The Scandal Involving Enron And Arthur Anderson Accounting Essay

The dirt affecting Enron and Arthur Anderson forced US regulators to enforce the Sarbanes-Oxley Act of 2002 ( SOX ) to reenforce investor assurance, corporate answerability and professional duties. UK followed suite as the Financial Reporting Council ( FRC ) published a Combine Code of Corporate Governance. In an environment with invariably lifting audit fees since the prostration of Andersen, has non peculiarly changed the drivers of client satisfaction from those indentified and tested in the yesteryear. Although the figure of ‘Big ‘ audit houses has declined, the figure of publically traded houses has non well changed, yet the grade of influence in audit house choice has decreased. Dysfunctional audit processs have been cut down due to bettering international regulative criterions coupled with high audit fees and a decrease in big audit houses, doing client satisfaction a more overpowering undertaking.

In the station SOX epoch, both internal control coverage and fiscal statement audit are compulsory and performed by the same audit house. Consulting services were temporarily barred after August 2002 following Andersen ‘s strong belief in the Enron affair. Since so although ordinances have somewhat alleviated and now audit houses provide non-audit services ( NAS ) , it is unsure if the staying Large 4 houses have been able to prolong sufficient degrees of client satisfaction under such restrictive ordinances ( GAO, 2003a ) . As many of Anderson ‘s 2500 clients dispersed to the staying Large 4 houses, GAO surveys a sample of Fortune 1000 companies, all of whom used a Large 4 house as their hearer ( GAO, 2003b ) . Although the study found mean auditor term of office to be 19 old ages, 30 % of the sample had auditor term of office of less than 2 old ages. 93 % of this short term of office group were former Andersen clients ( GAO, 2003b ) . Most of these clients claimed to be dissatisfied with their current hearer.

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As mentioned antecedently, modern corporation theory bureau cost, hence the chief aim of corporate administration in to efficaciously supervise and command behaviors of assorted interested parties, accordingly bettering the principal-agent relationships ( Maniam et al. , 2006 ) . Therefore corporate administration can be defined as s set of external and internal regulations, policies and steps to regulate behaviors of assorted interested parties with in a house, and effectual administration should be able to bridge the authorization and duties of assorted parites involved in order to cut down possible struggles of involvement ( — — ) .Singh and Davidson ( 2003 ) argue that this can merely be done by implementing contractual duties and duties to ease end congruity as a whole among all interest holders including the Board of Directors ( BoD ) , direction, employees and stockholders.

Anderson et Al. ( 2004 ) discovered that corporate administration is positively associated with a house ‘s operating efficiency and effectivity. Higher premiums are accepted by investors for houses with sound corporate administration ( McKinsey & A ; Company, 1999-2002 ; Steen, 2005 ) . After the ill-famed corporate dirts or WorldCom and Enron faculty members have extensively researched corporate administration ( function of Board and Audit Committee ) in the context of fiscal coverage, peculiarly concentrating on the importance on AC features including independency, composing, compensation, fiscal expertness, size and influence amongst others. These features seem to hold a direct/indirect relationship with audit quality. AC independency is at the head of such research. Bronson, Carcello, Hollingsworth and Nea ( 2009 ) argue that the benefits of audit commission independency are systematically achieved merely when the AC is wholly independent, which is in line with the SOX demand of 100 % independent AC ‘s. The implicit in premise being that “ Independent managers are better proctors of direction than T he are inside managers ” ( Bronson, Carcello, Hollingsworth and Nea 2009 ) .

Zhang, Zhou and Zhou ( 2007 ) further place that AC ‘s with less expertness ( accounting, fiscal and non-financial ) are more likely to hold internal control failing ensuing in deceitful coverage or audit failures. As audit provides independent cheque on the work of the house ‘s direction later reenforcing the assurance in corporate fiscal coverage, scrutinizing can be considered as a tool of corporate administration. Lee et Al. ( 2005 ) contend that hearers should besides look into and measure internal control processs which would guarantee effectual conformity, while heightening the function of corporate administration. Audits become valuable for a house when they significantly contribute towards corporate administration ( — — ) . Empirical research shows that the demand for independent audit as a device for corporate administration by houses in UK and US is a map of audit quality and the confidence provided by audit houses ( Cohen et al. , 2002 and Ghosh and Moon, 2005 ) .

However, corporate administration should besides hold a positive impact on the quality and effectivity of external auditing ( Abbott et al. , 2007 ; Ashbaugh and Warfield, 2003 ) . An efficient corporate administration construction should guarantee that their AC ‘s appoint independent and qualified hearers and that hearers should guarantee the houses appoint qualified hearers and guarantee that hearers should use independent and efficient monitoring while certifying the house ‘s fiscal statements for conformance with GAAP/ IFRS. Thus, corporate administration should play a function in heightening the credibleness and utility of the fiscal statements to all stakeholders ( Bushman and Smith, 2001 ; Dewing and Russell, 2003 ; Maniam et al. , 2006 ) .

Contrastingly, when there is a deficiency of sound corporate administration, it would be hard to forestall the house ‘s direction from conflicting upon the involvements of the house and other stakeholders while the audit map may be unable to play its monitoring and confidence functions efficaciously ( Marnet, 2005 ; Rosner, 2003 ) . Surely the association between corporate administration and external auditing ( including hearer pick and shift ) is an of import issue worthy of geographic expedition

2.2 The function of fiscal coverage and audit quality

In modern market economic systems, concern incorporation led to the separation of ownership and direction. Stockholders are normally non straight involved in the disposal or operations of the concern, a undertaking for which professional directors are employed. This separation in proprietor and command leads to information dissymmetry, enabling self interested directors to prosecute self public assistance at the disbursal of proprietors, necessarily taking towards ‘agency cost ‘ ( Jensen and Meckling, 1976 ) . This has forced regulators to enforce a system to adhere directors in order to act upon them to move in the best involvement of concern and its proprietors. A core portion of this system is scrutinizing, conducted by independent professional administrations to warrant and certify the information provided by the direction ( Watts and Zimmerman, 1986 ) .

Independent scrutinizing can ease the bureau costs associated with the contractual relationships between the proprietors and the direction or among assorted groups of stakeholders ( — — ) . An hearer is hence non merely responsible to confirm the equity and entirety of the fiscal statements produced by the direction but besides, size up the direction ‘s fiscal public presentation in footings of the supervisory dependability. This ability to observe net incomes direction enhances the utility of accounting Numberss for investor ‘s determination devising ( Imhoff, 2003 ) . This proves that an hearer performs two functions in corporate fiscal coverage, that of information mediator and confidence supplier. Financial coverage criterions as similar to public jurisprudence are a invariably germinating and developing procedure. Research workers have found that in the UK proposed changed to UK Company Law, increasing statute laws from the EU, post-Enron reform and switch to international fiscal coverage criterions import important and dearly-won execution challenge to UK companies, hearers, and regulators ( Fearnley and Hines, 2003 ) . However, regulators still aspire to stay occupied with the professional organic structures and go on to depute ordinance to private sector organic structures and support voluntary codifications of pattern wherever appropriate. Legislation and extended regulations are seen as a catcher merely to be applied where all else fails ( Beattie, Fearnley and Brandt, 2004 ) .

Fearnley & A ; Hines ( 2003 ) argues that the impact on the UK regulative environment of the SOX Act is still an unsolved issue. UK has about 50 % of its top 100 companies listed in the US markets. This necessarily provides a compelling statement for US regulators to prosecute in the inadvertence of UK companies and audit houses. This is an unpopular perceptual experience for the UK regulators, EU committee and concern community, particularly in the visible radiation of many other regulative alterations in the UK ( Fearnley and Hines 2003 ) . But, irrespective of alterations in the regulative model, research workers agree that mere conformity with such steps can non be sufficient in constructing investor assurance, therefore companies should overall better their corporate administration construction.

Rezaee ( 2005 ) explains that a good balanced operation of seven interconnected mechanisms ( inadvertence, managerial, conformity, audit, advisory, confidence, and supervising maps ) can bring forth responsible corporate administration, dependable fiscal studies, and believable audit services. Former SEC president Levitt viewed the net incomes direction job to be so terrible that he created a “ Blue Ribbon Panel ” to analyze the job and to do recommendations. If net incomes direction is so so permeant, a important part of hearer alterations may be motivated by a desire to pull off net incomes. They viewed client/auditor realignments as stand foring efficient responses to alterations in client operations and activities over clip. An incumbent hearer ‘s competitory advantage for an bing client can be eroded over clip by alterations in the client ‘s operations and activities ( Johnson and Lys, 1990 ) . However, efficient use of the scrutinizing map is dependent upon audit quality which is non easy defined, but can by and large be identified through the industrial expertness, good unity and grade of hearer independency ( Francis, 2004 and Teoh, 1992 ) .

Many bookmans have categorized audit quality in footings of size of the auditing house, the statement being that larger houses have a posses more industrial experience, have greater resources and a higher grade of independency enabling them to supply qualified service. Several empirical surveies demonstrate that investors normally attach greater market value to the accounting Numberss reported by the clients of larger scrutinizing house, as they perceive the fiscal revelation to hold greater information content ( Francis, 2004 ; Lennox, 2005 and Watkins et al. , 2004 ) . Switch overing to a big scrutinizing house signals to the market that the fiscal statements of the audited administration are more reliable and therefore the house may profit from lower costs in raising capital from the equity or debt markets or from the decrease of bureau costs in the enforcements of contractual duties.

Alternatively, the stockholders and direction may besides see the aptitude of big scrutinizing houses in observing ‘tunnelling ‘ behaviors and may prefer to exchange to a little auditing house with relatively lower quality of audit monitoring ( Imhoff, 2003 ; and Lee et al. , 2003 ) . Johnson et Al. ( 2002 ) follow the term of office of hearer with their clients to reflect the quality of audits. The greater the continuance of the relationship between hearer and client, the easier it becomes for the hearer to control net incomes direction behavior and other fiscal abnormalities as the hearer acquire the clip to to the full understand their client ‘s internal control and accounting systems. Conversely, the term of office of an hearer may besides hold a negative association with audit quality, as long term hearers may give up their independency to maintain a healthy relationship with their client Ghosh and Mood ( 2005 ) . Therefore, it is non surprising that the Combine Code of Corporate Governance lays out rigorous guidelines on hearer term of office to guarantee complete hearer independency and later audit quality ( FRC 2010 ) .

In order to separate the quality in fiscal coverage, other research worker use the figure of SEC probes or countenances as an index for audit quality ( Dye, 1993 and Kadous, 2000 ) or the regularity of publishing dirty hearer sentiments ( Chow and Rice, 1982 ) . Auditor switch by and large signals the addition of the possibility of net incomes direction in fiscal coverage which may ensue information dissymmetry ( Becker et al. 1998 and Nelson et Al. 2002 ) . Therefore, many research workers conclude that investors and markets normally perceive a alteration in hearer as a negative signal to in response to which market monetary value falls and cost of equity rises. They argue that exchanging leads to more ‘noise ‘ in the fiscal coverage Numberss, therefore significantly cut downing the unity and utility of reported net incomes.

2.3 Prior surveies on factors impacting hearer alterations

Arguably the pick of audit house is an of import determination in a corporation ‘s life rhythm as the implicit in grounds for such alterations are a immense concern for the populace, profession, stakeholders and fiscal markets ( Bedingfield and Loeb 1974 ) . Companies change hearers for a scope of different grounds. Harmonizing to Williams ( 1988 ) hearer alterations are associated with audit fees, qualified sentiments, and client/auditor dealingss. Companies opt to alter hearers when the undertaking environment of the corporation alterations, the company requires to upgrade a damaged image, when a they desire different services or a more effectual hearer Williams ( 1988 ) . Bedingfield and Loeb ( 1974 ) suggest that a deficiency of satisfaction with the services provided by the old hearer is another prevalent variable in the perceptual experience of hearer shift. Auditor alterations can besides be motivated by directions desire to better company operations or to intrench an incumbent direction squad by exchanging to a lower quality/ size hearer to profit from relaxed coverage demands[ 1 ], although the latter is termed under hearer shopping by ( Davidson III ) .

Harmonizing to ( Davidson III ) audit shopping can be subdivided into two classs. First, audit shopping could be an bureau cost, as directors could be seeking for a lower quality audit which would assist cut down the quality of information that reaches the fiscal markets, necessarily increasing asymmetric information which would benefits their motivations. The 2nd class of audit shopping does non affect direction desire to pull strings net incomes ; alternatively is due to a interruption down in auditor/ client relationship ensuing from excessively conservative accounting methods preferred by the hearer. Krishnan ( 1994 ) suggests, in such instances direction desire less conservative coverage which they consider better reflects the company ‘s true economic public presentation, and accordingly chooses an accounting house that is less conservative. Firms besides tend to exchange hearers after having qualified sentiment, but later do non have more unqualified sentiment ( Chow and Rice, 1982 ) . Failing houses have a greater inclination to exchange hearers than healthier houses, demoing a penchant to exchange from a big audit house to a lower grade house ( Schwartz and Menon, 1985 ) . The world of the state of affairs is that the literature on hearer alterations is interrelated due to the nature of this activity as it involves several complex and at times interrelated explanatory variable.

In order to efficaciously cover with the bing literature which would ease the apprehension of this activity and grounds behind it, each variable will be discussed individually every bit much as possible. Explanatory variable for factors behind hearer alteration include auditee company and their fiscal hurt ( Haskins and Williams, 1990 ; and Citron and Taffler, 1992 ) , Large 4/ Non-Big 4 audit house ( Warren, 1980 ; Shank and Murdock, 1978 ) , qualified or unqualified sentiment ( Chow and Rice, 1982 ) , describing differences ( Magee and Tseng, 1990 ) , alterations in top degree direction ( Burton and Roberts, 1967 ; and Carpenter and Strawser, 1971 ) asymmetric information ( Dye, 1991 ) and audit fees ( McKeown et al. , 1991 ; and Firth, 1980a and 2002 ) .

Audit monetary value plays a important function in hearer choice, as anterior research shows decrease of audit fees motivate some hearer alterations ( Johnson and Lys, 1990 and Eichenseher and Shields 1983 ) . Fearnley and Beattie ( 1995 ) in their survey of hearer alterations in UK listed companies show about 50 % of respondents declare the degree of audit fees to be a footing for hearer alteration out of which 45 % assert it to be the most of import ground. Clients benefit from a lessening in audit fees at least in the short term, although fee ‘s return to normal market degrees between 3 and 5 old ages ( Simon and Francis, 1988 ) termed by DeAngelo ( 1981 ) as ‘low balling ‘[ 2 ]. A simplistic reading of such findings can be attributed to the competitory nature of the scrutinizing market. Clients purchase audit services from the lowest cost provider and independent audit houses attain competitory advantages through specialization ( Johnson and Lys 1990 ) . Carcello et Al ( 1992 ) argues that in an progressively competitory environment it is critical to recognize the perceptual experiences of audit quality by both the hearers and auditees. After commanding for other factors related to audit fees, i.e. properties assigned to scrutinize quality, client satisfaction with their audit service was found to be positively associated with fees. Simultaneously lower cost audit reduces audit quality and the choice of a lower cost hearer could damage long-term company public presentation ( Behn et al. , 1999 ) .

Larger clients benefit from economic systems of graduated table ( dickering power ) which non merely assist over fee degrees, but besides in achieving direction desires i.e. net incomes use, therefore making a self-interest menace to objectiveness and independency Firth ( 1985 ) and McKeown et Al. ( 1991 ) . Therefore it is non surprising that UK respondents perceive high fees from a client to be damaging to independence Firth ( 1980a ) . Beattie, Brandt and Fearnley ( 1999 ) besides found audit fee dependance to be the most of import menace in the UK. As clients may incur both indirect and direct cost during an hearer switch ; Audit Committee ‘s topographic point huge significance on value for fees as compared to the gross magnitude of audit fees ( Schroeder et al. , 1986 ) . In order to find the effects of high audit fee ‘s DeAngelo ( 1981 ) classifies high audit fees based on the ratio of fees paid to the audit house ‘s entire fees, whereas ( hudaib — ) uses the ratio of audit fees paid to auditees ‘ entire assets as a placeholder for high audit fees. It is anticipated that a company with a high degree of plus would necessitate a significant and expensive audit. Whereas, a high ratio of paid fees to an administrations entire assets would bespeak that the administration is paying higher than mean fees for the size of assets it owns. Francis and Simon ( 1988 ) explain that, greater the degree of fee the less a qualified audit sentiment will be issued given that the client would non digest a qualified audit under hard conditions when their hearers are having higher than mean audit fees.

Beattie and Fearnley ( 1998 ) have suggested that the most common ground for hearer switches in the UK is due to the deficiency of hearer competence and professionalism. In their research fiscal managers of surveyed houses their old hearers did non understand the concern, there was ; deficiency of internal control, spreads in fiscal controls, improper revelation, incumbent mishandling of corporate finance advice and flexibleness on accounting policies. All these issues can about surely be termed under audit quality. In fact, over the past decennary the most common ground celebrated in literature for grounds related to hearer alterations has been audit making. The relation between hearer alteration and audit sentiments has been inspected around the subjects of grounds for alteration and sentiment shopping. The relation between exchanging and making in predating and following old ages has received peculiar involvement. Therefore it is non surprising to see literatures concentration on direction which tends to seek hearers who are less likely to give a qualified study, since the construct well amendss the impression of hearer independency ( Teoh 1992 ) .

Company possibly exchange hearers to shop for either more relaxed company consequence readings from hearer or better audit quality. After the issue of a qualified study administrations may alter their hearer to better their fiscal image ( Smith, 1986 and Chow and Rice, 1982 ) . It could be due to a dissension which may take to the choice of a lower quality hearer ( Whisenant and Sankaraguruswamy 2000b, 2000d ) or merely to happen a more indulgent hearer to accomplish long term managerial ends ( DeAngelo, 1981 ) . Issue of a qualified sentiment has an consequence on both the house ‘s market monetary value and director ‘s compensation bundles ( Chow and Rice, 1982 ) . If directors change hearers as a consequence of makings, this raises cardinal inquiries about the audit house ‘s ability to defy direction force per unit area and publish an nonsubjective audit study. In world, it is this ‘intimidation menace ‘ that jeopardises independency although the menace is non discernible. What is discernible are existent switches i.e. existent dismissal which are, in consequence, being used as a placeholder for state of affairss where shift was threatened ( Hudaib and Cooke, 2005 ) .

A sample of surveies concentrating entirely on sentiment shopping by look intoing the relation between exchanging and the subsequent audit sentiment have found consistent consequences. Some surveies have found a positive association between reception of qualified sentiment and hearer alteration in the twelvemonth predating alteration ( Hudaib and Cooke, 2002 ; Chow and Rice, 1982 ; Smith, 1986 ; Krishnan et al. , 1996, ) . Chow and Rice ( 1982 ) in their survey of Australian and U.S. companies found auditor alteration to be straight related to having a qualified study, although their study besides showed that exchanging houses due to qualified sentiment were no more likely to have a clean sentiment in following old ages than not switching houses. Similar surveies of companies in Hong Kong and Australia, Gul et Al. ( 1992 ) and Craswell ( 1988 ) severally, found consequences consistent with Chow and Rice ( 1982 ) . A positive association was besides found between the presence of ‘going concern making ‘ and auditor alteration in hard-pressed UK quoted companies for the period 1977-1986 Citron and Taffler ( 1992 ) .

While comparing pre- and post-switch sentiments by analyzing struggles between the house and its predecessor hearer, Smith ( 1986 ) in his sample of 139 houses that changed hearer on reception of a qualified sentiment suggests that merely five instances indicate the possibility of sentiment shopping. Similarly other surveies conducted by Williams ( 1988 ) and Ritson et Al. ( 1997 ) besides did non happen any important consequences. Krishnan and Stephens ( 1995 ) find that houses which change hearers are likely to be treated as cautiously by both the predecessor and replacement hearers, while Knapp and Elikai ( 1988 ) in their survey of U.S. houses unwrap that that exchanging houses do non have unqualified or more favorable sentiments from new hearers. Smith ( 1986 ) and Krishnan ( 1994 ) claim that hearers are non switched due to the type of audit sentiments issued, instead the cause is indentified at the hearers refusal to be flexible in their auditing processs.

Evidence suggests that bullying menace can act upon hearer ‘s sentiment, which is in contrast to empirical work mentioned earlier. Disagreement over a coverage policy ensuing in a possible bullying menace to exchange may non merely influence hearer independency but conversely may coerce the hearer to measure up ( Teoh, 1992 ; DeAngelo, 1982 ; and Krishnan et Al. 1996 ) . Therefore the hearer has to weigh the state of affairs between being independent and giving a qualified sentiment or the likeliness of being dismissed ( Hudaib and Cooke, 2005 ) . Krishnan ( 1994 ) found that exchanging houses received a more conservative intervention from their hearers than others. This presence of ‘mutli-directionality ‘ between audit sentiment and exchanging dramatis personaes some uncertainty on whether audit sentiment shopping occurs as a motivation for altering an hearer.

While rejecting the hypothesis of an association between exchanging and making, DeAngelo ( 1982 ) explains this ‘mutli-directionality ‘ reasoning that qualified sentiments can do hearer exchanging and vice-versa, and statement which is subsequently confirmed by Krishnan et Al. ( 1996 ) by utilizing a coincident equations theoretical account, found grounds of a bipartisan causing between the inclination of the client to exchange hearers and that of the hearer to publish a qualified sentiment. Given that different methodological analysiss are used in each research, no consensus has yet emerged sing the relationship between exchanging and publishing qualified audit sentiments. The SEC has expressed their concern over this issue while suggested that the appraisal of prior-year sentiment and exchanging would be utile to faculty members, policy shapers and practicians. Very few surveies have examined the success of sentiment shopping by analyzing pre and station twelvemonth sentiment and those that have professed sentiment shopping to be unsuccessful ( Chow and Rice, 1982 ; Smith, 1986 ) .

Since high quality hearers are more able to control net incomes direction, houses ‘ direction should hold a motive of exchanging hearers in order to recognize the additions from the use of accounting Numberss ( Krishnan 1994 ; Willenborg 1999 ; Kim et Al. 2003 ; Krishnan et Al. 2005 ) . Some anterior surveies report that direction may take or exchange to comparatively lower quality ( more fictile ) hearers in order to be able to obtain greater leeway in pull stringsing discretional accumulations to set the reported net incomes ( Francis and Krishnan 1999 ; Hay and Davis 2004 ) . In peculiar, when the incumbent hearers would publish an dirty sentiment, houses are more likely to originate a hunt for new hearers whose positions are more in line with that of the direction in the attendant twelvemonth, e.g. , switch from high quality to low quality hearers, because having an dirty hearer sentiment would deject the monetary value of a house ‘s securities and impair its ability to raise financess in the hereafter ( Klock 1994 ; Anderson et Al. 2004 ; Bedard and Johnstone 2004 ) . However, empirical consequences on whether houses can accomplish “ sentiment shopping ” through hearer switch are mixed as some surveies found no grounds of successful “ sentiment shopping ” after hearer switch in the US market ( Craswell, 1988 ; Krishnan, 1994 ; Schauer, 2002 ) . But other surveies argue that there are differences in the industrial cognition and scrutinizing resources between the incumbent hearers and their replacements so the direction should be able to pull strings accounting Numberss if exchanging from high quality ( big ) hearers to low quality ( little ) hearers as the later may be less effectual in controling net incomes direction behaviours ( Willenborg 1999 ; Nelson et Al. 2002 ; Kim and Kross 2005 ) . Therefore hearer pick or switch will impact audit quality and its public-service corporation, which should hold an consequence on investors ‘ perceptual experience of the credibleness of fiscal statements. The lower quality of hearers, the lower credibleness of fiscal statements and the less information content of the accounting Numberss being reported ( Watkins et Al. 2004 ) .

Auditor switch after a qualified sentiment being issued represents a bad intelligence, because the client may be perceived to shop for a clean sentiment from a new hearer. DeFond and Subramanyam ( 1998 ) and Kim et Al. ( 2003 ) property this phenomenon to the impression that a sensed diminution in audit quality due to auditor exchange impairs the credibleness of fiscal coverage, i.e. , it may ensue in a lower degree of confidence to investors and a higher chance that the reported net incomes and book values are overstated

As mentioned earlier, a desire for lower quality audit to help net incomes direction motivates clients to alter their hearers. Harmonizing to Abarbanell and Lehavy ( 2003 ) , net incomes direction implies the choice and reading of accounting policies and describing methods that may bring on fondness in describing net incomes Numberss to carry through certain aims. In order to minimise political costs Watts and Zimmerman ( 1990 ) suggest that larger houses conduct income diminishing accounting picks, while other surveies suggest direction of concerns use income cut downing discretional accumulations. The statement being that judicial proceeding concerns deter houses to pull off earning upwards due to the asymmetric loss map on companies that overstate their net incomes ( Watts and Zimmerman, 1990 ; Kadous 2000 ) . However, it is highly hard to mensurate audit quality, and many research workers have applied a assortment different methodological analysiss to their surveies to which they relate the quality of audit. DeAngelo ( 1981 ) defines audit quality as positively associated with size of the auditing house, as larger houses have a greater inducement to describe net incomes misstatements.

Empirical grounds experimenting the extent to which audit quality can be defined in footings of hearer size can be found in legion well-thought-of surveies including Warren ( 1980 ) , DeAngelo ( 1981 ) , Chow and Rice ( 1982 ) , Teoh and Wong ( 1993 ) and Krishnan et Al. ( 1996 ) although the experiments found assorted consequences. DeAngelo ( 1981 ) argues big audit houses have more resources, greater hazard exposure and inducements to avoid unfavorable judgment hence will execute qualified coverage in order to protect their repute. Becker et Al. ( 1998 ) studies, as discretional accumulations are greater for the clients of non-Big Six accounting houses net incomes direction transpires more often in such houses. Conversely Krishnan et Al. ( 1996 ) discovers that smaller companies in the US are less likely to be audited by Large 6 houses, attributable to the big premiums charged by the larger auditing houses which are 16 % to 19 % higher than non-Big 8 audit fees ( Simon and Francis 1988 ) . While associating net incomes direction ( audit quality ) with hearer size, Chaney and Philipich ( 2002 ) found that after the proclamation of a switch peculiarly from Big5/Big 4 to non-Big 5/Big 4 hearers, the market usually responded with a diminution in the company ‘s stock monetary value and market return. This is because the investor would anticipate a diminution in the quality of reported net incomes information.

Smaller companies audited by the Big 6 houses have a greater leaning to alter hearers following a qualified study, as compared to larger houses audited by Large 6 houses ( — – ) . Literature has noted auditee size as another of import explanatory variable. Krishnan et al. , ( 1996 ) recognises that the chance of a smaller company having a qualified hearer study and later exchanging its hearer is much higher than a larger company. 6 Firth ( 2002 ) farther justifies Krishnan et al. , ( 1996 ) claims by turn outing the statistical significance between size of auditee and making.

{ For case, DeAngelo ( 1981 ) contends that audit quality is positively associated with the size and market portions of scrutinizing houses. Other surveies found that big or trade name name hearers should hold to bear higher repute costs and they would be more prudent in audit battle and more likely to publish qualified or other dirty audit studies to their clients, therefore supply audit services with higher quality ( Francis and Krishnan, 1999 ; Lee et al. , 2004 ; Lennox, 2005 ; Menom, 2003 ) . Some empirical surveies have demonstrated that high quality hearers ( Large 6/Big 5 ) can more efficaciously detect direction ‘s net incomes direction through the usage of accounting accumulations and therefore better guarantee the truthfulness and utility of accounting information ( Balsam et al. , 2003 ; Francis and Krishnan, 1999 ; Watkins et al. , 2004 ) .

DeFond and Subramanyam ( 1998 ) argue that there are inducements for houses ‘ directors or commanding stockholders to seek self-welfare by pull stringsing accounting Numberss or reassigning resources through “ burrowing ” behaviours. Therefore, they will weigh their opportunisms in doing auditor pick or shift determinations ( Johnson et al. , 2000 ; La Porta et al. , 2002 ) .

Zhou and Rice 1982, Craswell 1988 ; Francis and Krishnan 1999 ) }

Previous research suggests that fiscal hurt is another of import factor in the issue of qualified sentiment and hearer shift ( Schwartz and Menon 1985 ; Citron and Taffler, 1992 ) . Highly levered companies are more likely to have a modified audit study in subsequent periods, particularly if they shift from high quality audit houses to low quality audit houses ( Lennox 2000 ) . Schwartz and Menon ( 1985 ) discourse the influence of fiscal hurt on hearer switches in two different ways. First, fiscal hurt causes complex uncertainnesss in a concern and is correlated with factors that support hearer exchanging such as ; direction alterations, reposting differences, issue of a qualified sentiment, ‘insurance ‘ motivations[ 3 ]and audit fees. Failing concerns are frequently plagued with such issues and therefore are more susceptible to do hearer alterations than healthy 1s. Second, assorted grounds for altering hearers may depend upon the fiscal status of an administration. Factors that are associated with exchanging hearers in financially hard-pressed companies may non the same as for the ‘non-distressed ‘ companies. Healthy administrations may exchange hearers to obtain extra service or competitory advantage through an industry specialised hearer. For these grounds Hudaib and Cooke ( 2005 ) sort fiscal status into hard-pressed and non-distressed and integrate them as an explanatory variable. Chow and Rice ( 1982 ) suggest to integrate non-distressed companies in variable is to command for the possible effects of auditees fiscal status on hearer exchanging. In whichever manner fiscal hurt may impact the auditor-client relationship, its being can hold some deductions for understanding the kineticss behind hearer shift.

Schwartz and Menon ( 1985 ) besides suggest that neglecting houses have a inclination to do direction alterations in an effort to revive their administration, as external stakeholders identify direction failures as a primary factor in the company ‘s deteriorating fiscal status. A new direction consequences in assorted alterations in the neglecting administration in an effort to deliverance or better the state of affairs, these may besides include alterations in hearer. New direction may be dissatisfied with the quality and cost of services provided by the past hearer ( Burton and Roberts, 1967 ) . New direction squad may see the choice of describing methods as a agency for act uponing determinations of providers of capital by uncovering corporate public presentation in a more favorable visible radiation, with the aid of a new more indulgent hearer ( Schwartz and Menon 1985 ) . Alternatively, new directors may merely prefer another hearer with whom they have had some old association ( Beattie and Fearnley, 1995 ) . Beattie and Fearnley ( 1998 ) study, that 35 % of companies cite top direction alterations as a ground for exchanging hearers. However, Chow and Rice ( 1982 ) found no significance in this variable, while Schwartz and Menon ( 1985 ) found that neither top direction alteration now audit sentiment in neglecting companies lead to a alteration in hearers. Hudaib and Cooke ( 2005 ) see the synergistic effects of distressed/non-distressed companies and MD change/no-MD alteration on type of audit study and happen assorted consequences. Nevertheless, issue of a qualified sentiment may be triggered by fiscal hurt or a alteration in direction or both.

Whereas several of the factors that have been considered as causes of hearer shift may be found to be in neglecting companies, non all of these need really take to auditor switches. If fiscal status is non explicitly controlled for, an obvious “ omitted variables ” job can be, since a correlativity of both a specious factor and a “ true ” determiner with fiscal hurt could take to doing some invalid illations on why companies decide to alter hearers. This being the instance, there are clear restrictions to the generalizability of findings that are based on experimental samples incorporating both neglecting and healthy houses.


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