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Does Shareholders Ratification Enhance Auditor Independence?

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Does Shareholders Ratification Enhance Auditor Independence?
Does shareholders ratification of auditor selection enhance auditor independence?

Sear Amiri

894560
Accounting
Supervisor : S.N.M. Van den Bogaerde

-2012-

Abstract: The U.S. Department of the Treasury 's Advisory Committee on the Auditing
Profession (ACAP) recommends that all public companies must have an annual shareholders ratification of external auditor selection. An important aim of their recommendation was to enhance auditor independence. However the ACAP did not provide empirical support for their recommendation. Using data of 80 companies I find that cost of capital (measure of auditor independence) is higher in firms with shareholders ratification of auditor independence than in firms without shareholders ratification of auditor selection. Using the data of 40 firms with a negative restatement, I also find that after announcement of restatement the increase cost of capital is higher in firms without shareholders ratification of auditor selection than in firms with shareholders ratification of auditor selection. My results indicates that shareholders ratification of auditor selection enhance external auditor independence.
I.

Introduction

The objective of this study is to examine whether shareholders ratification of external auditor selection enhance external auditor independence. The motivation for this study comes from the U.S. Department of the Treasury 's Advisory Committee on the Auditing Profession
(ACAP), which recommended that all public companies must have an annual shareholders ratification of external auditor selection. This recommendation is based on belief that, such an arrangement would make the auditor more a direct agent of the shareholder than of the board of directors and/or management.
Firms are separated by separation of ownership and management. Because the manager owns no more than a small portion of his firm 's equity shares, he has incentives to allocate the firm 's resources in ways that are


References: review vol. 19 (2010) nr. 4 Ashbaugh, H., R Brandon, D. M., Crabtree, A. D. and Maher, J. J. (2004) Non-audit fees, auditor independence, and bond ratings, Auditing: A Journal of Practice & Theory, 23 Chee W. Chow. 1982. The Demand for External Auditing: Size, Debt and Ownership Influences Accounting Association vol. 87 (2012) nr. 1 DeAngelo, L Dhaliwal, D., Gleason, C. A., Heitzman, S. and Melendrez, K. D. (2008) Auditor fees and cost of debt, Journal of Accounting, Auditing and Finance, 23 (2004) nr. 2 18 Shareholder Ratifications of the Auditor. Auditing: a journal of practice & theory vol. 28 (2009) nr Khurana, I. and Raman, K. (2006) Do investors care about the auditor’s economic dependence on the client? Contemporary Accounting Research, 23 Research vol. 42 (2004) nr. 3 KPMG Mayhew, B. W., and J. E. Pike. 2004. Does investor selection of auditors enhance auditor independence? The Accounting Review 79 Mishra, S., K. Raghunandan, and D. V. Rama. 2005. Do investors ' perceptions vary with types of nonaudit fees? Evidence from auditor ratification voting Raghunandan, 2003. Nonaudit Services and Shareholder Ratification of Auditors 19 auditors. Journal of accounting, auditing & finance vol. 17 (2002) nr. 2 Simunic, D endogeneity to Hermalin and Weisbach (2003). Hence, it is possible that the same factors that are associated with greater shareholder involvement in auditor selection are also associated with cost of debt (capital). According to Krishnan and Ye (2005) audit committee characteristics are associated with the likelihood of shareholder voting on auditor ratification. Therefore, I perform a two-stage analysis. In the first stage, I use a PROBIT regression model of Dao et al (2012) in addition to the bond rating and bond spread model discussed above.
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