A theory of auditor resignation

Article Abstract:

A theory of auditor resignation posits that auditors quit from engagements with risky clients. In a two-period model, clients are aware of the risk they present to their auditors who attempt to monitor for such risk. The clients will carry an incremental expected cost if the auditors detect the risk. However, if auditors do not identify the risk, they will acquire an incremental expected liability. The theory offers an explanation of how incumbent auditors rationally resign an engagement since risk-adjusted pricing creates unprofitable clients. Moreover, this theory explains how auditors with less knowledge about the client than the incumbent auditors can make a profit if they accept the engagement of a client whose auditors have made a rational resignation. The model shows that rising auditor liability increases the occurrence of auditor resignations. Meanwhile, resigned clients hire smaller wealth-constrained auditors.

Models, Appointments, resignations and dismissals, Employee resignations

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An experimental investigation of auditor-auditee interaction under ambiguity

Article Abstract:

A study experimentally investigating interaction between auditors and auditees in a strategic setting where intentional mis-statements may occur is presented. Previous studies examining management fraud in terms of game theory are referenced in developing the approach, as well as psychological studies examining ambiguity aversion and descriptive studies of how auditors make decisions. Subjects in the auditee role assert an asset value given knowledge of the true value, while those in the role of auditor select a costly sample of items constituting the asset and decide whether to accept or reject the auditee's statements. Findings include a strong response to the auditees' incentive to lie on the part of both participants and an increase in misstatements as the incentive increases.

United States, Science & research, Psychological aspects, Accounting

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Auditor independence, dismissal threats, and the market reaction to auditor switches

Article Abstract:

Auditor changes influence investors' perceptions of security prices. Investors react to the auditor switch depending on the nature of the change or on the characteristics of the company changing auditors. Given time for new information and switching costs, security price response to an announced auditor change is conditioned by the information carried by the last audit report prior to the switch. A management threat to dismiss an auditor does not by itself influence investor reaction since switching can be bad news even if audit is independent or good news even with management coercion.

Evaluation, Auditing, Securities

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