Academic journal article Academy of Accounting and Financial Studies Journal

Analysts' Evaluation of the Information Content of Changes in Auditor Types

Academic journal article Academy of Accounting and Financial Studies Journal

Analysts' Evaluation of the Information Content of Changes in Auditor Types

Article excerpt

ABSTRACT

Companies hire auditors to meet legal requirements if they are publicly traded and to provide credibility to their financial statements. However, all auditors may not provide the same level of service to third parties. Prior research regarding such events as initial public offerings has found qualitative differences among big Five and non-Big Five auditors. Companies may, therefore, switch auditors to attain some perceived qualitative difference in the audit engagement. The degree that this auditor change is or is not incorporated by financial analysts into analysts' forecasts has not been fully researched for the benefit of determining if there is any information content associated with the auditor change on security prices. The results of this study show that financial analysts do not fully incorporate information relative to auditor changes in their forecasts. This study might provide insight into the currently accepted view of the Efficient Market Hypothesis with respect to the information content of auditor changes and the market's interpretation of the information. In addition, analysts may need to scrutinize auditor changes more closely in order to fully understand the signal that may be included in the decision to change auditors.

INTRODUCTION

Financial analysts are one of the primary users of financial information. Analysts analyze publicly available information such as financial statements, and management earnings forecasts as well as non-public information obtained directly from firms they follow in order to make buy and sell recommendations and to make earnings forecasts. Given that the reward structure for analysts provides incentive for analysts to make accurate recommendations/forecasts, analysts expend considerable amounts of time and effort trying to uncover value relevant information about the companies and industries they follow.

This study will investigate whether information related to changes in auditor type is completely incorporated into analysts' earnings forecasts. It is generally accepted that large international (Big Five) auditors provide specific advantages and services to their clients that are not available from national auditors. Similarly, national auditors may provide specific advantages and services not available from regional auditors. A similar argument can be made when comparing widespread regional auditors with regional auditors that are more localized. Therefore, changes from national or regional auditors to Big Five auditors (or changes from Big Five auditors to national or regional auditors) may provide information about the future demands and needs of the client. This information in turn may provide a signal regarding the future earnings of the client. Since providing earnings forecasts is one of the primary roles of analysts, they would be expected to incorporate the information into their expectation of company earnings in an unbiased fashion if the information has an impact on earnings. If there is a statistically significant difference between the analysts' forecast and the actual earnings, the analysts may not have completely captured the information signaled by the change in auditor type.

The remainder of the paper is structured in the following manner. Section 2 outlines the theory utilized in developing the hypotheses. Section 3 describes the hypotheses tested. Section 4 specifies the methodology used for testing. Section 5 is the discussion of results and section 6 indicates the conclusions of the paper.

THEORY

Companies hire auditors to meet legal requirements if they are publicly traded and to provide credibility to their financial statements. The auditor provides an independent appraisal of the financial statements' correspondence to Generally Accepted Accounting Principles (GAAP), and the auditor's report provides assurance to third parties using the financial statements to make decisions. …

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