Evidence on the Auditor and Client Relationship : What Can Be Learned from Reasons Reported by Managers for Changing Auditors?

In this study I describe the population of auditor changes for companies subject to filing requirements with the Securities Exchange Commission over a five-year period 1992 to 1996. I use data obtained from Auditor Trak on the reasons why corporate managers change auditors. The description of the auditor changes over a five-year period and additional examination of factors leading to client-initiated changes, not only provide insights into client and auditor relations not documented in prior studies, but also offer evidence which financial reporting regulators can use to assess the need for increased or improved disclosures required when companies change auditors.The study has two primary findings. First, I examine auditor changes over a five-year period and document differences in those auditor changes dependent on the party initiating of the auditor realignment decision. The data suggest that clients are three times as likely to initiate a change as compared to auditors. Clients most frequently initiate an auditor change (54 percent of the sample), and auditors resign or decline to stand for re-election in 16 percent of observations. The remaining 30 percent are due to factors that cannot be reliably categorized as either client or auditor initiated. Second, I use evidence from prior studies to classify managers' reasons for an auditor change into three groups that summarize the motivating factors surrounding auditor realignment decisions. These groups relate to structural changes of the company, audit fees, and auditor-client frictions. The second primary result is obtained by grouping the reasons into similar motivating factors as shown in the literature (i.e., other than a simple classification by initiating party) for client-initiated changes. A structural change in the client or the auditor leads to the largest frequency of changes (38 percent) among client-initiated auditor switches. Another 25 percent of client-initiated changes report audit fees as being the reason for the change. Managers report that auditor-client frictions led to the change for approximately 5 percent of the changes. The remaining 32 percent cannot be reliably classified along the lines suggested by prior literature