AN ANALYSIS OF THE ECONOMIC-FACTORS RELATED TO AUDITOR CLIENT DISAGREEMENTS PRECEDING AUDITOR CHANGES

This study examines the relationship between economic performance of c lient firms and occurrence of auditor-client disagreements which lead to changes in auditor. It is argued that economic incentives for audit ors and clients are such that the economic condition of the client fir m may be inversely related to the likelihood of auditor-client disagre ement. Specifically, a client experiencing poor or deteriorating finan cial performance may face increased costs from contracting or covenant constraints. Management of such a client may prefer an auditor who pe rmits the client to increase or inflate earnings. However, the auditor faces increased costs in this setting, as an auditor's risk of litiga tion and loss of reputation increases for such a client. If the audito r refuses to permit accounting which increases or inflates earnings, t he conflict between auditor and client may be resolved by a client dec ision to change auditor. The empirical results confirm that clients ch anging auditor after a disagreement have poorer earnings performance, more debt, lower levels of current assets, and poorer stock price perf ormance than firms changing auditor without a disagreement and other f irms in the same industry. Further, many of these measures have deteri orated over the period leading up to the disagreement.