retail Trade 5999 178 15 193 8.20% 4.10% 7.65% 7.80%
6000-
Finance, Insurance, Real Estate 6999 409 104 513 18.90% 28.60% 20.32% 26.70%
7000-
Services, General 7999 360 57 417 16.70% 15.70% 16.52% 12.70%
Services, Health, Social, 8000-
Professional 8999 80 16 96 3.70% 4.40% 3.80% 3.40%
9000-
Public Administration 9999 15 2 17 0.70% 0.50% 0.67% 0.50%
All 2,160 364 2,524 100.00% 100.00% 100.00% 100.00%

Panel B: Auditor Changes By Type, Days to Filing, and Fiscal Year

Auditor Timely3 Untimely All Dismissal Timely3 Untimely All Resignation
Year Change1 Dismissal Dismissal % Resignation Resignation %
2001 302 148 120 12.41% 14 20 9.34%
2002 1,168 763 352 51.62% 28 25 14.56%
2003 348 145 130 12.73% 25 48 20.05%
2004 495 237 122 16.62% 43 93 37.36%
2005 211 124 19 6.62% 40 28 18.68%
All 2,524 1,417 743 100.00% 150 214 100.00%

Panel C: Auditor Changes by Type, Days to Filing, and Filing Month

All All Non-
Auditor Timely3 Untimely Dismissal Timely3 Untimely Resignation Andersen
Change1 Dismissal Dismissal % Resignation Resignation % Dismissal %
January 85 52 20 3.33% 11 2 3.57% 5.63%
February 89 45 27 3.33% 5 12 4.67% 5.31%
March 190 115 51 7.69% 13 11 6.59% 9.30%
April 375 216 97 14.49% 27 35 17.03% 14.69%
May 468 292 136 19.81% 24 16 10.99% 12.11%
June 392 256 113 17.08% 10 13 6.32% 11.25%
July 268 152 92 11.30% 8 16 6.59% 7.34%
August 154 68 55 5.69% 9 22 8.52% 5.70%
September 129 52 42 4.35% 9 26 9.62% 7.19%
October 163 81 46 5.88% 9 27 9.89% 9.84%
November 103 43 30 3.38% 14 16 8.24% 5.55%
December 108 45 34 3.66% 11 18 7.97% 6.09%
All 2,524 1,417 743 100.00% 150 214 100.00% 100.00%

Continued on next page.


 24

Panel D: Other Sample Characteristics
Sample Dismissal1 Resignation
No. of
Variable/Statistic4 Mean Median Mean Median Prob. > |t| Signif.5 obs.
1 2 3 4 5 6 7
I. Continuous variables
TOTA t-1, $ millions 3020.39 187.62 771.92 98.81 0.0002 *** 2,437
MCAP t-1, $ millions 1791.27 121.09 444.85 66.82 <.0001 *** 2,442
MKBK t-1 1.60 0.95 1.67 0.99 0.6397 ns 2,403
ZSCR t-1 4.02 3.30 3.71 3.56 0.6690 ns 1,971
DEBT t-1, % 33.23 18.96 29.13 11.14 0.1341 ns 2,417
LAFE t-1 12.28 12.11 12.15 12.07 0.0691 * 2,164
(LAFE t / LAFE t-1)-1, % 6.73 0.95 5.96 0.00 0.7639 ns 1,837
Change in EGRW months -5, 5, % -0.645 -0.064 -0.925 0.000 0.5218 ns 1,016
Change in EGRW months -5,-1, % -0.266 0.000 -0.648 0.000 0.1960 ns 1,016
Change in EGRW months -2, 1, % -0.311 0.000 -0.612 0.000 0.4438 ns 1,016
BETA, days -100,-1 1.025 0.903 0.917 0.880 0.0335 ** 2,524
MMR2, days -100,-1 0.105 0.054 0.081 0.035 0.0003 *** 2,494
RE# (no. of events), t 0.144 0.000 0.473 0.000 <.0001 *** 2,524
II. Nominal Variables
RE t 0.060 0.000 0.170 0.000 0.0025 *** 2,524
GCRN t-1 0.039 0.000 0.085 0.000 0.0013 *** 2,524
LITG t-1 0.094 0.000 0.113 0.000 0.2816 ns 2,524
LOSS t-1 0.403 0.000 0.504 1.000 0.0006 *** 2,428
BIGN 0.859 1.000 0.701 1.000 <.0001 *** 2,524

Notes to table 1.
1. Includes 628 Arthur Andersen involuntary dismissals in 2002.
2. CRSP/Comp. refers to the merged CRSP/Compustat data base.
3. A timely auditor change filing occurs when the Form 8-K filing date follows the auditor change event
date within five business days (four after 2004).
4. TOTA = total assets, year t-1; MCAP = market value of common shares, year t-1; MKBK = ratio of
MCAP to book value of common shareholders’ equity; ZSCR = Altman measure of bankruptcy risk, year
t-1 times minus one; DEBT = ratio of long-term debt to MCAP, year t-1; LAFE = log of audit fee for
incumbent auditor for year t-1; EGRW= consensus IBES expected five-year earnings growth rate at the
end of month t; BETA = market model systematic risk estimated over days -100 to -1 relative to 8-K
filing date; MMR2 = market model R2, estimated over days -100 to -1 relative to 8-K filing date; RE# =
number of reportable event disclosures in year t; RE = 1 if at least one reportable event disclosure in year
t, 0 otherwise; GCRN = 1 if a going concern audit opinion issued in year t-1, 0 otherwise; LITG = 1 if
class action securities litigation, late Form 12b-25 (NT) filing, or restatement prior to year t, 0 otherwise;
LOSS = 1 if year t-1 earnings before extraordinary items less than zero, 0 otherwise; BIGN = Big 4 or 5
incumbent auditor–Andersen through 2002, Deloitte, Ernst & Young, KPMG, and
PricewaterhouseCoopers.
5. Significance of two-tailed test of difference in means (t-test for continuous variables, difference in
proportions for nominal variables): *** = less than .01, ** = less than .05, * = less than .10, and ns=not
significant.


 25

Table
2

Mean
Excess
Return
Around
Auditor
Change
Filing
and
Auditor
Change
Event
Date

Reduced Reduced
Sample/subsample All All Timely Timely All All All All All All All All Growth Growth All All All All

Engagement

Engagement
Resignation

Resignation

Resignation

Bankruptcy

Bankruptcy
Small Coy.
Large Coy.

Non-Big N
Reportable

Reportable

Incumbent

Incumbent
Daily Excess
Dismissal

Dismissal

Dismissal

Litigation

Litigation
At Least
Return x 100

Higher
Lower
Big N

Delay

Delay
Event

Event

Prior
Relative to Filing

Risk

Risk
One
No

No

No
or Event Date 0
Partition1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
-5 -0.058 0.133 -0.060 0.226 -0.015 -0.226 0.062 -0.131 -0.060 0.119 -0.081 0.040 -0.280 -1.444 0.002 -0.343 -0.114 0.009
-4 0.095 0.056 0.031 0.341 0.104 -0.096 0.052 0.202 0.065 0.210 0.134 -0.082 -0.057 -0.133 0.114 -0.148 0.238 0.024
-3 -0.044 0.421 -0.076 0.481 0.000 0.301 -0.081 0.128 0.001 0.131 -0.105 0.279 -0.032 0.676 0.061 -0.334 0.009 -0.021
-2 -0.136 0.624 -0.097 0.382 -0.018 -0.124 0.052 -0.149 0.003 -0.175 -0.155 0.253 0.267 -0.097 -0.003 -0.248 0.299 -0.324
-1 0.060 0.097 0.006 -0.113 0.061 0.122 0.004 0.112 0.052 0.136 0.090 0.150 -0.292 -0.026 0.136 -0.595 0.306 -0.036
0 -0.048 -0.600 -0.065 -1.335 -0.107 -0.380 -0.013 -0.247 -0.147 -0.029 -0.038 -0.201 -0.065 -0.829 -0.091 -0.472 -0.129 -0.112
Sig. vs. 02 ns ** ns *** ns ns ns * * ns ns ns ns * ns * ns *
Sig. vs. prior col.2 ** *** ns ns ns ns ns ns ns
1 -0.003 -0.599 -0.015 -0.749 -0.123 0.333 -0.229 0.110 -0.155 0.247 0.015 -0.260 -0.021 -1.951 0.094 -1.808 0.024 -0.230
2 -0.129 0.012 -0.199 -0.462 -0.115 -0.029 -0.246 0.034 -0.065 -0.334 -0.080 -0.162 -0.008 0.054 -0.058 -0.581 -0.338 0.031
3 0.002 -0.264 0.049 -0.544 -0.062 0.277 0.011 -0.088 -0.100 0.285 0.004 -0.057 -0.090 -0.389 -0.128 0.819 0.004 -0.096
4 0.035 0.212 -0.063 1.120 0.078 -0.154 0.000 0.162 0.104 -0.160 0.161 -0.246 -0.137 0.649 0.068 -0.012 0.319 -0.040
5 0.091 0.039 0.107 0.020 0.123 -0.401 -0.022 0.138 0.086 0.066 0.140 -0.055 0.085 0.067 0.031 0.569 0.041 0.025
Filing date -1,1 0.010 -1.103 -0.074 -2.196 -0.169 0.076 -0.238 -0.024 -0.250 0.354 0.067 -0.310 -0.378 -2.805 0.139 -2.874 0.201 -0.378
Sig. vs. 0 ns ** ns *** ns ns ns ns * ns ns ns ns ** ns *** ns **
Sig. vs. prior col. ** ** ns ns ns ns ns *** **
Event date -1,1 -0.288 0.061 -0.234 0.244 -0.244 -0.157 -0.007 -0.449 -0.309 0.125 -0.410 0.235 -0.232 -0.792 -0.147 -1.090 -0.649 -0.127
Sig. vs. 0 ** ns ns ns * ns ns ** ** ns *** ns ns ns ns ** *** ns
Sig. vs. prior col. ns ns ns * ns ns ns ** ns
Event-1 Filing+1 -0.437 -0.961 -0.427 -2.079 -0.468 -1.054 -0.628 -0.428 -0.802 0.962 -0.486 -0.422 0.188 -3.110 -0.258 -2.902 -0.618 -0.873
Sig. vs. 0 ** ns * *** ** ns ** ns *** ns ** ns ns * ns *** * ***
Sig. vs. prior col. ns ** ns ns ns ns ns *** ns
No. of observations 2,160 364 1,417 150 2,161 363 1,201 1,236 2,110 414 1,827 506 480 51 2,164 360 987 914

Notes to table 2.
1. Definition of partition: Timely auditor change = Filing date follows the auditor change event date within 5 (4 after 2004) business days; Reduced growth (EGRW) = Change in
expected earnings growth from month -2 to 1 relative to auditor change month rate less than median change in IBES growth rate; Engagement delay (ENGD) if no concurrent
disclosure of replacement auditor; Litigation (LITG) = prior class action securities litigation, late Form 12b-25 (NT) filing, or restatement relative to year t; Bankruptcy risk
(ZSCR) = Altman measure of bankruptcy risk at the end of year t-1 relative to median in year t-1 times minus one.
2. Significance of one-tailed t-test of mean versus zero or one-tailed t-test of difference of column mean versus prior column mean: *** = less than .01, ** = less than .05, * = less
than .10, and ns=not significant.


 26

Table
3

Regression
of
Excess
Return
on
Auditor
Change,
Fundamental,
and
Control
Variables
for
Timely

Announcements1

XR_FLG-1,1 = α + ∑jβjAUDCj + ∑kφkECONk + ∑jkλjkAUDCj.ECONk + ∑mηmCNTLm + ε, (1)
Regression # 1 2 3 4 5 6 7 8
Variable2 Exp. Sign
Intercept 0.0329 0.0317 0.0317 0.0317 0.0152 0.0244 0.0255 0.0199
Significance3 ** ** ** ** * ** ** ***
RSGN – -0.0121 -0.0021 -0.0114 -0.0103 -0.0150 -0.0130 -0.0117 -0.0112
* ns ns ns ** * * ns
RE – 0.0011 0.0011 0.0013 0.0014 -0.0052 -0.0153 -0.0156
ns ns ns ns ns ns ns
DIS – -0.0107 -0.0107 -0.0104 -0.0104 -0.0148 -0.0242 -0.0244
ns ns ns ns * ** **
RE_IC – -0.0025 -0.0034 -0.0020 -0.0020 0.0149 0.0157
ns ns ns ns ns ns
RE_REL – -0.1542 -0.1384 -0.1451 -0.1452 -0.0868 -0.0862
*** *** *** *** ** **
GCRN – -0.0207 -0.0213 -0.0203 -0.0202 -0.0093
** ** ** ** ns
ENGD – -0.0057 -0.0044 -0.0051 -0.0051 -0.0035
ns ns ns ns ns
LITG – -0.0357 -0.0306 -0.0307 -0.0307 -0.0308
*** *** *** *** ***
ZSCR – -0.0006 -0.0006 -0.0007 -0.0007 -0.0006
*** *** *** *** ***
EGRW + 0.0009 0.0010 0.0009 0.0008 0.0009
ns ns ns ns ns
RSGN.LITG – -0.0469 -0.0402 -0.0403 -0.0498
** ** ** ***
RSGN.ZSCR – -0.0022 -0.0022 -0.0021
*** *** **
RSGN.EGRW + 0.0035 0.0034
ns ns
AA02 –/+ -0.0013 -0.0014 -0.0013 -0.0012 -0.0005
ns ns ns ns ns
SIZE –/+ 0.0014 0.0014 0.0014 0.0015 0.0013
ns ns ns ns ns
BIGN –/+ -0.0157 -0.0151 -0.0145 -0.0145 -0.0149
** ** ** ** **
MKBK –/+ -0.0006 -0.0006 -0.0008 -0.0008 -0.0009
ns ns ns ns ns
XR_FLG-5,-2 –/+ -0.1256 -0.1318 -0.1300 -0.1306 -0.1302
*** *** *** *** ***
XR_EVT 0 –/+ 0.3570 0.3570 0.3575 0.3587 0.3566
*** *** *** *** ***
Adjusted R2 9.99% 10.33% 10.73% 10.67% 0.15% 0.44% 0.36% 10.02%
F-test for Regression 8.60 8.42 8.31 7.88 1.56 1.97 1.57 10.38
Significance4 *** *** *** *** ns * ns ***
F-test for Incremental R2 2.78 3.23 4.23 1.71 1.76 1.83 2.21
Significance4 ** ** ns *** *** *** **
No. observations 1,096 1,096 1,096 1,096 1,096 1,096 1,096 1,096

Notes to table 3 on next page.


 27

Notes to table 3.
1. The dependent variable (XR_FLG-1,1) is the cumulative excess return for days -1 to 1 relative to
the auditor change filing date. Each column represents a different estimation of model 1
depending on the auditor change (AUDC), fundamental (ECON), interaction (AUDC.ECON), and
control (CNTL) variables. A timely auditor change filing occurs when the SEC filing date follows
the auditor change event date within five (four after 2004) business days.
2. Variable definitions.
AUDC variables: RSGN = 1 for a resignation, 0 for a dismissal; RE = 1 for at least one reportable
event, 0 otherwise; DIS = 1 for an auditor-company disagreement event, 0 otherwise; RE_IC = 1
for an internal control event, 0 otherwise; RE_REL = 1 for a reliability event, 0 otherwise; GCRN
= 1 if a going concern audit opinion issued in year t-1, 0 otherwise; and ENGD = 1 if no
concurrent disclosure of replacement auditor, 0 otherwise.
ECON variables: LITG = 1 if class action securities litigation, late Form 12b-25 (NT) filing, or
restatement prior to year t, 0 otherwise; ZSCR = Altman measure of bankruptcy risk at the end of
year t-1 times minus one; and EGRW = 1 if change in expected earnings growth from month -2 to
1 relative to auditor change month rate less than median change in IBES growth rate, 0 otherwise.
Interaction effects: RSGN.LITG = interaction of resignation and litigation risk; RSGN.ZSCR =
interaction of resignation and bankruptcy risk, and RSGN.EGRW = interaction of resignation and
change in long-term earnings growth.
CNTL variables: SIZE = natural logarithm of total assets at the end of year t-1; AA02 = 1 if
Andersen dismissal in 2002, 0 otherwise; BIGN = 1 if Big 4 or 5 incumbent auditor–Andersen
through 2002, Deloitte, Ernst & Young, KPMG, PricewaterhouseCoopers, 0 otherwise; MKBK =
market to book ratio at the end of year t-1; XR_FLG-5,-2 = cumulative excess return for auditor
change filing days -5 to -2; XR_EVT 0 = excess return for auditor change event day 0.
3. Significance of one-tailed t-test of coefficient of predicted sign versus zero (two-tailed test for the
control (CNTL) variables SIZE, AA02, BIGN, MKBK, XR_FLG-5,-2, XR_EVT 0)): *** = less than
.01, ** = less than .05, * = less than .10, and ns=not significant.
4. Significance of F-statistic. *** = less than .01, ** = less than .05, * = less than .10, and ns=not
significant.


 28

Table
4

Regression
of
Excess
Return
on
Auditor
Change,
Fundamental,
and
Control
Variables
for
Timely

Announcements
after
SOX1


XR_FLG-1,1 = α + ∑jβjAUDCj + ∑kφkECONk + ∑jkλjkAUDCj.ECONk + ∑mηmCNTLm + ε, (1)

Regression # 1 2 3 4 5 6 7 8
Variable Exp. Sign
Intercept 0.0203 0.0195 0.0236 0.0236 0.0171 0.0152 0.0162 0.0073
Significance2 ns ns ns ns ns ns ns ns
RSGN – -0.0129 -0.0083 -0.0139 -0.0139 -0.0320 -0.0147 -0.0124 -0.0148
** ns * * *** ** * *
RE – -0.0028 -0.0029 -0.0040 -0.0040 -0.0050 0.0054 0.0039
ns ns ns ns ns ns ns
DIS – -0.0124 -0.0129 -0.0171 -0.0171 -0.0152 -0.0112 -0.0108
ns ns ns ns ns ns ns
RE_IC – -0.0018 -0.0021 0.0031 0.0031 -0.0110 -0.0089
ns ns ns ns ns ns
RE_REL – -0.0784 -0.0617 -0.0606 -0.0606 -0.0989 -0.0937
*** *** *** *** *** ***
GCRN – -0.0112 -0.0118 -0.0084 -0.0084 -0.0115
ns ns ns ns ns
ENGD – -0.0029 -0.0013 -0.0033 -0.0033 -0.0075
ns ns ns ns ns
LITG – -0.0297 -0.0241 -0.0251 -0.0251 -0.0257
*** *** *** *** ***
ZSCR – -0.0001 -0.0001 -0.0002 -0.0002 -0.0002
ns ns ns ns ns
EGRW + -0.0003 -0.0003 -0.0002 -0.0002 -0.0002
ns ns ns ns ns
RSGN.LITG – -0.0290 -0.0278 -0.0277 -0.0466
* ns ns **
RSGN.ZSCR – -0.0026 -0.0026 -0.0023
*** *** ***
RSGN.EGRW + 0.0006 0.0010
ns ns
AA02 – -0.0053 -0.0056 -0.0069 -0.0069 -0.0069
ns ns ns ns ns
SIZE – 0.0066 0.0068 0.0069 0.0070 0.0063
ns * ns ns ns
BIGN – -0.0087 -0.0084 -0.0087 -0.0088 -0.0105
* * ns ns *
MKBK – -0.0009 -0.0009 -0.0019 -0.0019 -0.0020
ns ns * * **
XR_FLG-5,-2 –/+ -0.1238 -0.1300 -0.1171 -0.1170 -0.1089
*** *** *** *** ***
XR_EVT 0 –/+ 0.1806 0.1822 0.2577 0.2579 0.2721
*** *** *** *** ***
Adjusted R2 9.20% 9.38% 12.06% 11.86% 2.62% 3.87% 3.92% 9.63%
F-test for Regression 4.713 4.569 4.633 4.380 7.386 5.853 4.517 4.911
Significance3 *** *** *** *** *** *** *** ***
F-test for Incremental R2 2.793 3.242 4.242 1.720 1.773 1.839 2.222
Significance3 *** *** ns *** *** *** ***
No. observations 478 478 478 478 478 478 478 478

Notes to table 4.
1. Table 3 defines the variables. Each column represents a different estimation of model 1 depending
on the auditor change (AUDC), fundamental (ECON), interaction (AUDC.ECON), and control
(CNTL) variables.
2. Significance of one-tailed t-test of coefficient of predicted sign versus zero (two-tailed test for the
control variables SIZE, AA02, BIGN, MKBK, XR_FLG-5,-2, XR_EVT 0): ***=less than .01, **=less
than .05, *=less than .10, and ns=not significant.
3. Significance of F-statistic. ***=less than .01, **=less than .05, *=less than .10, and ns=not significant.


 29