The scandal of Enron and Arthur Anderson

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The scandal involving Enron and Arthur Anderson forced US regulators to enforce the Sarbanes-Oxley Act of 2002 (SOX) to strengthen investor confidence, corporate accountability and professional responsibilities. UK followed suit as their Financial Reporting Council (FRC) published a Combine Code of Corporate Governance. An environment with constantly rising audit fees since the collapse of Andersen has not explicitly changed the drivers of client satisfaction from those identified and tested in the past. Although the number of 'Big' audit firms has declined the number of publicly traded firms has not changed substantially, yet the degree of influence in audit firm selection has decreased. The decline in dysfunctional audit procedures has been largely due to improving international regulatory standards coupled with high-audit fees and a reduction in large audit firms, making client satisfaction a more overwhelming task.

Post SOX both internal-control reporting and financial statement audit are mandatory, and performed by the same audit firm, while consulting services were temporarily barred after august 2002 following Anderson's conviction in the Enron matter. Since then although regulations have somewhat eased as now audit firms provide non-audit services (NAS), it is uncertain if the remaining Big 4 firms have been able to maintain sufficient levels of client satisfaction under such restrictive regulations (GAO, 2003a). As many of Anderson's 2500 clients dispersed to the remaining Big 4 firms, GAO surveyed a sample of Fortune 1000 companies, all of whom used a Big 4 firm as their auditor (GAO, 2003b). While the survey found average auditor tenure to be 19 years, 30% of the sample had auditor tenure of less than 2 years. 93% of this short tenure group were former Andersen clients (GAO, 2003b). Most of these clients claimed to be dissatisfied with their current auditor.

In modern market economies, business incorporation led to the separation of ownership and control. Shareholders are usually not directly involved in the administrative or operational aspects of a business as such tasks require the need to employ professional managers. These separations lead to information asymmetry enabling self-interested managers to pursue self welfare at the expense of owners, inevitably directing towards 'agency cost' (Jensen and Meckling, 1976). An effective system of corporate governance assures efficient monitoring and control behaviours focused at improving the principal-agent relationships to help reduce potential conflicts of interest (Maniam et al., 2006). Anderson et al. (2004) discovered that corporate governance is positively associated with a firm's operational efficiency and effectiveness. Investors accept higher premiums for firms with sound corporate governance (McKinsey & Company, 1999-2002; Steen, 2005). 

The infamous scandals of WorldCom and Enron led academics to extensively research corporate governance in the context of financial reporting, giving particular attention to the importance of AC characteristics including independence, composition, compensation, financial expertise, size and influence amongst others. These characteristics seem to have a direct/indirect relationship with audit quality. AC independence is at the forefront of such research. Bronson et al. (2009) argue that benefits of an audit committee's independence are only consistently achieved when it is fully independent, which is in line with the SOX requirement of 100% independent AC's. The underlying assumption being that "Independent directors are better monitors of management than are inside directors" (Bronson, Carcello, Hollingsworth and Nea 2009).

Zhang, Zhou and Zhou (2007) further identify that AC's with less expertise (accounting, financial and non financial) are more likely to have internal control weakness resulting in fraudulent reporting or audit failures. As audit provides an independent check on the work of a firm's management subsequently reinforcing the confidence in financial reporting, auditing can thus be considered as a tool of corporate governance. Lee et al. (2005) contend that auditors should also investigate and appraise internal control procedures which would ensure effective compliance, while enhancing the role of corporate governance. Audits become valuable for a firm when they significantly contribute towards corporate governance. Empirical research shows that the demand for independent audit as a device for corporate governance by firms in UK and US is a function of audit quality and the assurance provided by audit firms (Cohen et al., 2002 and Ghosh and Moon, 2005).

Nonetheless, corporate governance should also have a positive impact on the quality and effectiveness of external auditing (Abbott et al., 2007; Ashbaugh and Warfield, 2003). It is the responsibility of AC's to appoint qualified independent auditors who they believe would perform objective and systematic monitoring, while also attesting the firm's financial statements for conformity with GAAP/ IFRS. Thus, corporate governance must play a crucial role in enhancing the credibility and usefulness of the financial statements for all stakeholder's (Bushman and Smith, 2001; Dewing and Russell, 2003; Maniam et al., 2006). Contrastingly, when there is a lack of sound corporate governance, it would be difficult to prevent the firm's management from infringing upon the interests of the organization and other stakeholder's while the audit function may be unable to perform its monitoring and assurance roles effectively (Marnet, 2005; Rosner, 2003). Certainly the relationship between corporate governance and external auditing (including auditor selection and switching) is a fundamental issue worthy of exploration.

2.2 The role of financial reporting and audit quality

Independent auditing can reduce the agency costs associated with the contractual relationships between owners and management or among various groups of stakeholder's (Fearnley and Hines, 2003). Therefore, an auditor is not only responsible to substantiate the fairness and totality of financial statements produced by the management, but also to investigate management's financial performance in terms of their supervisory reliability. This ability to detect earnings management enhances the usefulness of accounting numbers for investor's decision making (Imhoff, 2003). Thus, proving that an auditor performs two roles in financial reporting, that of information intermediary and assurance provider. Financial reporting standards are similar to public laws as they are constantly evolving. Concerning the United Kingdom, researchers state that proposed changed to UK Company Law, increasing legislations from the EU, post-Enron reform and transition to international financial reporting standards import significant and costly implementation challenge to UK companies, auditors, and regulators (Fearnley and Hines, 2003).

Nevertheless, regulators still aspire to remain engaged with the professional body's which suggests their willingness in continuing to delegate regulation to private sector bodies and support voluntary codes of practice wherever appropriate. Legislation and extensive rules are considered as a backstop only to be applied where all else fails (Beattie, Fearnley and Brandt, 2004). Fearnley & Hines (2003) argues that the impact on the UK regulatory framework of the SOX Act is still an unresolved issue. UK has almost 50% of its  top 100 companies listed in the US markets. This inevitably provides compelling reasons for US regulators to engage in the oversight of UK companies and audit firms. This is an unpopular perception for the UK regulators, EU commission and business community, especially in the light of many other regulatory changes in the UK (Fearnley and Hines 2003). However, regardless of changes in the regulatory framework researchers agree that mere compliance with such measures cannot be sufficient in building investor confidence, in fact, they suggest that companies need to improve their overall governance structure.

Rezaee (2005) explains that a well balanced functioning of seven interrelated mechanisms (oversight, managerial, compliance, audit, advisory, assurance, and monitoring functions) can produce responsible corporate governance, reliable financial reports, and credible audit services. Arthur Levitt, the former chairman of the Securities and Exchange Commission (SEC) created a "Blue Ribbon Panel" in order to tackle the severe issue of earnings management. Researchers believe is earnings management is indeed so pervasive; some reasons behind auditor changes may be motivated by a desire to manage earnings. However, efficient utilisation of an auditing function is dependent upon audit quality. Though not easily defined, but can be identified through auditor's industrial expertise, ethical integrity and degree of independence (Francis, 2004 and Teoh, 1992).

Many scholars have categorized audit quality in terms of size of the auditing firm. They suggest that larger firms possess more industrial experience, have greater resources and a higher degree of autonomy enabling them to provide qualified service. Several empirical studies demonstrate an investor's frequency to attach greater market value to accounting numbers reported by clients of larger auditing firm, as they perceive their financial disclosure to have greater information content (Francis, 2004; Lennox, 2005 and Watkins et al., 2004). A company switching to a larger auditing firm signals to the market that their financial statements are now more dependable. This signal may also benefit firms in the form of low costs in raising capital from equity/debt markets or reduction in agency costs.

Alternatively, shareholder and management may also consider the capability of large auditing firms in detecting 'tunnelling' behaviour, thus preferring a switch to a small auditing firm with comparatively lower quality of audit monitoring (Imhoff, 2003 and Lee et al., 2003). Johnson et al. (2002) adopt tenure of the auditor with their clients to reflect the quality of audits. Longer the duration of the relationship between the auditor and client, the easier it becomes for the auditor to curb earnings client's behaviour and other financial irregularities as the auditor gets the time to analyse their client's internal control and accounting systems. Conversely, the tenure of an auditor may also have a negative association with audit quality, as long term auditors may surrender their independence to keep a healthy relationship with their client (Ghosh and Mood, 2005). Therefore, it is not surprising that the Combine Code of Corporate Governance lays out strict guidelines on auditor tenure to ensure complete auditor independence and subsequently audit quality (FRC 2010).

In order to distinguish quality in financial reporting, other researchers apply the number of SEC investigations or sanctions as an indicator for audit quality (Dye, 1993 and Kadous, 2000) or the regularity of issuing unclean auditor opinions (Chow and Rice, 1982). Auditor switch signals the increase of the possibility of earnings management in financial reporting, which may result in information asymmetry (Becker et al. 1998 and Nelson et al. 2002). Therefore, many researchers conclude that investors and markets usually perceive a change in the auditor as a negative signal to in response to which market price falls and cost of equity rises. They argue that switching leads to more 'noise' in the financial reporting numbers, thus significantly reducing the integrity and usefulness of reported earnings.

2.3 Prior studies on factors affecting auditor changes

Arguably the choice of audit firm is a crucial decision in a corporation's life cycle as the underlying reasons for such changes are of enormous concern for the public, profession, stakeholder's and financial markets (Bedingfield and Loeb 1974). The level of agency costs and disparity in signalling incentives suggest that there is a heterogeneous demand for audit services, characterised by DeAngelo (1981) as different levels of audit quality. According to (Davidson III) audit shopping can be subdivided into two categories, firstly, audit shopping could be an agency cost motivated by managements desire to entrench an incumbent management team by switching to a lower quality/size auditor to benefit from relaxed reporting requirements [1] , inevitably increasing asymmetric information benefiting their motives. The second category of audit shopping does not involve management desire to manipulate earnings, instead, is due to a break down in auditor/client relationship resulting from overly conservative accounting methods preferred by the auditor.

Recent literature has particularly focused on the link between audit opinion and auditor change, especially given the concerns over opinion-shopping that emerged in the competitive environment of the 1990s. Most of the existing empirical works explaining the decision to change auditors have been archival studies, which use statistical analysis to investigate the association between the switch and not switch decision variable and related variables of interest. While earlier studies employed only univariate tests to examine single variables of interest (Schwartz and Menon, 1985; Craswell, 1988; Gul et al., 1992), the use of multivariate logit models has now become the norm (Williams, 1988; Ritson et al., 1997, Woo and Koh, 2001, Moizer, Porter and Mohamed, 2001, Hudaib and Cooke, 2005). Researchers argue based on contingency theory that 'auditor changes are likely to be induced by combinations of cross factors' (Hudaib and Cooke, 2005).

However, empirical studies show mixed results. The susceptibility to auditor switching is notably positively associated with financial distress (Schwartz and Menon, 1985, Hudaib and Cooke, 2002), audit opinion (Chow and Rice, 1982), growth (Chaney et al., 1997), breakdown in auditor client relationship (DeAngelo, 1982), length of auditor tenure (Williams, 1988), change in the top level management (Hudaib and Cooke, 2002) and receipt of adverse media publicity by the client company (Williams, 1988). Conversely significant negative association was found for top tier auditor (Krishnan, et al., 1996, Hudaib and Cooke, 2002), industry specialisation (Williams, 1988; Chaney et al., 1997, Ritson et al., 1997, Woo and Koh, 2001) and size (Krishnan, et al., 1996, Chaney et al., 1997, Hudaib and Cooke, 2002).

However, in other studies researchers found no significance for: distress (Krishnan, et al., 1996), growth (Williams, 1988; Krishnan et al., 1996; Ritson et al., 1997, Woo and Koh, 2001), top tier auditor (Ritson et al., 1997), size of the organisation (Woo and Koh, 2001), industry specialisation (Krishnan et al., 1996), top management change (Williams, 1988, Ritson et al., 1997), audit fees (Ritson et al., 1997, Woo and Koh, 2001, Hudaib and Cooke, 2002) or level of non audit service provision by the incumbent (DeBerg et al., 1991). Reality of the matter is that the literature on auditor switching is interrelated due to the nature of this activity, as it involved several complex and at time correlated explanatory variables. In order to effectively deal with existing literature which would facilitate the understanding of this activity and reason behind it, each variable/factor with be discussed separately as much as possible.

The price of audit plays a significant role in auditor selection, as prior research shows reduction of audit fees motivate some auditor changes (Johnson and Lys, 1990; Eichenseher and Shields 1983). Fearnley and Beattie (1995) in their study of auditor changes in UK listed companies declare that almost 50% of respondents declare the level of audit fees to be a basis for auditor change out of which 45% assert it to be the most influential reason. Clients benefit from a decrease in audit fees at least in the short term, although fee's return to normal market levels between 3 to 5 years (Simon and Francis, 1988) termed by DeAngelo (1981) as 'low balling'. A simplistic interpretation of such findings can be attributed to the competitive nature of the auditing market. Clients purchase audit services from the lowest-cost supplier and independent audit firms attain competitive advantages through specialisation (Johnson and Lys 1990).

Carcello et al (1992) argues, in an increasingly competitive environment, it is vital to recognise the perceptions of audit quality by both the auditors and auditee's. After controlling for other factors related to audit fees, (i.e. attributes assigned to audit quality) client satisfaction with their audit service was found to be positively associated with fees. Simultaneously, lower cost audit reduces audit quality, subsequently damaging the company's long-run performance (Behn et al., 1999). Larger clients benefit from economies of scale (bargaining power) which not only help over fee levels, but also in attaining management desires i.e. earnings manipulation, thus creating a self-interest threat to objectivity and independence (Firth, 1985; and McKeown et al.,1991). Therefore, it is not surprising that UK respondents perceive high fees from a client to be detrimental to independence (Firth, 1980a).

Beattie, Brandt and Fearnley (1999) also found audit fee dependence to be the most significant threat to UK businesses. Clients may incur both indirect and direct cost during an auditor switch, AC's place immense significance on the value for fees as compared to the gross magnitude of audit fees (Schroeder et al., 1986). In order to determine the effects of high audit fee's DeAngelo (1981) classifies high-audit fees based on the proportion of fees paid to the audit firm's total fees, whereas Hudaib and Cooke (2005) use the ratio of audit fees paid to auditees' total assets as a substitute for high-audit fees. Researchers anticipate that a company with a high level of assets would require a substantial and expensive audit. Whereas, a high ratio of paid fees to organisations' total assets would indicate that the organisation is paying higher than average fees for the size of assets it owns. Francis and Simon (1988) explain that greater level of fees reduces the probability of being issues a qualified audit opinion, given that the client would not tolerate a qualified audit under difficult conditions when their auditors are receiving higher than average audit fees.

Beattie and Fearnley (1998) have suggested that the most common reason for auditor switches in the UK is due to the lack of auditor competency and professionalism. In their research financial directors of surveyed firms argued that their previous auditors did not understand the business, there was; lack of internal control, gaps in financial controls, improper disclosure, incumbent mishandling of corporate finance advice and flexibility on accounting policies. All these issues can almost certainly be termed under audit quality. In fact, over the past decade the most common reason celebrated in literature for reasons related to auditor changes has been audit qualification. Recent studies based around the themes of reasons for change and opinion shopping inspects the relationship between auditor change and audit opinions. Therefore, it is not surprising to see literatures concentration on management, which tends to seek auditors who are less likely to produce a qualified report since the concept considerably damages the perception of auditor independence (Teoh 1992).

Companies perhaps switch auditors to shop for either more relaxed company result interpretations from their auditor or better audit quality. After, the issuance of a qualified report, an organisation may change their auditor to improve their financial image (Smith, 1986 and Chow and Rice, 1982). It could be due to a disagreement which would likely lead to the selection of a lower quality auditor (Whisenant and Sankaraguruswamy 2000b, 2000d), or simply to find a more lenient auditor to achieve long term managerial goals (DeAngelo, 1981). Issuance of a qualified opinion has an effect on both the firm's market price and manager's compensation packages (Chow and Rice, 1982). If managers change auditors as a result of qualifications, this raises fundamental questions about the audit firm's ability to resist management pressure and issue an objective audit report. In reality, it is this 'intimidation threat' that jeopardises independence although the threat is not observable. What is observable are actual switches i.e. actual dismissal which are, in effect, used as a proxy for situations where switching is threatened (Hudaib and Cooke, 2005).

A sample of studies concentrating exclusively on opinion shopping by investigating the relation between switching and the subsequent audit opinion found consistent results. Some studies have found a positive association between receipt of qualified opinion and auditor change in the year preceding change (Hudaib and Cooke, 2002; Chow and Rice, 1982; Smith, 1986; and Krishnan et al., 1996). Chow and Rice (1982) in their study of Australian and U.S. companies found auditor change to be directly related to receiving a qualified report, although their report also showed that switching firms due to audit opinion were no more likely to receive a clean opinion in following years than non-switching firms. Similar studies of companies in Hong Kong and Australia, Gul et al. (1992) and Craswell (1988) respectively, found results consistent with Chow and Rice (1982). A positive association was also found between the presence of 'going concern qualification' and auditor change in distressed UK quoted companies for the period 1977-1986 Citron and Taffler (1992).

While comparing pre and post-switch opinions by studying conflicts between the firm and its predecessor auditor, Smith (1986) in his sample of 139 firms that changed auditor on receipt of a qualified opinion suggests that only five cases indicate the possibility of opinion shopping. Similarly, other studies conducted by Williams (1988) and Ritson et al. (1997) also did not find any significant results. Krishnan and Stephens (1995) find that firms which change auditors are likely to be treated as conservatively by both the predecessor and successor auditors, while Knapp and Elikai (1988) in their study of U.S. firms disclose that that switching firms do not receive unqualified or more favourable opinions from new auditors. Smith (1986) and Krishnan (1994), state that auditors are not switched due to audit opinions, rather the cause is identified as auditors refusal to be flexible in their auditing procedures.

Evidence suggests that intimidation threat can influence auditor's opinion, which is in contrast to empirical work mentioned earlier. Disagreement over a reporting policy resulting in a possible intimidation threat to switch may not only influence auditor independence but conversely may force the auditor to qualify (Teoh, 1992; DeAngelo, 1982; and Krishnan et al. 1996). Therefore, the auditor has to weigh the situation between being independent and giving a qualified opinion or the likelihood of dismissal (Hudaib and Cooke, 2005). Krishnan (1994) found that switching firms received a more conservative treatment from their auditors than others. This presence of 'mutli-directionality' between audit opinion and switching casts doubt on the ability of audit opinion as a motive for firms changing their auditors. While rejecting the hypothesis of an association between switching and qualification, DeAngelo (1982) explains this 'mutli-directionality' arguing that qualified opinions can cause auditor switching and vice-versa. Krishnan et al. (1996) later confirms this argument, by using a simultaneous equations model found evidence of a two-way causation between the tendency of the client to switch auditors and that of the auditor to issue a qualified opinion.

In particular when an incumbent auditor issues an unclean opinion, the firm is more likely to instigate a search for new auditors whose views are in line with that of the management. AS the receipt of a qualified opinion would lower the price of a firm's securities and impairs its ability to raise funds in the future, the organization in such cases would theoretically switch from a high-quality auditor to a low-quality auditor (Klock 1994; Anderson et al. 2004; Bedard and Johnstone 2004). Nontheless, empirical results on whether organisations can accomplish "opinion shopping" through auditor switch are varied as some studies found no evidence of successful 'opinion shopping' after auditor switch in the US market (Craswell, 1988; Krishnan, 1994; Schauer, 2002). However, other researchers argue that there is noticeable disparity in the industrial knowledge and auditing resources between the incumbent auditors and their successors. Thus, the management must be able to influence accounting numbers if switching from high-quality auditors to low-quality auditors (Willenborg 1999; Nelson et al. 2002; Kim and Kross 2005). Given each research used different methodologies, no consensus has yet emerged regarding the relationship between switching and issuing qualified audit opinions.

The SEC has expressed their concern over this issue while suggesting that the assessment of prior-year opinion and switching would be useful to academics, policy makers and practitioners. Very few studies have examined the success of opinion shopping by examining pre and post year opinion and those that have professed opinion shopping to be unsuccessful (Chow and Rice, 1982; Smith, 1986). Auditor switch after the receipt of a qualified opinion represents bad news for the market, as the organisation may be alleged to shop for clean opinion from a new auditor. DeFond and Subramanyam (1998) and Kim et al. (2003) characterise this phenomenon to the belief that an apparent decline in audit quality due to opinion shopping impairs the credibility of financial reporting. As mentioned earlier, a desire for lower quality audit to assist earnings management motivates clients to change their auditors.

According to Abarbanell and Lehavy (2003) earnings management implies the selection and interpretation of accounting policies and reporting methods that may induce partiality in reporting earnings numbers to accomplish certain objectives. In order to minimise political costs Watts and Zimmerman (1990) suggest that larger firms conduct income decreasing accounting choices, while other studies suggest management of businesses use income reducing discretionary accruals. The argument being that litigation concerns discourage firms to manage earnings upwards due to the asymmetric los function on companies that overstate their earnings upwards (Watts and Zimmerman, 1990; and Kadous, 2000). However, it is extremely difficult to measure audit quality, and many researchers have applied various methodologies to their studies to which they relate the quality of audit. DeAngelo (1981) defines audit quality as positively associated with size of the auditing firm, as larger firms have a greater incentive to report earnings misstatements.

Empirical evidence experimenting the extent to which audit quality can be defined in terms of auditor size can be found in several respected studies including Warren (1980), DeAngelo (1981), Chow and Rice (1982), Teoh and Wong (1993) and Krishnan et al. (1996) although the experiments found mixed results. DeAngelo (1981) argues large audit firms have more resources, greater risk exposure and incentives to avoid criticism, therefore, will perform qualified reporting in order to protect their reputation. Becker et al. (1998) reports, as discretionary accruals are greater for the clients of non-Big6 accounting firm's earnings management transpires more frequently in such firms. Conversely, Krishnan et al. (1996) discovers that smaller companies in the US are less likely to be audited by Big 6 firms, attributable to the high premiums charged by the larger auditing firms which are 16% to 19% higher than non-Big 8 audit fees (Simon and Francis 1988).

While relating earnings management (audit quality) with auditor size, Chaney and Philipich (2002) found that after the announcement of a switch particularly from Big5/Big 4 to non-Big 5/Big 4 auditors, the market typically responded with a decline in the company's stock price and market return. This is because the investor would expect a decline in the quality of reported earnings information. Smaller companies audited by the Big6 firms have a greater propensity to change auditors following a qualified report, as compared to larger firms audited by Big6 firms (Citron and Taffler, 1992). Literature has noted auditee size as another crucial explanatory variable. Krishnan et al. (1996) recognises that the probability of a smaller company receiving a qualified auditor report and subsequently switching its auditor is much higher than a larger company. Firth (2002) further justifies Krishnan et al. (1996) claims by proving the statistical significance between size of auditee and qualification. Previous research suggests that financial distress is another significant factor in the issuance of qualified opinion and auditor switching (Schwartz and Menon 1985; Citron and Taffler, 1992).

Highly levered companies are more likely to receive a modified audit report in subsequent periods especially if they shift from high quality to low quality audit firms (Lennox, 2000). Schwartz and Menon (1985) discuss the influence of financial distress on auditor switches in two different ways. Firstly, financial distress causes complex uncertainties in a business and are correlated with factors that support auditor switching such as; management changes, reporting disputes, issuance of a qualified opinion, 'insurance' motives and audit fees. Failing businesses are often plagued with such issues and, therefore, are more susceptible to make auditor changes than healthy ones. Secondly, various reasons for changing auditors may depend upon the financial condition of an organisation. Factors associated with switching auditors in financially distressed companies may not the same as for the 'non-distressed' companies. Healthy organisations may switch auditors to obtain additional service or competitive advantage through an industry specialised auditor.

In order to tackle such issues Hudaib and Cooke (2005) classify financial condition into distressed and non-distressed and incorporate them as an explanatory variable. Chow and Rice (1982) suggest to incorporate non-distressed companies in variable is to control for the possible effects of auditees financial condition on auditor switching. In whichever way financial distress may affect the auditor-client relationship, its existence can have some implications for understanding the dynamics behind auditor switching. Schwartz and Menon (1985) also suggest that failing firms have a tendency to make management changes in an attempt to resuscitate their organisation, as external stakeholders identify management failures as a primary factor in the company's deteriorating financial condition. New management results in various changes in the failing organisation, in an attempt to rescue or better the situation, these may also include changes in auditor. New management may be dissatisfied with the quality and cost of services provided by the past auditor (Burton and Roberts, 1967). New management team may view the selection of reporting methods as a means for influencing decisions of suppliers of capital by revealing corporate performance in a more favourable light, with the help of a new more lenient auditor (Schwartz and Menon 1985).

Alternatively, new managers may simply prefer another auditor with whom they have had some previous association (Beattie and Fearnley, 1995). Beattie and Fearnley (1998) report that 35% of companies cited top management changes as a reason for switching auditors. However, Chow and Rice (1982) found no significance in this variable, while Schwartz and Menon (1985) found that neither top management change neither audit opinion in failing companies led to a change in auditors. Hudaib and Cooke (2005) examined the interactive effects of distressed/non-distressed companies and MD change/no-MD change on the type of audit opinion and found mixed results. Nevertheless, issuance of a qualified opinion may be triggered by financial distress or a change in management, or maybe even both. Whereas several of the factors that considered as causes of auditor switching may be found to exist in failing companies or financially healthy firms, not all bring about a definite change in auditor. If the financial condition is not explicitly controlled for, an obvious "omitted variables" problem can exist, since a correlation of both a spurious factor and a 'true' determinant with financial distress could lead to making some invalid inferences on why companies decide to change auditors. This being the case, there are clear limitations to the generalizabillity of findings based on experimental samples containing both failing and healthy firms.

Chapter 3

Research Methodology