Auditor's Reputation, Independence and Impact

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Auditor Reputation, Auditor Independence, and the Stock-Market Impact of Andersen's Indictment on Its Client Firms*

\SRINIVASAN KRISHNAMURTHY, SUNY — Binghamton JIAN ZHOU. SVNY — Binghamton NAN ZHOU, SUNY —

Binghamton Abstract

In this paper, we study a broad sample of Arthur Andersen clients and investigate whether the decline in Andersen's reputation, due to its criminal indictment on March 14. 2002, adversely affected the stock market's perception of its audit quality. Because these reputational concerns are more of an issue if an auditor's independence is impaired, we investigate the relationship between the abnormal market retums for Andersen clients around the time of the indictment announcement and several fee-based measures of auditor independence. Our results suggest that when news about Andersen's indictment was released, the market reacted negatively to Andersen clients. More importantly, we find that the indictment period abnormal return is significantly more negative when the market perceived the auditor's independence to be threatened. We also examine the abnormal retums when firms announced the dismissal of Andersen as an auditor. Consistent with the audit quality explanation, we document that when firms quickly dismissed Andersen, the atinouncement retums are significantly higher when firms switched to a Big 4 auditor than when they either switched to non-Big 4 auditors or did not announce the identity of the replacement auditor. Our empirical results support the notion that auditor reputation and independence have a material impact on perceived audit quality and the credibility of audited financial statements, and that the market prices this. Keywords Audit fee; Auditor independence; Auditor reputation; Nonaudit fee G1, M41, M42

JEL Descriptors

Accepted by Greg Waymire. We thank Greg Waymire (associate editor) and two anonymous referees for detailed and insightful suggestions that have signiñcantly improved the paper. We also thank Paul Caster (discussant). Randy Elder, Murali Jagannathan, Kristian Rydqvist, Ute St. Clair, Steve Wheeler (discussant), and workshop participants at the 2003 American Accounting Association (AAA) Annual Meeting and the 2003 AAA Northeast Regional Meeting for helpful comments.

Contemporary Accounting Research Vol. 23 No. 2 (Summer 2006) pp. 465-90 © CAAA

466

Contemporary Accounting Research Réputation et indépendance du vérificüteur, et incidence boursière de la mise en accusation d'Arthur Andersen pour les sociétés clientes du cabinet

Condensé
L'échec de la vérification d'Enron attribué à Arthur Andersen ainsi que d'autres scandales comptables connexes ayant fait l'objet d'une vaste publicité et qui mettaient en cause Sunbeam, Waste Management et WorldCom (entre autres) ont amené le Congrès à adopter la Loi Sarbanes-Oxley de 2002 (Sarbanes-Oxley Ad). Afin de préserver l'indépendance des vériticateurs, cette loi leur interdit de fournir simultanément à un client des services de vérification et des services de consultation. L'information contenue dans les états financiers étant précieuse pour les investisseurs, toute nouvelle négative quant à la qualité du travail des vérificateurs et à leur indépendance risque de créer de l'incertitude en ce qui a trait à l'exactitude des états financiers vérifiés de leurs sociétés clientes et d'être préjudiciable à ces sociétés. Les auteurs de la présente étude abordent ces questions en analysant les rendements anormaux réalisés par un vaste échantillon de clients d'Arthur Andersen au cours de la période entourant la mise en accusation criminelle d'Arthur Andersen, survenue le 14 mars 2002, et en documentant la relation entre les variables substituts de l'indépendance et de la réputation des vérificateurs et ces rendements anormaux. Les travaux précédents semblent indiquer que le maintien d'une réputation de qualité supérieure est d'une importance primordiale pour les cabinets de services financiers en général et les...
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