UBC Theses and Dissertations

UBC Theses Logo

UBC Theses and Dissertations

Market structure, auditor independence and auditor turnover Nielsen, Abigail 1985

Your browser doesn't seem to have a PDF viewer, please download the PDF to view this item.

Item Metadata

Download

Media
831-UBC_1985_A4_6 N53.pdf [ 4.97MB ]
Metadata
JSON: 831-1.0095895.json
JSON-LD: 831-1.0095895-ld.json
RDF/XML (Pretty): 831-1.0095895-rdf.xml
RDF/JSON: 831-1.0095895-rdf.json
Turtle: 831-1.0095895-turtle.txt
N-Triples: 831-1.0095895-rdf-ntriples.txt
Original Record: 831-1.0095895-source.json
Full Text
831-1.0095895-fulltext.txt
Citation
831-1.0095895.ris

Full Text

MARKET STRUCTURE, AUDITOR INDEPENDENCE AND AUDITOR TURNOVER by A B I G A I L NIELSEN B.A. ( F i r s t C l a s s H o n o u r s ) , Simon F r a s e r U n i v e r s i t y , 1982 A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE ( B u s i n e s s A d m i n i s t r a t i o n ) i n THE FACULTY OF GRADUATE STUDIES F a c u l t y o f Commerce a n d B u s i n e s s A d m i n i s t r a t i o n We a c c e p t t h i s t h e s i s a s c o n f o r m i n g t o t h e r e q u i r e d s t a n d a r d THE UNIVERSITY- OF B R I T I S H COLUMBIA O c t o b e r 1985 © A b i g a i l N i e l s e n , 1985 In p r e s e n t i n g this thesis in partial fu l f i lment of the r e q u i r e m e n t s for an a d v a n c e d d e g r e e at the Univers i ty of Brit ish C o l u m b i a , I agree that the Library shall m a k e it freely avai lable for re ference a n d s tudy . I further agree that p e r m i s s i o n for ex tens ive c o p y i n g of this thesis for scho lar ly p u r p o s e s may b e granted by the h e a d of m y d e p a r t m e n t o r by his o r her representat ives . It is u n d e r s t o o d that c o p y i n g o r p u b l i c a t i o n of this thesis for f inanc ia l gain shall not b e a l l o w e d w i t h o u t m y wr i t ten p e r m i s s i o n . •Department of and ftuSunevs /VdyyvorusV/^UoKv, T h e Univers i ty of Brit ish C o l u m b i a 1 9 5 6 M a i n M a l l V a n c o u v e r , C a n a d a V 6 T 1Y3 D a t e OC>oW lS t l^ gtT DE-6(3/81) i i A b s t r a c t T h i s t h e s i s e x a m i n e s some o f t h e r e l a t i o n s h i p s b e t ween t h e m a r k e t s t r u c t u r e o f p u b l i c a u d i t i n g , a u d i t o r i n d e p e n d e n c e , a nd t h e r a t e o f a u d i t o r c h a n g e s o v e r t i m e . The f i r s t s e c t i o n o f t h i s t h e s i s e x a m i n e s t h e r e l a t i o n s h i p b e t ween m a r k e t s t r u c t u r e a n d a u d i t o r i n d e p e n d e n c e w i t h a summary a n d e x t e n s i o n o f a r e c e n t p a p e r w r i t t e n i n c o l l a b o r a t i o n w i t h two o t h e r r e s e a r c h e r s . We c o n c l u d e d t h a t c o m p e t i t i v e p r i c i n g w i l l l e a d t o a u d i t o r i n d e p e n d e n c e , w h e r e a s t h e e x i s t e n c e o f e c o n o m i c r e n t s r e s u l t i n g f r o m n o n - c o m p e t i t i v e p r i c i n g a l l o w s f o r t h e p o s s i b i l i t y o f n o n i n d e p e n d e n c e . We a l s o c o n c l u d e d t h a t i f a n o n - c o m p e t i t i v e m a r k e t f o r a u d i t s c h a n g e s t o a more c o m p e t i t i v e s t a t e , t h e n a p e r i o d o f d i s e q u i l i b r i u m o c c u r s where i n d e p e n d e n c e may be c o m p r o m i s e d u n t i l t h e c o m p e t i t i v e e q u i l i b r i u m i s a c h i e v e d . The s e c o n d s e c t i o n o f t h i s t h e s i s e x a m i n e s t h e e f f e c t s o f s u c h a d i s e q u i l i b r i u m p e r i o d on a u d i t o r i n d e p e n d e n c e , a u d i t o r f e e s , a n d i n p a r t i c u l a r , t h e r a t e o f a u d i t o r t u r n o v e r . D u r i n g t h e d i s e q u i l i b r i u m , p r i c e r i v a l r y s h o u l d d r i v e a u d i t o r f e e s down t o t h e c o m p e t i t i v e e q u i l i b r i u m . I n c u m b e n t a u d i t o r s w i l l e i t h e r r e d u c e f e e s t o m a t c h t h e l o w e r b i d s o f t h e i r c o m p e t i t o r s , o r c l i e n t c o m p a n i e s w i l l c h a n g e t o n o n i n c u m b e n t a u d i t o r s o f f e r i n g i d e n t i c a l - a u d i t s e r v i c e s a t a l o w e r p r i c e . A t h i r d p o s s i b i l i t y i s t h a t i n d e p e n d e n c e may be c o m p r o m i s e d i f i n c u m b e n t s m a i n t a i n h i g h e r f e e s t r u c t u r e s i n e x c h a n g e f o r n o n i n d e p e n d e n t actions--. • H owever, a s n o t a l l a u d i t o r s w i l l be w i l l i n g t o r i s k n o n i n d e p e n d e n t a c t i o n , an e m p i r i c a l i m p l i c a t i o n w o u l d be t h a t p r i c e r i v a l r y n o t o n l y l o w e r s f e e s b u t , c e t e r i s p a r i b u s , a l s o i n c r e a s e s a u d i t o r t u r n o v e r . The e m p i r i c a l p o r t i o n o f t h i s t h e s i s e x a m i n e s t h e e f f e c t o f i n c r e a s e d r i v a l r y on a u d i t o r t u r n o v e r . A f t e r a r e v i e w o f t h e e x i s t i n g l i t e r a t u r e on a u d i t o r c h a n g e s , an e m p i r i c a l s t u d y o f a u d i t o r c h a n g e s between 1969 a n d 1983 was p e r f o r m e d f o r a random s a m p l e of OTC f i r m s . A s s u m i n g t h a t t h e r e c e n t r e m o v a l o f AICPA p r o h i b i t i o n s on c o m p e t i t i v e b i d d i n g , a d v e r t i s i n g and d i r e c t s o l i c i t a t i o n have a c t e d a s i n v i t a t i o n s f o r i n c r e a s e d p r i c e r i v a l r y , t h e n we w o u l d e x p e c t t o o b s e r v e an i n c r e a s e i n a u d i t o r t u r n o v e r d u r i n g t h e p e r i o d e x a m i n e d . A n n u a l t u r n o v e r r a t e s were c o m p u t e d , a n d a s e r i e s o f r e g r e s s i o n t e s t s were p e r f o r m e d u s i n g t h e M i c h i g a n D a t a A n a l y s i s S y s t e m (MIDAS). The r e s u l t s o f t h e s e t e s t s f a i l e d t o r e j e c t t h e h y p o t h e s i s o f no c h a n g e i n a u d i t o r t u r n o v e r o v e r t h e f i f t e e n y e a r p e r i o d e x a m i n e d . F u r t h e r m a r k e t s e g m e n t a t i o n f o r c h a n g e s w i t h i n B i g E i g h t a u d i t o r s a n d f o r c h a n g e s w i t h i n n o n - B i g E i g h t a u d i t o r s d i d n o t a l t e r t h e b a s i c r e s u l t o f r e l a t i v e l y c o n s t a n t a u d i t o r c h a n g e s o v e r t i m e . O n l y t h e c h a n g e s f r o m n o n - B i g E i g h t t o B i g E i g h t a u d i t o r s i n d i c a t e d any s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p t o t i m e . A number o f p o t e n t i a l e x p l a n a t i o n s a s t o why t h i s s t u d y d i d n o t p r o d u c e t h e e x p e c t e d r e s u l t s o f i n c r e a s e d a u d i t o r t u r n o v e r a r e e x a m i n e d , and a r e a s f o r f u t u r e r e s e a r c h a r e d i s c u s s e d . i v TABLE OF CONTENTS Page ABSTRACT i i TABLE OF CONTENTS i v L I S T OF TABLES v i ACKNOWLEDGEMENT v i i CHAPTER 1 INTRODUCTION 1 I s s u e s i n P u b l i c A u d i t i n g 1 A u d i t o r I n d e p e n d e n c e 3 The R o l e o f t h e I n d e p e n d e n t A u d i t o r 4 M a r k e t S t r u c t u r e a n d A u d i t o r I n d e p e n d e n c e 5 E m p i r i c a l E f f e c t s o f P r i c e R i v a l r y 7 R e s e a r c h M e t h o d s a nd H y p o t h e s e s 9 O r g a n i z a t i o n o f t h i s T h e s i s 10 CHAPTER 2 REVIEW OF THE S T E I N , N I E L S E N AND SIMUNIC A R T I C L E 11 D e f i n i t i o n o f A u d i t o r I n d e p e n d e n c e 12 M a r k e t S t r u c t u r e E f f e c t s on A u d i t o r I n d e p e n d e n c e 14 A s s u m p t i o n s E m p l o y e d by SNS f 14 The C o s t s o f N o n i n d e p e n d e n c e 15 The E f f e c t s o f I n c r e a s e d R i v a l r y 16 Page CHAPTER 3 LITERATURE REVIEW OF RESEARCH ON AUDITOR CHANGES 22 CHAPTER 4 EMPIRICAL RESEARCH METHODS AND RESULTS 35 Summary o f T h e o r e t i c a l H y p o t h e s e s 36 A s s u m p t i o n s E m p l o y e d i n t h e E m p i r i c a l S t u d y 37 S o u r c e s o f D a t a 40 R e s e a r c h M e t h o d s 42 Summary o f D e s c r i p t i v e S t a t i s t i c s .. 44 F o r m a l T e s t s f o r T r e n d s i n A u d i t o r T u r n o v e r 47 R e s u l t s o f R e g r e s s i o n T e s t s 49 CHAPTER 5 SUMMARY OF RESULTS AND IMPLICATIONS FOR FURTHER RESEARCH 51 Summary o f T e s t R e s u l t s 51 P o s s i b l e E x p l a n a t i o n s f o r R e s u l t s o f S t a t i s t i c a l T e s t s 52 A r e a s f o r S u b s e q u e n t R e s e a r c h 54 CHAPTER 6 SUMMARY AND CONCLUSIONS 57 FOOTNOTES 64 BIBLIOGRAPHY 70 APPENDIX A " M a r k e t S t r u c t u r e a n d A u d i t o r I n d e p e n d e n c e " by M. S t e i n , A. N i e l s e n a n d D. S i m u n i c 74 APPENDIX B L i s t o f Sample OTC C o m p a n i e s 95 APPENDIX C L i s t o f OTC C o m p a n i e s C h a n g i n g A u d i t o r s 99 APPENDIX D R e s u l t s o f R e g r e s s i o n T e s t s 104 v i L I S T OF TABLES Page T a b l e I T o t a l A u d i t o r Changes and T u r n o v e r R a t e s , 1969-1983 .. 60 T a b l e I I Summary o f OTC A u d i t o r Change R e s u l t s 61 T a b l e I I I F r e q u e n c y o f A u d i t o r C h a n g e s by Company 62 T a b l e I V Segmented A u d i t o r C h a n g e s , 1969-1983 63 v i i A c k n o w l e d g e m e n t I w i s h t o t h a n k t h e members o f my c o m m i t t e e , P a t r i c i a H ughes, B i l l S t a n b u r y and e s p e c i a l l y Dan S i m u n i c , who a c t e d a s C h a i r m a n a n d who gave g u i d a n c e a n d s u p p o r t t h r o u g h o u t t h e p r o j e c t . A d d i t i o n a l t h a n k s a r e o w i n g t o G o r d o n R i c h a r d s o n and M i k e S t e i n f o r t h e i r h e l p f u l comments, and t o my f a m i l y , J i m and K a t e F r a s e r . 1 C h a p t e r One INTRODUCTION I s s u e s i n P u b l i c A u d i t i n g O v e r t h e p a s t t w e n t y y e a r s , c o n s i d e r a b l e a t t e n t i o n h a s been d i r e c t e d t o w a r d t h e o r g a n i z a t i o n a n d c o m p o s i t i o n o f t h e p u b l i c a u d i t i n g i n d u s t r y i n t h e U n i t e d S t a t e s . I s s u e s s u c h a s t h e a p p a r e n t l a c k o f a u d i t o r c o m p e t i t i o n , an a l l e g e d e r o s i o n o f a u d i t o r i n d e p e n d e n c e a nd c o n t i n u i n g t r e n d s o f m a r k e t c o n c e n t r a t i o n a r e e x a m p l e s o f s u c h g e n e r a l s c r u t i n y . And w h i l e t h e a c a d e m i c r e s e a r c h on t h e i n d u s t r i a l o r g a n i z a t i o n o f a u d i t i n g h a s been e x t e n s i v e , i n t e r e s t i n s u c h i s s u e s by no means h a s been l i m i t e d t o t h e a c a d e m i c c o m m u n i t y . S i n c e t h e e a r l y 1 9 7 0 ' s , numerous o t h e r p a r t i e s h a v e i n d i c a t e d e i t h e r a c o n c e r n o r i n t e r e s t i n b o t h t h e s t r u c t u r e a n d b e h a v i o r o f t h e p u b l i c a u d i t i n g i n d u s t r y . 1 F o r e x a m p l e , t h e p e r c e i v e d a n t i - c o m p e t i t i v e n a t u r e o f t h e a u d i t i n g i n d u s t r y was c h a l l e n g e d by t h e U.S. F e d e r a l J u s t i c e D e p a r t m e n t i n 1972. I n t h a t y e a r , t h e J u s t i c e D e p a r t m e n t c h a r g e d t h a t t h e I n s t i t u t e ' s Code o f P r o f e s s i o n a l E t h i c s R u l e 3.03 p r o h i b i t i n g c o m p e t i t i v e b i d d i n g v i o l a t e d a n t i t r u s t l e g i s l a t i o n . A c o n s e n t j u d g m e n t b e t w e e n t h e A I C P A and t h e J u s t i c e D e p a r t m e n t s e t t l e d t h e s u i t , a n d t h e b i d d i n g p r o h i b i t i o n was removed. A n o t h e r e x a m p l e o f g e n e r a l p u b l i c c o n c e r n r e g a r d i n g t h e m a r k e t s t r u c t u r e o f p u b l i c a u d i t o r s was t h e U.S. S e n a t e ' s e x a m i n a t i o n o f m a r k e t c o n c e n t r a t i o n i n p u b l i c a u d i t i n g . I n t h e i r 1977 r e p o r t e n t i t l e d "The R e p o r t o f t h e S u b c o m m i t t e e on 2 R e p o r t s , A c c o u n t i n g a n d Management o f t h e C o m m i t t e e on G o v e r n m e n t O p e r a t i o n s " (commonly known as t h e M e t c a l f R e p o r t ) , t h e y c o n c l u d e d t h a t t h e r e was i n s u f f i c i e n t c o m p e t i t i o n i n a u d i t m a r k e t s , p a r t i c u l a r l y among t h e l a r g e s t n a t i o n a l f i r m s . T h e i r c o n c l u s i o n r e f l e c t e d an a t t i t u d e , s t i l l p r e v a l e n t a f t e r t h e e l i m i n a t i o n o f t h e b i d d i n g p r o h i b i t i o n , t h a t t h e n a t i o n a l a c c o u n t i n g f i r m s ( o r t h e s o - c a l l e d B i g E i g h t f i r m s ) r e p r e s e n t e d an a l m o s t c a r t e l - l i k e o l i g o p o l y w h i c h s t i l l d i s p l a y e d l i t t l e o r no p r i c e c o m p e t i t i o n i n a u d i t i n g . A t a p p r o x i m a t e l y t h e same t i m e , t h e AICPA a l s o e x a m i n e d t h e l e v e l s o f c o m p e t i t i v e n e s s i n a u d i t i n g . The 1978 r e p o r t o f t h e i r i n v e s t i g a t i o n by t h e C o m m i s s i o n on A u d i t o r ' s R e s p o n s i b i l i t i e s (Cohen C o m m i s s i o n ) s t r o n g l y d i s a g r e e d w i t h t h e c o n c l u s i o n s o f t h e S e n a t e S u b c o m m i t t e e . I n s t e a d o f f i n d i n g e v i d e n c e of i n s u f f i c i e n t p r i c e c o m p e t i t i o n , t h e AICPA c o m m i s s i o n e r s a s s e r t e d t h a t e x c e s s i v e p r i c e c o m p e t i t i o n i n a u d i t i n g j e o p a r d i z e d a u d i t q u a l i t y . The f e d e r a l a n t i t r u s t s u i t a n d t h e M e t c a l f a n d Cohen C o m m i s s i o n s a r e n o t a b l e e x a m p l e s o f n o n - a c a d e m i c c o n c e r n r e g a r d i n g t h e U.S. a u d i t i n g i n d u s t r y . H owever, t h e g e n e r a l i n t e r e s t i n t h e o r g a n i z a t i o n of p u b l i c a u d i t i n g d i d n o t end i n t h e 1 9 7 0 ' s . I n f a c t , t h e c o n t i n u i n g s u c c e s s o f t h e p r i v a t e l y p r o d u c e d p u b l i c a t i o n Who A u d i t s A m e r i c a ( f i r s t p u b l i s h e d i n 1 9 7 6 ) , r e f l e c t s t h e o n - g o i n g i n t e r e s t i n b o t h t h e c u r r e n t c o m p o s i t i o n a n d c o n t i n u i n g c h a n g e s i n the; p u b l i c a u d i t i n g i n d u s t r y . A d d i t i o n a l l y , t h e c u r r e n t u p r o a r o v e r " o p i n i o n -3 s h o p p i n g " now u n d e r r e v i e w by t h e House S u b c o m m i t t e e on O v e r s i g h t and I n v e s t i g a t i o n s o f t h e C o m m i t t e e on E n e r g y a n d Commerce, i l l u s t r a t e s t h e c o n t i n u i n g p u b l i c c o n c e r n .over t h e b e h a v i o r o f a u d i t o r s . 2  A u d i t o r I n d e p e n d e n c e The a c a d e m i c r e s e a r c h i n t o t h e s t r u c t u r e a n d c o n d u c t o f p u b l i c a u d i t o r s h a s been e x t e n s i v e . 3 Of p a r t i c u l a r i n t e r e s t h a s been t h e p o t e n t i a l e r o s i o n of a u d i t o r i n d e p e n d e n c e . An a u d i t o r i s deemed t o be " i n d e p e n d e n t " o f a g i v e n c l i e n t i f he i s n o t i n f l u e n c e d by t h e p r e f e r e n c e s o f h i s c l i e n t i n t h e e x e c u t i o n o f h i s a u d i t i n g a n d a t t e s t f u n c t i o n . Thus an " i n d e p e n d e n t " a u d i t o r i s e x p e c t e d t o be w i l l i n g t o r e p o r t a n y b r e a c h e s d i s c o v e r e d i n h i s c l i e n t ' s f i n a n c i a l r e p o r t s , a n d be u n w i l l i n g t o " c o l l u d e " w i t h t h e c l i e n t r e g a r d i n g any p o s s i b l e m i s r e p r e s e n t a t i o n . . On t h e o t h e r h a n d , an a u d i t o r who c h o o s e s t o be " n o n i n d e p e n d e n t " may a l t e r h i s a u d i t i n g a c t i o n s o r o p i n i o n b a s e d on t h e p r e f e r e n c e s o f h i s c l i e n t . G i v e n t h e r e c o g n i z e d s o c i e t a l v a l u e o f t h e a t t e s t f u n c t i o n o f an i n d e p e n d e n t a u d i t o r , b r e a c h e s o f i n d e p e n d e n c e a r e g e n e r a l l y v i e w e d w i t h g r e a t c o n c e r n . B u t c e r t a i n l y n o t a l l a u d i t o r s a r e a l w a y s p e r f e c t l y i n d e p e n d e n t . Thus t h e c o n d i t i o n s l e a d i n g t o a u d i t o r n o n i n d e p e n d e n c e a r e o f i n t e r e s t , n o t o n l y t o a c a d e m i c r e s e a r c h e r s , b u t s u c h c o n d i t i o n s a r e of c o n s e q u e n c e t o t h e u s e r s o f a u d i t e d f i n a n c i a l s t a t e m e n t s . " 4 The R o l e o f t h e I n d e p e n d e n t A u d i t o r The r o l e o f t h e p u b l i c a u d i t o r i s w e l l e s t a b l i s h e d i n t h e modern b u s i n e s s c o m m u n i t y . As a. p r o f e s s i o n a l h i r e d f r o m o u t s i d e o f t h e f i r m , t h e a u d i t o r i s e x p e c t e d t o e x a m i n e t h e a c c o u n t i n g m e thods a n d p r o c e d u r e s of t h e c l i e n t company ( a u d i t ) a n d s u b m i t a w r i t t e n s t a t e m e n t ( o p i n i o n ) a s t o w h e t h e r t h e f i n a n c i a l s t a t e m e n t s a c c u r a t e l y r e f l e c t t h e f i n a n c i a l p o s i t i o n o f t h e f i r m . S u c h r e p o r t s f r o m " i n d e p e n d e n t " o u t s i d e a u d i t o r s p r o v i d e c r e d i b i l i t y a s t o t h e a c c u r a c y o f t h e f i r m ' s f i n a n c i a l r e p o r t i n g . T h e r e f o r e a u d i t e d f i n a n c i a l s t a t e m e n t s a r e o f i n t e r e s t t o t h e o w n e r s of c o m p a n i e s , e s p e c i a l l y w h ere t h e r e i s a s e p a r a t i o n b e t w e e n o w n e r s h i p a n d e f f e c t i v e management, a n d a r e o f p a r t i c u l a r i n t e r e s t t o t h i r d p a r t i e s , s u c h a s c u r r e n t and p o t e n t i a l i n v e s t o r s , c r e d i t o r s , e m p l o y e e s , a n d g o v e r n m e n t a l a g e n c i e s . H o w e v e r , t h e r e a r e a number o f p o t e n t i a l c o n f l i c t s c o n f r o n t i n g t h e p u b l i c a u d i t o r t h a t may impede h i s a b i l i t y t o b e h a v e i n d e p e n d e n t l y . 5 A u d i t o r s a r e e n g a g e d a n d p a i d by t h e c l i e n t f i r m ; h o w e v e r , t h e o w n e r s o f t h e f i r m a r e c o n c e r n e d a b o u t t h e i m p a c t t h a t a n y n e g a t i v e i n f o r m a t i o n t r a n s m i t t e d t o t h i r d p a r t i e s m i g h t h a v e upon t h e i r p r o f i t a b i l i t y . T h us o w n e r s (and m a n a g e r s ) may p u t p r e s s u r e on t h e i r a u d i t o r s t o e n s u r e s u i t a b l e f i n a n c i a l r e p o r t i n g . Whereas t h e t h i r d p a r t y u s e r s o f f i n a n c i a l s t a t e m e n t s demand i m p a r t i a l f i n a n c i a l r e p o r t i n g , t h e s e u s e r s have l i m i t e d l e v e r a g e o v e r a u d i t o r s to- e n s u r e ' t h i s r e s u l t . 5 F u r t h e r m o r e , t h e o u t s i d e a u d i t o r may g e t c a u g h t b e t w e e n t h e c o n f l i c t i n g i n t e r e s t s o f o w n e r s ( s h a r e h o l d e r s ) a n d management. A l t h o u g h t h e o w n e r s ' and m a n a g e r s ' i n t e r e s t s may d i r e c t l y c o r r e s p o n d r e g a r d i n g t h e r e p o r t i n g t o o u t s i d e u s e r s , s h a r e h o l d e r s may use a u d i t e d f i n a n c i a l i n f o r m a t i o n i n t h e i r e v a l u a t i o n a n d c o m p e n s a t i o n o f h i r e d management. T h u s , management may a p p l y p r e s s u r e on a u d i t o r s t o m i s r e p r e s e n t t h e i r p e r f o r m a n c e t o t h e owners o f t h e f i r m . The most o b v i o u s method o f p r e s s u r i n g a u d i t o r s i s t h r o u g h t h e t h r e a t o f t e r m i n a t i o n a n d / o r t h e r e d u c t i o n o f a u d i t f e e s . And w h i l e a u d i t o r s c a n e i t h e r r e s i g n o r q u a l i f y t h e i r a u d i t o p i n i o n s , t h e p u b l i c a u d i t o r a l s o c o n f r o n t s h i s own c o n f l i c t o f s e l f - i n t e r e s t , . The r a t i o n a l e a u d i t o r may c h o o s e t o be " n o n i n d e p e n d e n t " and m a i n t a i n t h e c l i e n t a c c o u n t r a t h e r t h a n r e f u s i n g c l i e n t r e q u e s t s f o r m i s r e p r e s e n t a t i o n a n d r i s k c l i e n t d e f e c t i o n . S u c h a c h o i c e w o u l d be b a s e d on t h e e x p e c t e d c o s t s and b e n e f i t s a s s o c i a t e d w i t h e i t h e r c h o i c e o f a c t i o n . Thus t h e i n s t i t u t i o n a l e n v i r o n m e n t f a c e d by t h e p u b l i c a u d i t o r p r o v i d e s f o r p o t e n t i a l " n o n i n d e p e n d e n t " a c t i o n . 6  M a r k e t S t r u c t u r e a n d A u d i t o r I n d e p e n d e n c e How t h e m a r k e t s t r u c t u r e o f p u b l i c a u d i t i n g a f f e c t s a u d i t o r i n d e p e n d e n c e h a s n o t been w e l l a d d r e s s e d i n t h e e x i s t i n g l i t e r a t u r e . To p u t i t s i m p l y , d o e s c o m p e t i t i o n i n a u d i t i n g f o s t e r more o r l e s s a u d i t o r i n d e p e n d e n c e ? A t t h e p r e s e n t t i m e , t h e l i t e r a t u r e p r o v i d e s , a t b e s t , o n l y s p o t t y a n d r a t h e r a n e c d o t a l e v i d e n c e i n d i c a t i n g t h a t i n c r e a s e d l e v e l s o f 6 c o m p e t i t i o n a r e o f t e n p e r c e i v e d t o impede t h e i n d e p e n d e n c e o f p u b l i c a u d i t o r s . As a c t u a l i n d e p e n d e n c e v e r s u s n o n i n d e p e n d e n t a c t i v i t y i s d i f f i c u l t t o g a u g e , e m p i r i c a l s t u d i e s h a v e g e n e r a l l y e x a m i n e d u s e r s ' p e r c e p t i o n s o f a u d i t o r i n d e p e n d e n c e . Whereas S h o c k l e y [ 1 9 8 1 ] f o u n d e v i d e n c e o f u s e r s a s s e s s i n g a r i s k t o a u d i t o r i n d e p e n d e n c e w i t h i n c r e a s i n g l e v e l s o f c o m p e t i t i o n , a r e c e n t s t u d y by Knapp [ 1 9 8 5 ] f o u n d no c o n c l u s i v e e v i d e n c e t h a t t h e p e r c e i v e d i n d e p e n d e n c e o f a u d i t o r s i s u n d e r m i n e d i n h i g h l y c o m p e t i t i v e a u d i t i n g m a r k e t s . Thus t h e e x i s t i n g l i t e r a t u r e on t h e p e r c e i v e d e f f e c t o f m a r k e t s t r u c t u r e on a u d i t o r i n d e p e n d e n c e p r o v i d e s o n l y a m i x e d r e s p o n s e . N o n e t h e l e s s , a s s e r t i o n s o f d i m i n i s h e d a u d i t o r i n d e p e n d e n c e w i t h h i g h e r l e v e l s o f c o m p e t i t i o n c a n s t i l l be f o u n d i n v a r i o u s a c c o u n t i n g p e r i o d i c a l s . 7 T h e o r e t i c a l r e s e a r c h on t h e u n d e r l y i n g r e l a t i o n s h i p b e t w e e n m a r k e t s t r u c t u r e a nd a u d i t o r i n d e p e n d e n c e i s v i r t u a l l y n o n -e x i s t e n t . The s o l e e x c e p t i o n i s t h e u n p u b l i s h e d p a p e r o f G o n e d e s a n d K i h l s t r o m [ 1 9 8 2 ] t h a t e x a m i n e d t h e e f f e c t o f m a r k e t s t r u c t u r e on a u d i t q u a l i t y . As h a s been w e l l d e m o n s t r a t e d , a u d i t o r i n d e p e n d e n c e i s a s i g n i f i c a n t i n g r e d i e n t o f a u d i t q u a l i t y . 8 However, t h e c o n c e p t o f a u d i t q u a l i t y p r e s e n t e d by G o n e d e s and K i h l s t r o m i s l a r g e l y u n d e f i n e d , a n d t h u s t h e i r a n a l y s i s c a n n o t be d i r e c t l y a p p l i e d t o t h e i s s u e o f a u d i t o r i n d e p e n d e n c e . 7 The r e s e a r c h c o n t a i n e d i n t h i s t h e s i s a d d r e s s e s t h i s i s s u e o f how t h e m a r k e t s t r u c t u r e o f p u b l i c a u d i t i n g may a f f e c t a u d i t o r i n d e p e n d e n c e . F o r t h e f i r s t segment o f t h i s t h e s i s w o r k , t h e a u t h o r r e c e n t l y c o l l a b o r a t e d w i t h two o t h e r r e s e a r c h e r s on t h e c o n s t r u c t i o n o f a model d e m o n s t r a t i n g how v a r i o u s m a r k e t c o n d i t i o n s p r o v i d e i n c e n t i v e s f o r e i t h e r a u d i t o r i n d e p e n d e n c e o r n o n i n d e p e n d e n c e . The r e s u l t o f t h i s r e s e a r c h e f f o r t i s a p a p e r by S t e i n , N i e l s e n a n d S i m u n i c [ 1 9 8 5 ] e n t i t l e d " M a r k e t S t r u c t u r e a n d A u d i t o r I n d e p e n d e n c e . " The e n t i r e t e x t o f t h a t p a p e r i s i n c l u d e d i n A p p e n d i x A, b u t w i l l be d i s c u s s e d a n d e x t e n d e d w i t h i n t h i s t h e s i s . H owever, two main c o n c l u s i o n s o f t h a t p a p e r s h o u l d be m e n t i o n e d h e r e . F i r s t , we c o n c l u d e d t h a t a s u f f i c i e n t c o n d i t i o n f o r a u d i t o r i n d e p e n d e n c e i s t h e a t t a i n m e n t o f t h e c o m p e t i t i v e p r i c e i n t h e m a r k e t f o r p u b l i c a u d i t s . 9 T h i s i n i t s e l f i s s i g n i f i c a n t i n t h a t i t g e n e r a l l y r e f u t e s t h o s e a r g u m e n t s w h i c h c l a i m t h a t " c o m p e t i t i o n " w i l l l e a d t o d i m i n i s h e d a u d i t o r i n d e p e n d e n c e . We a l s o made t h e d i s t i n c t i o n b e t w e e n r i v a l r y , a s t h e a c t o f c o m p e t i n g , and c o m p e t i t i o n , a s t h e a t t a i n m e n t o f t h e c o m p e t i t i v e e q u i l i b r i u m . T h u s , we showed t h a t when p r i c e r i v a l r y i s i n t r o d u c e d i n t o t h e a u d i t i n g m a r k e t , a u d i t o r i n d e p e n d e n c e may be c o m p r o m i s e d u n t i l f e e c o m p e t i t i o n d r i v e s t h e p r i c e t o t h e c o m p e t i t i v e e q u i l i b r i u m . A t t h a t t i m e , a u d i t o r i n d e p e n d e n c e i s r e s t o r e d . 1 0  E m p i r i c a l E f f e c t s o f P r i c e R i v a l r y The s e c o n d m a j o r component o f t h i s t h e s i s e x t e n d s t h e a b o v e m e n t i o n e d r e s e a r c h work o f S t e i n , N i e l s e n a n d S i m u n i c ( h e r e a f t e r r e f e r r e d t o a s S N S ) . U s i n g t h e a n a l y s e s o f SNS a s a 8 s t a r t i n g p o i n t , t h e r e a r e c e r t a i n e m p i r i c a l r a m i f i c a t i o n s t h a t c a n be t e s t e d . One s u c h e m p i r i c a l i m p l i c a t i o n r e s u l t s f r o m t h e s e c o n d c o n c l u s i o n i n d i c a t e d a b o v e . The i n t r o d u c t i o n o f p r i c e r i v a l r y i n t o n o n - c o m p e t i t i v e a u d i t i n g m a r k e t s p r e s u m a b l y w o u l d have t h e f o l l o w i n g t h r e e c o n s e q u e n c e s . F i r s t , a u d i t o r i n d e p e n d e n c e may be c o m p r o m i s e d i f i n c u m b e n t a u d i t o r s a t t e m p t t o m a i n t a i n c l i e n t s a t e x i s t i n g f e e r a t e s , by a c q u i e s c i n g t o c l i e n t s ' demands f o r n o n i n d e p e n d e n t a c t i o n , r a t h e r t h a n l o s e t h o s e c l i e n t s t o c o m p e t i t o r s o f f e r i n g i d e n t i c a l a u d i t s e r v i c e s a t a l o w e r p r i c e . However, a s n o t a l l a u d i t o r s a r e w i l l i n g t o r i s k n o n i n d e p e n d e n c e ( i n o t h e r w o r d s , t h e c o s t s o f n o n i n d e p e n d e n c e o u t w e i g h any e x p e c t e d b e n e f i t s ) , we w o u l d a l s o e x p e c t t o s e e r i v a l r y d r i v i n g down a u d i t o r s ' f e e s . 1 1 E i t h e r t h e i n c u m b e n t a u d i t o r w i l l l o w e r h i s p r i c e , o r t h e c l i e n t w i l l s w i t c h t o a n o t h e r c o m p e t i n g a u d i t o r . A u d i t o r s w i t c h i n g w o u l d o c c u r i f t h e i n c u m b e n t a u d i t o r d o e s n o t m a t c h h i s c o m p e t i t o r s ' l o w e r b i d s , due t o i m p e r f e c t i n f o r m a t i o n r e g a r d i n g t h e l o w e r b i d amounts o r i f t h e a u d i t o r r a t i o n a l l y c h o o s e s t o m a i n t a i n h i g h e r f e e s f o r c e r t a i n c l i e n t s . S u c h a u d i t o r b e h a v i o r i s p l a u s i b l e i f t h e i n c u m b e n t b e l i e v e s t h a t l o w e r i n g some c u r r e n t c l i e n t s ' f e e s may t r i g g e r s i m i l a r demands f o r f e e r e d u c t i o n s f r o m h i s r e m a i n i n g s t o c k o f c l i e n t s ( a g a i n , some l e v e l o f i n f o r m a t i o n a s ymmetry i s i m p l i e d ) . H e n c e , i n an a u d i t m a r k e t w i t h p e r f e c t s u b s t i t u t e s , an e m p i r i c a l i m p l i c a t i o n w o u l d be t h a t p r i c e r i v a l r y n o t o n l y l o w e r s f e e s b u t , c e t e r i s p a r i b u s , a l s o i n c r e a s e s a u d i t o r t u r n o v e r . 1 2 9 R e s e a r c h M e t h o d s a n d H y p o t h e s e s T h i s q u e s t i o n o f a u d i t o r t u r n o v e r i s a d d r e s s e d i n t h e s e c o n d p h a s e o f t h i s t h e s i s r e s e a r c h . A s s u m i n g t h a t t h e e x t a n t a u d i t m a r k e t s c a n be s u c c e s s f u l l y s u b d i v i d e d i n t o g r o u p s o f a u d i t o r s p r o v i d i n g s u b s t i t u t a b l e p r o d u c t s , a n d f u r t h e r a s s u m i n g t h a t t h e r e c e n t r e m o v a l of r e s t r i c t i o n s on c o m p e t i t i v e b i d d i n g , a u d i t o r a d v e r t i s i n g and s o l i c i t a t i o n c o n s t i t u t e d an i n v i t a t i o n f o r i n c r e a s e d p r i c e r i v a l r y , we e x a m i n e w h e t h e r t h e r a t e o f a u d i t o r c h a n g e s o v e r t i m e h a s , o r h a s n o t , r e m a i n e d c o n s t a n t . A u d i t o r i n f o r m a t i o n was p r o c u r e d f o r a s t a b l e s e t o f c o m p a n i e s r e p o r t i n g i n Moody's OTC I n d u s t r i a l M a n u a l s o v e r t h e f i f t e e n y e a r p e r i o d o f 1969 - 1983. A l l f i r m s w h i c h i n d i c a t e d a u d i t o r c h a n g e s were t h e n r e c o r d e d by y e a r , and f u r t h e r e x a m i n e d i n an e f f o r t t o d i s t i l l o n l y t h o s e c h a n g e s a p p a r e n t l y m o t i v a t e d by p r i c e c o n s i d e r a t i o n s ( t h a t i s , where f e e l e v e l s c h a n g e d b e c a u s e o f a c h a n g e i n m a r k e t s t r u c t u r e ) a n d n o t by o t h e r i d e n t i f i a b l e e x o g e n o u s c a u s e s . Thus any a u d i t o r c h a n g e r e s u l t i n g f r o m an a u d i t o r m e r g e r o r f r o m a s i g n i f i c a n t f i n a n c i a l o r s t r u c t u r a l e v e n t a f f e c t i n g t h e OTC f i r m was n o t c o n s i d e r e d a s an " a u d i t o r c h a n g e , " a s d e f i n e d i n t h i s s t u d y . The i n t e n t o f t h i s r e s e a r c h was t o d e t e r m i n e w h e t h e r we c o u l d o b s e r v e an i n c r e a s e i n t h e r a t e o f a u d i t o r t u r n o v e r d u r i n g t h e f i f t e e n y e a r p e r i o d e x a m i n e d . Thus t h e t o t a l a u d i t o r c h a n g e s r e c o r d e d f r o m t h i s s a m p l e were r e g r e s s e d o v e r t i m e . A d d i t i o n a l l y , i n an a t t e m p t t o f u r t h e r , s u b d i v i d e - t h e e x i s t i n g a u d i t m a r k e t s t o a p p r o x i m a t e m a r k e t s w i t h h i g h l y s u b s t i t u t a b l e 10 p r o d u c t s , we a l s o p e r f o r m e d r e g r e s s i o n s on t h e f o l l o w i n g s u b -s e c t o r s o f a u d i t o r c h a n g e s : [ 1 ] . a l l a u d i t o r c h a n g e s w i t h i n t h e B i g E i g h t a u d i t i n g f i rms; [ 2 ] a l l a u d i t o r c h a n g e s w i t h i n t h e n o n - B i g E i g h t a u d i t i n g f i rms; [ 3 ] t h e sum o f a l l a u d i t o r c h a n g e s w i t h i n t h e B i g E i g h t a nd n o n - B i g E i g h t a u d i t i n g f i r m s . Our h y p o t h e s i s p r e d i c t s t h a t i n c r e a s e d a u d i t o r t u r n o v e r s h o u l d c o n f i r m t h a t p r i c e r i v a l r y o c c u r r e d d u r i n g t h e p e r i o d e x a m i n e d , and t h a t n o t a l l a u d i t o r s c h o s e n o n i n d e p e n d e n c e o v e r t h e p o s s i b l e l o s s o f c l i e n t a c c o u n t s . O r g a n i z a t i o n o f t h i s T h e s i s The o r g a n i z a t i o n o f t h i s t h e s i s i s as f o l l o w s . C h a p t e r Two s u m m a r i z e s and d i s c u s s e s t h e main i m p l i c a t i o n s o f t h e SNS p a p e r . The m a j o r a s s u m p t i o n s a r e s p e c i f i e d a nd t h e e m p i r i c a l i m p l i c a t i o n s a r e n o t e d . C h a p t e r T h r e e p r o v i d e s a r e v i e w o f t h e r e c e n t l i t e r a t u r e on a u d i t o r t u r n o v e r , and t h e r e l e v a n c e o f t h e s e e a r l i e r w o r k s t o t h e t e s t s p e r f o r m e d h e r e i n . C h a p t e r F o u r d e s c r i b e s t h e r e s e a r c h p r o c e d u r e s f o l l o w e d , t h e s t a t i s t i c a l t e s t s a n d m a j o r c o n c l u s i o n s o f t h e t i m e s e r i e s a n a l y s e s p e r f o r m e d . C h a p t e r F i v e s u m m a r i z e s t h e r e s u l t s o f C h a p t e r F o u r a n d p r o v i d e s s u g g e s t i o n s f o r f u r t h e r r e s e a r c h . C h a p t e r S i x c o n c l u d e s . 11 C h a p t e r Two REVIEW OF THE S T EIN, N I E L S E N AND SIMUNIC ARTICLE I n t h i s c h a p t e r , a b r i e f summary a n d o v e r v i e w of t h e p a p e r e n t i t l e d " M a r k e t S t r u c t u r e and A u d i t o r I n d e p e n d e n c e " by S t e i n , N i e l s e n and S i m u n i c [ 1 9 8 5 ] ( h e r e a f t e r r e f e r r e d t o a s SNS) i s p r e s e n t e d . 1 3 The m a i n c o n c l u s i o n s a n d m a j o r a s s u m p t i o n s a r e r e v i e w e d , and t h e r e l e v a n t e m p i r i c a l i m p l i c a t i o n s a r e d i s c u s s e d . One s u c h e m p i r i c a l r a m i f i c a t i o n i s i d e n t i f i e d a s t h e m o t i v a t i o n f o r t h e a d d i t i o n a l r e s e a r c h r e p o r t e d l a t e r i n t h i s t h e s i s . The SNS p a p e r r e s u l t e d n o t o n l y f r o m t h e a p p a r e n t l a c k o f t h e o r e t i c a l r e s e a r c h on t h e e f f e c t o f m a r k e t s t r u c t u r e on a u d i t o r i n d e p e n d e n c e , b u t f r o m what we saw a s a common m i s u n d e r s t a n d i n g o f t h e i n h e r e n t r e l a t i o n s h i p b e t ween t h e s e two f a c t o r s . A r e c u r r i n g a s s e r t i o n i n a u d i t i n g l i t e r a t u r e h a s b een t h a t t h e r e i s some i n h e r e n t t r a d e - o f f b e t w e e n c o m p e t i t i o n a n d i n d e p e n d e n c e . T h i s a r g u m e n t i s w e l l s u m m a r i z e d by S h o c k l e y [ 1 9 8 1 , p . 7 8 7 ] : As c o m p e t i t i o n f o r a u d i t c l i e n t s i n c r e a s e s , c l i e n t s ' o p p o r t u n i t i e s a n d i n c e n t i v e s t o r e p l a c e i n c u m b e n t a u d i t o r s a l s o i n c r e a s e . R e a s o n s f o r t h e c h a n g e may r a n g e f r o m m i n i m i z a t i o n o f a u d i t f e e s t o a s e a r c h f o r a more c o m p l i a n t a u d i t o r . R e g a r d l e s s , a u d i t o r s ' d e p e n d e n c e on t h e i r c l i e n t s may i n c r e a s e i f t h e y b e l i e v e t h a t o t h e r a u d i t i n g f i r m s w o u l d be happy t o a c c e p t t h e engagement s h o u l d a c l i e n t become d i s p l e a s e d . As a r e s u l t o f s u c h a r g u m e n t s , t h e q u e s t i o n a s t o w h e t h e r c o m p e t i t i o n a f f e c t s a u d i t o r i n d e p e n d e n c e h a s been i n c l u d e d i n a t l e a s t two e m p i r i c a l s t u d i e s e x a m i n i n g u s e r s ' p e r c e p t i o n s o f t h e 1 2 i n d e p e n d e n c e o f p u b l i c a u d i t o r s . As i n d i c a t e d i n C h a p t e r One, t h e r e s u l t s o f s u c h t e s t s have been m i x e d ( S h o c k l e y [ 1 9 8 1 ] , and Knapp [ 1 9 8 5 ] ) . On t h e o t h e r h a n d , a n o t h e r s e t o f a u t h o r s h a v e s t a t e d t h a t t h e r e i s b a s i c a l l y no r e l a t i o n s h i p b e t w e e n m a r k e t s t r u c t u r e a nd a u d i t o r i n d e p e n d e n c e . I n t h e i r c o n c l u s i o n , Kay a n d L a v i n [ 1 9 7 9 ] a s s e r t e d t h a t w h i l e a u d i t o r i n d e p e n d e n c e i s c r i t i c a l , " I n o u r v i e w , c o m p e t i t i o n h a s v e r y l i t t l e t o . do w i t h p r o f e s s i o n a l i n d e p e n d e n c e . . ." [ p . 3 7 ] I n f a c t , t h e a u t h o r s c o n t i n u e d t h a t e v e n t h e i s s u e o f i n d e p e n d e n c e i s n o t a m a j o r p r o b l e m i n p u b l i c a u d i t i n g . G i v e n t h i s l a c k o f u n d e r s t a n d i n g a n d e v e n c o n s e n s u s on t h e r e l a t i o n s h i p b e t w e e n a u d i t o r i n d e p e n d e n c e a n d m a r k e t s t r u c t u r e , we f e l t t h a t a g e n e r a l t h e o r e t i c a l m o d e l was i n o r d e r . H e n c e , i n t h e SNS a r t i c l e we n o t o n l y d e v i s e d an o p e r a t i o n a l d e f i n i t i o n o f a d i t o r i n d e p e n d e n c e , b u t we showed how i n d e p e n d e n c e may be c o m p r o m i s e d u n d e r v a r i o u s m a r k e t c o n d i t i o n s . 1 0  D e f i n i t i o n o f A u d i t o r I n d e p e n d e n c e As s t a t e d i n t h e SNS a r t i c l e , "an a u d i t o r i s i n d e p e n d e n t o f h i s c l i e n t i f t h e a u d i t o r ' s a c t i o n s a r e n o t i n f l u e n c e d by t h e p r e f e r e n c e s o f t h e c l i e n t . " [ p . 3 ] However, w h i l e s u c h a d e f i n i t i o n may be s u f f i c i e n t l y b r o a d t o encompass v i r t u a l l y a l l i s s u e s o f i n d e p e n d e n c e , i t i s n o t p a r t i c u l a r l y u s e f u l i n t h e c o n s t r u c t i o n o f a t h e o r e t i c a l m o d e l . H e n c e , i n t h e SNS a r t i c l e , we " o p e r a t i o n a l i z e d " t h e a b o v e d e f i n i t i o n i n t h e f o l l o w i n g manner. F i r s t , we u s e d t h e common a s s u m p t i o n t h a t a u d i t o r s a r e 1 3 u t i l i t y m a x i m i z e r s o v e r w e a l t h . Then we a s k e d t h e q u e s t i o n , when i s i t i n t h e a u d i t o r ' s e c o n o m i c i n t e r e s t t o be i n d e p e n d e n t o f h i s c l i e n t ? F i r s t , an a u d i t o r i s deemed t o be " i n c e n t i v e i n d e p e n d e n t " when n o n i n d e p e n d e n t a c t i o n w i l l make h i m w o r s e o f f . S u c h an a s s e s s m e n t i s made by t h e i n d i v i d u a l a u d i t o r b a s e d on a s i m p l e e x a m i n a t i o n o f t h e e x p e c t e d c o s t s a n d b e n e f i t s o f t h e n o n i n d e p e n d e n t a c t i o n w i t h r e s p e c t t o h i s u t i l i t y o v e r w e a l t h . The b e n e f i t s o f n o n i n d e p e n d e n c e i n c l u d e m a i n t a i n i n g t h e c l i e n t a c c o u n t a n d any a c c o m p a n y i n g c u r r e n t a n d f u t u r e c l i e n t - s p e c i f i c e c o n o m i c r e n t s . The a u d i t o r ' s c o s t s o f n o n i n d e p e n d e n c e may i n c l u d e p o s s i b l e f i n e s o r l e g a l c o s t s i f t h e n o n i n d e p e n d e n t a c t i o n i s d e t e c t e d , a n d a l s o t h e p o t e n t i a l l o s s o f o t h e r c l i e n t s ' r e n t s c a u s e d by any damage t o r e p u t a t i o n a n d / o r t h e l o s s o f p r o f e s s i o n a l a u d i t o r s t a t u s . 1 5 The s e c o n d f o r m o f i n d e p e n d e n c e o c c u r s when t h e a u d i t o r h a s s u f f i c i e n t b a r g a i n i n g power t o r e s i s t c l i e n t p r e s s u r e f o r n o n i n d e p e n d e n t a c t i o n . T h i s i s t e r m e d " b a r g a i n i n g i n d e p e n d e n c e . " I n t h i s c a s e , t h e i n c u m b e n t a u d i t o r n o t o n l y e x a m i n e s h i s own c o s t s a n d b e n e f i t s , b u t a l s o c o n s i d e r s ( o r e s t i m a t e s ) t h e c l i e n t ' s e x p e c t e d b e n e f i t s a n d c o s t s o f c h a n g i n g a u d i t o r s . Thus t h e a u d i t o r w i l l be " b a r g a i n i n g i n d e p e n d e n t " i f he j u d g e s t h e t h r e a t o f t e r m i n a t i o n t o be n o t c r e d i b l e i f , f o r e x a m p l e , t h e c l i e n t f a c e s s i g n i f i c a n t t r a n s a c t i o n s c o s t s a s s o c i a t e d w i t h c h a n g i n g a u d i t o r s . T h e s e two o p e r a t i o n a l d e f i n i t i o n s c a n t h e n be t r a n s l a t e d i n t o t h e s i m p l e m a t h e m a t i c a l m o d e l u s e d by S N S . 1 6 1 4 M a r k e t S t r u c t u r e E f f e c t s on A u d i t o r I n d e p e n d e n c e W i t h an o p e r a t i o n a l d e f i n i t i o n o f a u d i t o r i n d e p e n d e n c e c o n s t r u c t e d , t h e i s s u e o f how m a r k e t s t r u c t u r e may a f f e c t i n d e p e n d e n c e c a n be a n a l y z e d . I n t h e SNS a r t i c l e , we e x a m i n e d t h e p a r a d i g m c a s e s o f c o m p e t i t i o n a n d m o n o p o l y , w i t h a l s o a b r i e f r e v i e w o f c o l l u s i v e o l i g o p o l y . The i n t e n t was t o d e t e r m i n e u n d e r w h i c h m a r k e t c o n d i t i o n s i n c e n t i v e a n d / o r b a r g a i n i n g i n d e p e n d e n c e e x i s t . We c o n c l u d e d t h a t c o m p e t i t i v e p r i c i n g ( w i t h t h e a b s e n c e o f e c o n o m i c r e n t s ) l e a d s t o i n c e n t i v e i n d e p e n d e n c e , w h e r e a s t h e e x i s t e n c e o f r e n t s r e s u l t i n g f r o m n o n -c o m p e t i t i v e p r i c i n g a l l o w s f o r t h e p o s s i b i l i t y o f n o n i n d e p e n d e n c e . N o n i n d e p e n d e n t a u d i t o r a c t i o n w i l l r e s u l t i f t h e c o s t s o f n o n i n d e p e n d e n c e a r e c o n s i d e r e d " s m a l l " a n d c l i e n t c o s t s o f d e f e c t i o n a r e deemed " l a r g e . " I n t h i s c a s e , b a r g a i n i n g i n d e p e n d e n c e w i l l n o t h o l d a s t h e a u d i t o r knows t h a t t h e c l i e n t ' s t h r e a t o f t e r m i n a t i o n i s c r e d i b l e . I n summary, a m a j o r r e s u l t o f t h e SNS r e s e a r c h i s t h a t " o u t s i d e o f t h e m o n o p o l y , m a n d a t o r y a u d i t c a s e we c o n c l u d e [ d ] t h a t c o m p e t i t i v e p r i c i n g i s s u f f i c i e n t t o e n s u r e i n d e p e n d e n c e a nd [ e c o n o m i c ] r e n t s a r e n e c e s s a r y f o r n o n i n d e p e n d e n c e . " [ p . 1 0 ] A s s u m p t i o n s E m p l o y e d by SNS The a b o v e c o n c l u s i o n s a r e p r e d i c a t e d on a number o f a s s u m p t i o n s , s e v e r a l o f w h i c h must be h i g h l i g h t e d h e r e . A c e n t r a l a s s u m p t i o n u s e d i n t h e SNS p a p e r s t a t e d t h a t a l l a u d i t s w ere a c c o m p l i s h e d by a homogeneous t e c h n o l o g y . T h i s a s s u m p t i o n was u s e f u l i n t h a t we c o u l d t h e n l i m i t t h e d i s c u s s i o n t o a 15 s i n g l e a u d i t i n g m a r k e t a n d t h e r e b y a v o i d t h e i s s u e s o f p r o d u c t d i f f e r e n t i a t i o n a n d s c a l e e c o n o m i e s . O b v i o u s l y , t h i s a s s u m p t i o n must be r e l a x e d b e f o r e any e x t e n s i o n o f t h i s r e s e a r c h i s a p p l i e d e m p i r i c a l l y . An i m p o r t a n t e x a m p l e o f t h e h e t e r o g e n o u s n a t u r e o f t h e a u d i t i n g p r o d u c t i s t h a t i n some a r e a s , a c c o u n t i n g s t a n d a r d s a r e s u f f i c i e n t l y v a g u e t o a l l o w l e g i t i m a t e d i f f e r e n c e s o f o p i n i o n s b e t w e e n a u d i t o r s r e g a r d i n g r e p o r t i n g m e t h o d s . Thus one a u d i t o r may p e r c e i v e a p o t e n t i a l a c t i o n a s " n o n i n d e p e n d e n t , " w h e r e a s a n o t h e r a u d i t o r may v i e w t h e same a c t i o n ( s u c h a s t h e u s e o f a p a r t i c u l a r r e p o r t i n g method) as an a c c e p t a b l e , i n d e p e n d e n t a c t i o n . F u r t h e r m o r e , i t i s commonly a c c e p t e d i n t h e a c t u a l a u d i t i n g m a r k e t s , t h a t some amount o f p r o d u c t d i f f e r e n t i a t i o n e x i s t s b e t w e e n t h e s e r v i c e s o f f e r e d by t h e n a t i o n a l a n d s m a l l e r , n o n - n a t i o n a l a u d i t i n g f i r m s . F i n a l l y , a l l of t h e m o d e l l i n g i n t h e SNS a r t i c l e was b a s e d on a s i n g l e p e r i o d o n l y . T h i s a s s u m p t i o n i s t o o r e s t r i c t i v e , e s p e c i a l l y when e x a m i n i n g t h e i s s u e o f a u d i t o r t u r n o v e r , where a u d i t o r s e l e c t i o n may be m o t i v a t e d , a t l e a s t i n p a r t , by m u l t i -p e r i o d c o n s i d e r a t i o n s . The C o s t s o f N o n i n d e p e n d e n c e As i n d i c a t e d e a r l i e r , t h e s i z e o f t h e c o s t s o f n o n i n d e p e n d e n c e i s c r u c i a l i n t h e a u d i t o r ' s c h o i c e o f a c t i o n . 1 7 I f t h e c o s t s o f n o n i n d e p e n d e n t a c t i o n a r e deemed t o be " l a r g e " ( a n d t h e r e f o r e e x c e e d t h e e x p e c t e d b e n e f i t s ) , t h e n i n c e n t i v e i n d e p e n d e n c e w i l l e n s u r e t h e a u d i t o r ' s i n d e p e n d e n c e . On t h e o t h e r h a n d , i f t h e a u d i t o r a s s e s s e s t h e s e c o s t s a s " s m a l l , " t h e n 16 t h e r e a r e two p o s s i b l e o u t c o m e s . I f c l i e n t d e f e c t i o n i s c o s t l y ( t o t h e c l i e n t ) , t h e n b a r g a i n i n g i n d e p e n d e n c e w i l l o c c u r . H o wever, i f t h e t r a n s a c t i o n s c o s t s f a c e d by t h e c l i e n t a r e n o t s i g n i f i c a n t , t h e n t h e a u d i t o r may be n o n i n d e p e n d e n t i f t h e c l i e n t so r e q u i r e s . T h i s i s s u e o f t h e n a t u r e a n d m a g n i t u d e o f t h e c o s t s f a c e d by a n o n i n d e p e n d e n t a u d i t o r i s of some i n t e r e s t . I n t h e SNS p a p e r , we r e f e r r e d t o D e A n g e l o ' s [ 1 9 8 1 b ] a r g u m e n t t h a t a p r i m a r y c o s t o f n o n i n d e p e n d e n c e i s t h e r e s u l t i n g l o s s o f r e n t s f r o m o t h e r c l i e n t s . A c c o r d i n g t o D e A n g e l o , t h e sum o f t h e s e l o s t r e n t s a c t a s a c o l l a t e r a l bond e n s u r i n g t h a t a u d i t o r s c o l l e c t i n g l a r g e r e n t s w i l l n o t j e o p a r d i z e them w i t h n o n i n d e p e n d e n t a c t i v i t y . Thus D e A n g e l o ' s a r g u m e n t w o u l d l e a d t o t h e r e s u l t t h a t w h i l e i n d i v i d u a l r e n t s c r e a t e t h e p o s s i b i l i t y o f n o n i n d e p e n d e n c e , t h e a g g r e g a t e l o s s o f r e n t s w i l l e n s u r e i n c e n t i v e i n d e p e n d e n c e . I n t h e SNS a r t i c l e , we i n d i c a t e d a number o f p o s s i b l e p r o b l e m s w i t h t h e c o l l a t e r a l bond a r g u m e n t . N e v e r t h e l e s s , t h e m a g n i t u d e o f t h e s e c o s t s o f n o n i n d e p e n d e n t a c t i o n r e m a i n u n c l e a r . T h i s i s l e f t a s an e m p i r i c a l i s s u e t h a t s h o u l d be a d d r e s s e d i n f u t u r e r e s e a r c h . The E f f e c t s o f I n c r e a s e d R i v a l r y The f i n a l s e c t i o n o f t h e SNS a r t i c l e r e t u r n e d t o t h e c e n t r a l q u e s t i o n o f w h e t h e r i n c r e a s e d l e v e l s o f c o m p e t i t i o n p r o m o t e s o r l i m i t s a u d i t o r i n d e p e n d e n c e . To do t h i s , we made t h e d i s t i n c t i o n b e t ween c o m p e t i t i o n a n d r i v a l r y . R i v a l r y i s 17 c o m p e t i n g ; t h a t i s , r i v a l r y i s t h e s e t o f c o m p e t i t i v e a c t i o n s t h a t t a k e s p l a c e b e t w e e n f i r m s a s t h e y t r y t o i n c r e a s e t h e i r p r o f i t l e v e l s a t t h e e x p e n s e o f r i v a l s . S u c h a c t i o n s c a n i n c l u d e b o t h p r i c e and n o n - p r i c e c o m p e t i t i o n t h r o u g h p r o d u c t d i f f e r e n t i a t i o n . On t h e o t h e r h a n d , c o m p e t i t i o n r e f e r s t o t h e s t a t e o f c o m p e t i t i v e e q u i l i b r i u m c h a r a c t e r i z e d b y , among o t h e r t h i n g s , t h e a b s e n c e o f e c o n o m i c p r o f i t s . I n t h e SNS s t u d y , we showed t h a t t h e a r g u m e n t t h a t c o m p e t i t i o n ( a c t u a l l y r i v a l r y ) i mpedes a u d i t o r i n d e p e n d e n c e i s b a s e d on a d i s e q u i l i b r i u m s i t u a t i o n where i n d e p e n d e n c e may be c o m p r o m i s e d u n t i l t h e c o m p e t i t i v e e q u i l i b r i u m h a s been a c h i e v e d . The f o l l o w i n g e x a m p l e s e r v e s t o i l l u s t r a t e t h i s d i s e q u i l i b r i u m s c e n a r i o . F i r s t , l e t us assume t h a t a t h e o r e t i c a l m a r k e t f o r a u d i t s i s o r g a n i z e d o l i g o p o l i s t i c a l l y . S e c o n d l y , l e t us assume t h a t t h e r e i s no r i v a l r y among t h e a u d i t o r s , and t h a t t h e o l i g o p o l i s t s h a v e s u f f i c i e n t p o l i c i n g m e c h anisms t o e n s u r e t h a t no c h e a t i n g t a k e s p l a c e . G i v e n t h e s e a s s u m p t i o n s , a n d r e c a l l i n g t h e SNS a s s u m p t i o n o f homogeneous t e c h n o l o g y , t h e n t h e f e e s o f s u c h c o l l u s i v e l y o r g a n i z e d o l i g o p o l i s t s w o u l d be i d e n t i c a l . I f we a l s o assume p o s i t i v e t r a n s a c t i o n s c o s t s f o r c l i e n t c o m p a n i e s c h a n g i n g a u d i t o r s , t h e n b a r g a i n i n g i n d e p e n d e n c e w i l l h o l d . W i t h c h e a t i n g d i s a l l o w e d , no o l i g o p o l i s t w o u l d c o n s i d e r n o n - i n d e p e n d e n c e , and i n c u m b e n t a u d i t o r s w o u l d a l s o know t h a t t h e i r c l i e n t s ' t h r e a t s o f d e f e c t i o n a r e g r o u n d l e s s . T h e r e f o r e an o l i g o p o l y o p e r a t i n g u n d e r s u c h h y p o t h e t i c a l c o n d i t i o n s p r o v i d e s f o r t h e o p p o r t u n i t y 18 where t h e l a c k o f p r i c e r i v a l r y e n s u r e s a u d i t o r i n d e p e n d e n c e . ( A d d i t i o n a l l y , i f we h o l d c o n s t a n t o t h e r e x o g e n o u s r e a s o n s f o r c h a n g i n g a u d i t o r s , we w o u l d e x p e c t l i m i t e d a u d i t o r t u r n o v e r w i t h s u c h a c o l l u s i v e o l i g o p o l y . ) L e t us now r e l a x some o f t h e r e s t r i c t i v e a s s u m p t i o n s e m p l o y e d a b o v e , so t h a t we c a n more c l o s e l y a p p r o x i m a t e t h e " r e a l - w o r l d m a r k e t " f o r a u d i t s . The a s s u m p t i o n o f an o l i g o p o l i s t i c m a r k e t s t r u c t u r e i n a u d i t i n g i s n o t u n r e a s o n a b l e , and w o u l d c o n f o r m w i t h much o f t h e a n e c d o t a l e v i d e n c e c i t e d t h r o u g h o u t t h e 1 9 7 0 ' s . C e r t a i n l y m a r k e t c o n c e n t r a t i o n e x i s t e d ( a n d c o n t i n u e s t o e x i s t ) t h r o u g h t h e d o m i n a n c e o f t h e n a t i o n a l , o r B i g E i g h t , a u d i t i n g f i r m s . And f u r t h e r m o r e , p r i c e c o m p e t i t i o n was p r o h i b i t e d u n t i l t h e a n t i t r u s t s u i t i n 1972, w i t h a l l e g a t i o n s o f t h e c o n t i n u e d l a c k o f p r i c e c o m p e t i t i v e n e s s e x t e n d i n g i n t o t h e m i d - 1 9 7 0 ' s . 1 8 Our s e c o n d a s s u m p t i o n u s e d above i n d i c a t e d no r i v a l r y among t h e o l i g o p o l i s t i c a u d i t o r s . S u c h a s c e n a r i o may have been a p p r o a c h e d when p r o f e s s i o n a l e t h i c s c o d e s p r o h i b i t e d a c t i v i t i e s s u c h a s c o m p e t i t i v e b i d d i n g , a d v e r t i s i n g a n d d i r e c t s o l i c i t a t i o n t h a t p r o m o t e r i v a l r y . H owever, o t h e r methods o f n o n - p r i c e c o m p e t i t i o n must have been a v a i l a b l e t o a u d i t o r s p r e c e d i n g t h e AICPA r u l e c h a n g e s . Thus w h i l e we may be u n a b l e t o s t a t e t h a t r i v a l r y was n o n - e x i s t e n t p r i o r t o t h e r u l e c h a n g e s , we c a n s a f e l y assume t h a t s u c h r i v a l r y was m i n i m a l c o m p a r e d t o t h e p e r i o d f o l l o w i n g t h e r e m o v a l o f t h e p r o f e s s i o n a l p r o h i b i t i o n s i, 19 The n e x t two a s s u m p t i o n s o f no c h e a t i n g among o l i g o p o l i s t s a n d common t e c h n o l o g y a c r o s s a l l . a u d i t s a r e o b v i o u s l y t o o r e s t r i c t i v e t o a p p r o x i m a t e t h e " r e a l - w o r l d . " C h e a t i n g d o e s e x i s t , a n d d i f f e r e n t a u d i t o r s f a c e d i f f e r i n g c o s t s , t h u s a l l o w i n g f o r some d i s p e r s i o n i n f e e s . H e nce, b a r g a i n i n g i n d e p e n d e n c e may n o t n e c e s s a r i l y h o l d i n a " r e a l - w o r l d " a u d i t i n g o l i g o p o l y . N e v e r t h e l e s s , w i t h e v e n some c o l l u s i o n b e t w e e n a u d i t o r s , we w o u l d e x p e c t a r e a s o n a b l y s t a b l e m a r k e t f o r a u d i t o r s u n d e r an o l i g o p o l y , w i t h l i m i t e d f e e d i s p e r s i o n a n d t h e r e f o r e e n h a n c e d l e v e l s o f i n d e p e n d e n c e and m i n i m a l a u d i t o r t u r n o v e r . Now, assume t h a t p r i c e r i v a l r y i s i n t r o d u c e d i n t o t h e m a r k e t ( t o e i t h e r o u r t h e o r e t i c a l m a r k e t , o r t o a l e s s r e s t r i c t i v e o l i g o p o l y s i t u a t i o n ) s u c h t h a t n o n i n c u m b e n t a u d i t f i r m s h a v e i n c e n t i v e s t o l o w e r p o t e n t i a l f e e s . A u d i t o r s c a n no l o n g e r p r e v e n t c l i e n t d e f e c t i o n , a n d t h e y may be w i l l i n g t o c o m p r o m i s e i n d e p e n d e n c e i n o r d e r t o r e t a i n t h e i r e x i s t i n g s t o c k o f c l i e n t s ( a n d t h e a c c o m p a n y i n g r e n t s ) . H o w e v e r , i f t h e i n c u m b e n t a u d i t o r i s w i l l i n g t o r e d u c e h i s f e e t o meet t h e c o m p e t i t o r ' s b i d , i n d e p e n d e n c e c a n be m a i n t a i n e d . T h e r e f o r e , a s s t a t e d i n t h e SNS s t u d y : Thus t h e i n t r o d u c t i o n o f r i v a l r y c o u l d p r o d u c e t h e a p p e a r a n c e o f n o n i n d e p e n d e n c e a s t h o s e a u d i t o r s a t t e m p t i n g t o m a i n t a i n r e n t s c a n n o t a l s o m a i n t a i n i n d e p e n d e n c e . . . . H o w e v e r , o n c e r i v a l r y f o r c e s f e e s t o t h e c o m p e t i t i v e p r i c e , t h e r e w i l l be no f u r t h e r p r i c e c u t t i n g a n d a u d i t o r i n d e p e n d e n c e w i l l be g u a r a n t e e d . [ p . 1 4 ] 20 To s u m m a r i z e , i n t h e SNS a r t i c l e we a r g u e d t h a t t h e a s s e r t i o n t h a t c o m p e t i t i o n ( w h i c h s h o u l d be r i v a l r y ) i n h i b i t s a u d i t o r i n d e p e n d e n c e i s b a s e d on a d i s e q u i l i b r i u m s i t u a t i o n . D u r i n g t h e p e r i o d o f d i s e q u i l i b r i u m , we w o u l d e x p e c t t o f i n d t h e f o l l o w i n g e v e n t s o c c u r r i n g . A u d i t o r i n d e p e n d e n c e may be a t r i s k i n t h a t i n c u m b e n t a u d i t o r s may c h o o s e n o n i n d e p e n d e n t a c t i o n s o v e r t h e p o s s i b l e l o s s o f e c o n o m i c r e n t s . H owever, a s a l l a u d i t o r s w i l l n o t be w i l l i n g t o r i s k n o n i n d e p e n d e n c e (where t h e c o s t s o f n o n i n d e p e n d e n t a c t i o n a r e c o n s i d e r e d " l a r g e " ) , we w o u l d t h e n e x p e c t t o s e e d e c r e a s i n g f e e s a s t h e r e n t s a r e e r o d e d ; a n d , c e t e r i s p a r i b u s , we w o u l d a l s o e x p e c t an i n c r e a s e i n a u d i t o r t u r n o v e r , a s c l i e n t c o m p a n i e s move t o n o n i n c u m b e n t a u d i t o r s o f f e r i n g i d e n t i c a l ( i n d e p e n d e n t ) a u d i t s e r v i c e s a t a l o w e r p r i c e . S u c h i n c r e a s e d t u r n o v e r w o u l d r e s u l t when i n c u m b e n t s do n o t m a t c h t h e i r r i v a l s ' l o w e r b i d s b e c a u s e o f e i t h e r i m p e r f e c t i n f o r m a t i o n r e g a r d i n g t h e l o w e r b i d a m o u n t s , o r t h a t i n c u m b e n t a u d i t o r s c h o o s e n o t t o r e d u c e some f e e s b e c a u s e t h e y f e a r t h a t t h e i r o t h e r c l i e n t s w i l l t h e n demand s i m i l a r f e e r e d u c t i o n s . H o w e v e r , o n c e r i v a l r y h a s c o m p l e t e l y e r o d e d a l l e c o n o m i c r e n t s a n d t h e c o m p e t i t i v e p r i c e i s a c h i e v e d , a u d i t o r i n d e p e n d e n c e w o u l d be a s s u r e d , a n d a u d i t o r t u r n o v e r s h o u l d r e m a i n r e l a t i v e l y c o n s t a n t o v e r t i m e . T h i s t h e n l e a d s t o t h e e m p i r i c a l p o r t i o n o f t h i s t h e s i s . I f t h e SNS c o n c l u s i o n s r e g a r d i n g p r i c e r i v a l r y a r e c o r r e c t , t h e n t h e a b o v e m e n t i o n e d r e s u l t s t o f e e s a n d a u d i t o r t u r n o v e r s h o u l d be o b s e r v a b l e . As f e e d a t a i s v e r y d i f f i c u l t t o o b t a i n , i n t h i s t h e s i s t h e e m p i r i c a l i n v e s t i g a t i o n i s l i m i t e d t o t h e s e c o n d a r y 21 s e t o f o b s e r v a b l e e v e n t s , t h e r a t e o f a u d i t o r c h a n g e . 1 9 I f a u d i t o r a p p o i n t m e n t i s p r i m a r i l y m o t i v a t e d by p r i c e c o n s i d e r a t i o n s , a n d i f we c a n s u c c e s s f u l l y segment a u d i t m a r k e t s i n t o s u b d i v i s i o n s where a u d i t o r s a r e o f f e r i n g s u b s t i t u t a b l e p r o d u c t s , t h e n w i t h p r i c e r i v a l r y p r e s e n t , we w o u l d e x p e c t t o f i n d an i n c r e a s i n g r a t e o f a u d i t o r c h a n g e s . I n t h i s c h a p t e r , we h a v e p r o v i d e d a b r i e f r e v i e w o f t h e S t e i n , N i e l s e n and S i m u n i c a r t i c l e e n t i t l e d " M a r k e t S t r u c t u r e and A u d i t o r I n d e p e n d e n c e . " The m a i n c o n c l u s i o n s o f t h e a r t i c l e were p r e s e n t e d , and t h e e m p i r i c a l i m p l i c a t i o n s h a v e been h i g h l i g h t e d . One i m p l i c a t i o n t h a t r e s u l t s f r o m i n c r e a s e d f e e c o m p e t i t i o n , i s t h a t , c e t e r i s p a r i b u s , t h e r a t e o f a u d i t o r c h a n g e s s h o u l d i n c r e a s e w h i l e r i v a l r y d r i v e s f e e s down t o t h e e q u i l i b r i u m p r i c e . T h i s t h e n p r o v i d e s t h e t h e o r e t i c a l f r a m e w o r k t h a t m o t i v a t e s t h e e m p i r i c a l p o r t i o n of t h i s t h e s i s d e t a i l e d i n l a t e r c h a p t e r s . However, b e f o r e t u r n i n g t o t h a t r e s e a r c h e n d e a v o r , a r e v i e w o f t h e e x i s t i n g l i t e r a t u r e on a u d i t o r t u r n o v e r i s p r e s e n t e d i n C h a p t e r T h r e e . 22 C h a p t e r T h r e e LITERATURE REVIEW OF RESEARCH ON AUDITOR CHANGES The t h e o r e t i c a l s t u d i e s on a u d i t o r - c l i e n t c o n f l i c t by b o t h N i c h o l s a n d P r i c e [ 1 9 8 3 ] a n d Goldman a n d B a r l e v [ 1 9 7 4 ] c o n c l u d e d t h a t t h e a s y m m e t r y i n power b e t w e e n t h e a u d i t o r and c l i e n t may s e r v e t o c o m p r o m i s e a u d i t o r i n d e p e n d e n c e i n t h a t t h e c l i e n t ' s a b i l i t y t o t e r m i n a t e and r e p l a c e an i n c u m b e n t a u d i t o r i n c r e a s e s t h e c l i e n t ' s power o v e r t h e a u d i t o r . T h u s , t h e a p p a r e n t r e l a t i o n s h i p b e t w e e n a u d i t o r i n d e p e n d e n c e a n d a u d i t o r c h a n g e s h a s been a c k n o w l e d g e d i n p r i o r r e s e a r c h . F u r t h e r m o r e , a number of e m p i r i c a l s t u d i e s h a v e been p r o d u c e d e x a m i n i n g d i f f e r e n t a s p e c t s o f a u d i t o r t u r n o v e r . The most i m p o r t a n t o f t h e s e s t u d i e s r e g a r d i n g a u d i t o r c h a n g e s a r e p r e s e n t e d , i n c h r o n o l o g i c a l o r d e r , i n t h e r e m a i n d e r o f t h i s c h a p t e r . The e a r l i e s t r e s e a r c h on a u d i t o r c h a n g e s was p r o d u c e d by B u r t o n a n d R o b e r t s [ 1 9 6 7 ] , U s i n g a d a t a b a s e c o n s i s t i n g o f t h e F o r t u n e 500 l i s t o f t h e l a r g e s t i n d u s t r i a l c o m p a n i e s o v e r t h e t h i r t e e n y e a r p e r i o d o f 1952 - 1965, B u r t o n a n d R o b e r t s s e t o u t t o a c c o m p l i s h two t a s k s . F i r s t , t h e y w a n t e d t o s y s t e m a t i c a l l y e x a m i n e a u d i t o r c h a n g e s , a n d t h e y a l s o s o u g h t e v i d e n c e w h e t h e r c l i e n t c o m p a n i e s were a t t e m p t i n g t o e x p l o i t t h e e x i s t i n g e c o n o m i c r e l a t i o n s h i p s t o t h r e a t e n a u d i t o r i n d e p e n d e n c e . B u r t o n a n d R o b e r t s f o u n d 137 a u d i t o r c h a n g e s o c c u r r i n g i n t h e 620 c o m p a n i e s l i s t e d i n t h e Moody's I n d u s t r i a l M a n u a l s d u r i n g t h e t h i r t e e n y e a r s p a n . Of t h e s e 137 c h a n g e s , 54 c h a n g e s were due t o CPA f i r m m e r g e r s , w i t h t h e r e m a i n i n g 83 ( n o n - m e r g e r ) 23 c h a n g e s b r o k e n down a s f o l l o w s : 70 c o m p a n i e s moved t o B i g E i g h t a u d i t o r s w i t h 13 c o m p a n i e s c h a n g i n g t o n o n - B i g E i g h t a u d i t f i r m s . B u r t o n a n d R o b e r t s t h e n a t t e m p t e d t o d e t e r m i n e t h e p r i n c i p a l r e a s o n ( s ) f o r t h e 83 i d e n t i f i e d a u d i t o r c h a n g e s . To a c c o m p l i s h t h i s , t h e i r r e s e a r c h c o n s i s t e d o f t h e f o l l o w i n g t h r e e a s p e c t s : t h e y a n a l y z e d t h e a n n u a l r e p o r t s o f t h e c o m p a n i e s i n v o l v e d f o r t h e y e a r s b o t h p r e c e d i n g a n d s u c c e e d i n g t h e c h a n g e , t h e y s e n t q u e s t i o n n a i r e s t o t h e c o m p a n i e s a s k i n g f o r t h e p r i n c i p a l r e a s o n s f o r t h e c h a n g e , a n d l a s t l y , t h e y made i n q u i r i e s t o t h e a u d i t i n g f i r m s i n v o l v e d . From t h i s r e s e a r c h , t h e y c o n c l u d e d t h a t t h e most common r e a s o n s f o r a u d i t o r c h a n g e s c i t e d w e r e , r e s p e c t i v e l y , c h a n g e s i n management, a n d t h e n e e d f o r a d d i t i o n a l s e r v i c e s . B u r t o n a n d R o b e r t s f o u n d l i t t l e e m p i r i c a l e v i d e n c e t h a t f e e c o m p e t i t i o n e x i s t e d d u r i n g t h e t i m e p e r i o d e x a m i n e d . As s t a t e d i n t h e i r p a p e r : I t w o u l d a p p e a r , h o w e v e r , t h a t f e e c o m p e t i t i o n was n o t a m a j o r f a c t o r i n t h e s w i t c h e s . I t i s p o s s i b l e that-a u d i t o r c h a n g e s i n s m a l l c o r p o r a t i o n s a r e more a f f e c t e d by t h i s f a c t o r . [ p . 34] S u c h a r e s u l t i s n o t u n e x p e c t e d , g i v e n t h a t t h e AICPA p r o h i b i t i o n s on c o m p e t i t i v e b i d d i n g were n o t o f f i c i a l l y r e moved u n t i l 1972. The n e x t s t u d y on a u d i t o r c h a n g e s , by C a r p e n t e r a n d S t r a w s e r [ 1 9 7 1 ] , e x a m i n e d t h e e x t e n t o f d i s p l a c e m e n t o f s m a l l e r a u d i t i n g f i r m s by n a t i o n a l f i r m s a s a r e s u l t o f f i r s t t i m e r e g i s t r a t i o n u n d e r t h e S e c u r i t i e s A c t o f 1933 (a phenomenon 24 w h i c h i s commonly known a s " g o i n g p u b l i c " ) . C a r p e n t e r and S t r a w s e r s e n t q u e s t i o n n a i r e s t o t h e c h i e f f i n a n c i a l o f f i c e r s o f a l l c o m p a n i e s w h i c h made i n i t i a l f i l i n g s i n e i t h e r t h e f i n a l q u a r t e r o f 1969 o r d u r i n g t h e f i r s t q u a r t e r o f 1970. They r e c e i v e d 165 u s a b l e r e s p o n s e s w i t h 137 r e s p o n s e s i n d i c a t i n g n a t i o n a l CPA f i r m s a s a u d i t o r s . From t h i s d a t a , C a r p e n t e r and S t r a w s e r c o n c l u d e d t h a t s m a l l e r a u d i t i n g f i r m s were l i k e l y t o be r e p l a c e d when a c l i e n t company "goes p u b l i c . " The t h i r d s t u d y on a u d i t o r c h a n g e s was p e r f o r m e d by B e d i n g f i e l d a n d L o e b [ 1 9 7 4 ] u s i n g t h e n e w l y m a n d a t e d a u d i t o r c h a n g e s i n f o r m a t i o n r e p o r t e d on t h e SEC Forms 8-K. 2 0 T h e i r s t u d y , w h i c h e x a m i n e d 250 d i s c l o s u r e s r e p o r t e d b e t w e e n November 1, 1971 a n d , F e b r u a r y 1973, s o u g h t t o d e t e r m i n e i f n a t i o n a l f i r m s ( d e f i n e d a s B i g E i g h t p l u s o t h e r n a t i o n a l a u d i t i n g f i r m s ) were e i t h e r g a i n i n g o r l o s i n g c l i e n t s . A d d i t i o n a l l y , t h e y s e a r c h e d f o r e v i d e n c e o f a u d i t o r - c l i e n t d i s a g r e e m e n t s . H e n c e , b e y o n d t h e i r e x a m i n a t i o n o f t h e Forms 8-K, t h e y a l s o s e n t q u e s t i o n n a i r e s t o e a c h o f t h e 250 l i s t e d c o m p a n i e s . The r e s u l t s o f t h e B e d i n g f i e l d and L o e b s t u d y c a n be c o n t r a s t e d t o t h e e a r l i e r work o f B u r t o n and R o b e r t s . Whereas B u r t o n a n d R o b e r t s f o u n d t h a t t h e n a t i o n a l f i r m s h a d g a i n e d c l i e n t s b e t w e e n 1952 and 1965, B e d i n g f i e l d a n d L o e b f o u n d t h a t w h i l e t h e n a t i o n a l a u d i t o r s h a d more c l i e n t s ( r e l a t i v e t o t h e n o n - n a t i o n a l s ) b o t h b e f o r e a n d a f t e r t h e r e p o r t e d c h a n g e s , t h e n a t i o n a l s a c t u a l l y i n c u r r e d a n e t l o s s o f c l i e n t s . F u r t h e r m o r e , w h e r e a s B u r t o n a n d R o b e r t s c o n c l u d e d t h a t f e e c o m p e t i t i o n s e l d o m 25 m o t i v a t e d a u d i t o r d i s p l a c e m e n t , B e d i n g f i e l d a n d L o e b r e p o r t e d t h a t 47 p e r c e n t o f t h e i r r e s p o n d e n t s i n d i c a t e d f e e c o m p e t i t i o n a s h a v i n g t o c o n t r i b u t e d t o c a u s i n g t h e r e p o r t e d a u d i t o r c h a n g e . A g a i n , s u c h c o n t r a s t i n g r e s u l t s a r e n o t s u r p r i s i n g , i n t h a t t h e B u r t o n a n d R o b e r t s s t u d y was c o n d u c t e d p r i o r t o t h e r e m o v a l o f AICPA c o m p e t i t i v e b i d d i n g s a n c t i o n s , w h e r e a s B e d i n g f i e l d and L o e b e x a m i n e d a u d i t o r c h a n g e s a f t e r t h e 1972 r u l e c h a n g e . A l t h o u g h t h e r e s u l t s o f t h e B e d i n g f i e l d a n d L o e b s t u d y were p u b l i s h e d i n 1974, no o t h e r m a j o r p a p e r s p e r t a i n i n g t o a u d i t o r c h a n g e s were p r e s e n t e d u n t i l 1979. T h i s i n i t s e l f i s r e m a r k a b l e i n t h a t t h e m i d - 1 9 7 0 ' s r e p r e s e n t s a p e r i o d when c o n s i d e r a b l e a t t e n t i o n was f o c u s e d on t h e o r g a n i z a t i o n o f p u b l i c a u d i t i n g . I n p a r t i c u l a r , b o t h t h e M e t c a l f a n d Cohen C o m m i s s i o n s a d d r e s s e d t h e i s s u e o f w h e t h e r a u d i t o r s b e h a v e d c o m p e t i t i v e l y g i v e n t h e h i g h l e v e l s o f c o n c e n t r a t i o n a t t r i b u t e d t o t h e B i g E i g h t f i r m s . The n e x t s t u d y p r o d u c e d on a u d i t o r c h a n g e s , p r e p a r e d by Coe and P a l m on . [ 1 9 7 9 ] , p r e s e n t e d an o v e r v i e w o f e m p i r i c a l d a t a on a u d i t o r c h a n g e s . I n t h e i r p a p e r , Coe a n d P a l m o n e x a m i n e d two d a t a b a s e s f o r e v i d e n c e o f a u d i t o r t u r n o v e r . The f i r s t d a t a b a s e c o n s i s t e d o f l a r g e i n d u s t r i a l c o m p a n i e s ( s e l e c t e d f r o m t h e S t a n d a r d a n d P o o r ' s C o m p u s t a t t a p e ) w h i c h were l i s t e d o v e r a t w e n t y - f o u r y e a r p e r i o d e n d i n g i n 1976. The i n i t i a l random s a m p l e i n c l u d e d 500 NYSE, 200 AMEX a n d 300 OTC c o m p a n i e s l i s t e d a s o f December 3 1 , 1976. H o w e v e r , a f t e r t h e i r s e l e c t i o n c r i t e r i a was a p p l i e d , t h e s a m p l e was r e d u c e d t o 461 NYSE, 150 AMEX a n d o n l y 115 OTC c o m p a n i e s . T h e s e f i r m s were t h e n e x a m i n e d 26 i n o r d e r t o a s s e s s a l l a u d i t o r c h a n g e s , p l u s t h o s e c h a n g e s n o t r e s u l t i n g f r o m CPA f i r m m e r g e r a c t i v i t y . Coe a n d P a l m o n ' s f i n d i n g s i n d i c a t e d t h a t B i g E i g h t d o m i n a n c e g e n e r a l l y i n c r e a s e d o v e r t h e t w e n t y - f o u r y e a r p e r i o d , and t h a t a u d i t o r c h a n g e r a t e s o v e r t i m e c o u l d n o t be shown t o be s t a t i s t i c a l l y r e l a t e d t o m a c r o e c o n o m i c v a r i a b l e s s u c h a s t h e p r i m e o r i n f l a t i o n r a t e s . F u r t h e r m o r e , t h e a u t h o r s f o u n d no s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p b e t w e e n a u d i t o r t u r n o v e r r a t e s a n d t i m e , e x c e p t t h a t t h e r a t e o f c h a n g e f o r t h e B i g E i g h t a u d i t o r s was s t a t i s t i c a l l y r e l a t e d t o t i m e . And a l t h o u g h Coe an d Palmon a s s e r t e d t h a t t h e r a t e o f B i g E i g h t c h a n g e s i n c r e a s e d s i g n i f i c a n t l y d u r i n g t h e l a s t s i x y e a r s o f t h e s a m p l e p e r i o d , c a r e f u l a n a l y s i s o f t h e i r d a t a c a n n o t s u b s t a n t i a t e t h i s c l a i m . 2 1 The s e c o n d d a t a b a s e e x a m i n e d by Coe a n d Palmon c o n t a i n e d a l l SEC p u b l i c l y - l i s t e d c o m p a n i e s c h a n g i n g a u d i t o r s d u r i n g t h e y e a r s o f 1974 a n d 1975. T h e i r r e s u l t s i n d i c a t e d t h a t f o r t h e two y e a r s e x a m i n e d , t h i s c r o s s - s e c t i o n o f SEC f i r m s e x h i b i t e d a h i g h e r t u r n o v e r r a t e t h a n was t h e c a s e w i t h t h e l a r g e company d a t a t h a t was e x a m i n e d o v e r t h e t w e n t y - f o u r y e a r p e r i o d . A d d i t i o n a l l y , t h e B i g E i g h t f i r m s l o s t c l i e n t s t o s m a l l e r a u d i t i n g f i r m s d u r i n g t h e t w o - y e a r p e r i o d . A s e c o n d Coe a n d Palmon p a p e r [ 1 9 8 0 ] s o u g h t t o o b t a i n e v i d e n c e r e g a r d i n g t h e l i n k a g e b e t w e e n a u d i t o r i n d e p e n d e n c e a nd a u d i t o r t u r n o v e r . The two i s s u e s t h a t t h e y a d d r e s s e d were a s f o l l o w s : w h e t h e r an an a u d i t o r d i s m i s s a l i s more p r o b a b l e a f t e r t h e i s s u a n c e o f an u n f a v o r a b l e o p i n i o n ; a n d , w h e t h e r o r n o t management i s 27 s u c c e s s f u l i n h i r i n g a more c o m p l i a n t a u d i t o r a f t e r t h e t e r m i n a t i o n o f a p r e d e c e s s o r who i s s u e d an u n f a v o r a b l e o p i n i o n . The s t u d y was c o n d u c t e d by a n a l y z i n g t h e a u d i t o p i n i o n s on f i n a n c i a l s t a t e m e n t s f o r s a m p l e s o f b o t h l a r g e and s m a l l i n d u s t r i a l c o m p a n i e s b e t w e e n 1973 and 1977. Coe a n d Palmon f o u n d t h a t i n t h e l a r g e company s a m p l e , where a l l o f t h e c o m p a n i e s were a u d i t e d by B i g E i g h t f i r m s , d i s m i s s a l o f t h e B i g E i g h t a u d i t o r s was n o t s i g n i f i c a n t l y more l i k e l y a s a r e s u l t o f i s s u i n g an u n f a v o r a b l e o p i n i o n . On t h e o t h e r h a n d , t h e y f o u n d t h a t t h e s m a l l i n d u s t r i a l f i r m s were more l i k e l y t o d i s m i s s b o t h B i g E i g h t a n d s m a l l e r a u d i t o r s f o l l o w i n g t h e i s s u a n c e o f u n f a v o r a b l e o p i n i o n s . R e s u l t s f o r t h e s e c o n d , s u b j e c t i v e r e s e a r c h q u e s t i o n p e r t a i n i n g t o c l i e n t s ' s e a r c h f o r a more c o m p l i a n t s u c c e s s o r a u d i t o r c o u l d n o t be a n a l y z e d s t a t i s t i c a l l y . N e v e r t h e l e s s , Coe and Palmon t e n t a t i v e l y c o n c l u d e d t h a t s u c h a t t e m p t s by a u d i t e e s a r e n o t s u c c e s s f u l . I n t h e f o l l o w i n g y e a r , F r i e d a n d S c h i f f [ 1 9 8 1 ] e x a m i n e d e m p i r i c a l e v i d e n c e on t h e e x i s t e n c e a n d d e g r e e o f m a r k e t i m p a c t o f t h e SEC d i s c l o s u r e r e q u i r e m e n t s c o n c e r n i n g a u d i t o r c h a n g e s ( a s r e p o r t e d i n t h e SEC Forms 8 - K ) . I n p a r t i c u l a r t h e y s o u g h t t o d e t e r m i n e i f t h e d i s c l o s u r e r e q u i r e m e n t o f r e p o r t i n g a u d i t o r -c l i e n t c o n f l i c t s p r e c e d i n g a u d i t o r c h a n g e s p r o v i d e d an i n f o r m a t i o n s i g n a l t o t h e m a r k e t . F o r t h e i r s t u d y , F r i e d and S c h i f f a n a l y z e d s t o c k p r i c e s f o r b o t h a s a m p l e o f 48 p u b l i c l y -l i s t e d c o m p a n i e s t h a t s w i t c h e d a u d i t o r s b e t w e e n 1972 a n d 1975, a n d f o r a m a t c h e d s e t o f c o n t r o l c o m p a n i e s t h a t d i d n o t c h a n g e 28 a u d i t o r s . Of t h e 48 c o m p a n i e s t h a t d i d c h a n g e a u d i t o r s , 25 f i r m s s t a t e d no a u d i t o r - c l i e n t c o n f l i c t e x i s t e d p r i o r t o t h e a u d i t o r d i s m i s s a l , w h e r e a s 13 c o m p a n i e s r e p o r t e d d i s a g r e e m e n t s w i t h t h e i r p r e v i o u s a u d i t o r s . 2 2 U s i n g a s e r i e s o f m u l t i v a r i a t e t e s t s , t h e a u t h o r s f o u n d some e v i d e n c e o f a n e g a t i v e m a r k e t r e a c t i o n a r o u n d t h e t i m e o f t h e announcement o f t h e a u d i t o r c h a n g e f o r t h o s e c o m p a n i e s t h a t d i d s w i t c h a u d i t o r s . However, i n s p e c i f i c t e s t s f o r s i z e a n d r e p o r t e d c o n f l i c t s p r e c e d i n g t h e a u d i t o r c h a n g e , F r i e d a n d S c h i f f f o u n d no r e l a t i o n s h i p s o f s t a t i s t i c a l s i g n i f i c a n c e . T h u s , t h e y a c k n o w l e d g e d t h a t i n t e r p r e t a t i o n o f t h e i r g e n e r a l r e s u l t was d i f f i c u l t a s t h e m o t i v a t i o n f o r t h e n e g a t i v e m a r k e t r e a c t i o n r e m a i n e d u n c l e a r . The n e x t s t u d y on a u d i t o r c h a n g e s , by Chow and R i c e [ 1 9 8 2 ] , r e t u r n e d t o t h e p o s s i b l e r e l a t i o n s h i p b e t w e e n a u d i t o r t u r n o v e r a n d t h e i s s u a n c e o f q u a l i f i e d a u d i t o r o p i n i o n s . The a u t h o r s s o u g h t e m p i r i c a l e v i d e n c e on w h e t h e r c o m p a n i e s t e n d t o c h a n g e a u d i t o r s r e s u l t i n g f r o m t h e i s s u a n c e o f a q u a l i f i e d o p i n i o n . They a l s o h o p e d t o d e t e r m i n e w h e t h e r a u d i t i n g f i r m s d i f f e r i n t h e i r p r o p e n s i t y t o i s s u e q u a l i f i e d r e p o r t s . F i n a l l y , t h e y e x a m i n e d w h e t h e r , a f t e r an a u d i t o r c h a n g e , a c l i e n t company was more l i k e l y t o r e c e i v e an u n q u a l i f i e d o p i n i o n f r o m t h e s u c c e e d i n g a u d i t o r . F o r t h e i r r e s e a r c h , Chow and R i c e c o l l e c t e d d a t a on a l l SEC c o m p a n i e s l i s t e d i n t h e D i s c l o s u r e J o u r n a l b e t w e e n t h e 1973 a n d 1974 f i s c a l y e a r - e n d s . The r e s u l t i n g 9,460 company r e p o r t s were 29 t h e n c a t e g o r i z e d by q u a l i f i e d and u n q u a l i f i e d a u d i t o p i n i o n s , a n d by a u d i t o r c h a n g e s and n o n - c h a n g e s . From t h e r e s u l t s o f t h e i r c h i - s q u a r e t e s t f o r i n d e p e n d e n c e , t h e y c o n c l u d e d t h a t c h a n g i n g a u d i t o r s i s n o t i n d e p e n d e n t o f r e c e i v i n g a q u a l i f i e d a u d i t o p i n i o n . F u r t h e r m o r e , u s i n g a l o g i t a n a l y s i s t h e y f o u n d t h a t a u d i t q u a l i f i c a t i o n was t h e o n l y s i g n i f i c a n t v a r i a b l e i n a u d i t s w i t c h i n g , when c o m p a r e d w i t h s u c h v a r i a b l e s a s a management c h a n g e , m e r g e r a c t i v i t y , new f i n a n c i n g , an a c c o u n t i n g p o l i c y d i s p u t e , o r any o t h e r i t e m i d e n t i f i e d by management a s a r e a s o n f o r c h a n g i n g a u d i t o r ' s . Fee d i s p u t e s , a s a p o t e n t i a l r e a s o n f o r a u d i t o r c h a n g e s , was n o t e x a m i n e d . To a d d r e s s t h e q u e s t i o n a s t o w h e t h e r a u d i t o r s d i f f e r e d i n t h e i r p r o p e n s i t y t o i s s u e q u a l i f i e d r e p o r t s , Chow a n d R i c e a g a i n u s e d a l o g i t a n a l y s i s , w i t h t h e r e s u l t s t h a t t h r e e a u d i t o r s were i d e n t i f i e d a s b e i n g more l i k e l y t o i s s u e q u a l i f i e d r e p o r t s . 2 3 F i n a l l y , t h e a u t h o r s u s e d a c h i - s q u a r e t e s t t o d e t e r m i n e i f s u c c e s s o r a u d i t o r s t e n d t o i s s u e more u n q u a l i f i e d o p i n i o n s . Chow an d R i c e f o u n d no e v i d e n c e t h a t a. company- i s more l i k e l y t o r e c e i v e an u n q u a l i f i e d o p i n i o n a f t e r an a u d i t o r c h a n g e . The most e x t e n s i v e r e s e a r c h s t u d y on a u d i t o r c h a n g e s was p u b l i s h e d by M c C o n n e l l [ 1 9 8 3 ] . B a s e d on h i s d o c t o r a l t h e s i s , M c C o n n e l l s o u g h t t o e x t e n d much o f t h e r e s e a r c h work d i s c u s s e d a b o v e , by c l o s e l y e x a m i n i n g a l a r g e s e t o f a u d i t o r c h a n g e s o c c u r r i n g b e t w e e n J a n u a r y 1, 1974 a n d December 3 1 , 1978. The d a t a s e t s e x a m i n e d by M c C o n n e l l o v e r t h e f i v e y e a r p e r i o d i n c l u d e d a l l NYSE and AMEX a u d i t o r c h a n g e s , and a l a r g e s a m p l e 30 o f OTC c h a n g e s . 2 " The a c t u a l number o f a u d i t o r c h a n g e s t h a t were s u b s e q u e n t l y a n a l y z e d v i a t h e f i n a n c i a l s t a t e m e n t s a n d SEC Forms 8-K and 10-K were a s f o l l o w s : 205 NYSE a u d i t o r c h a n g e s , 277 AMEX c h a n g e s , a n d 406 OTC c h a n g e s ( o r a p p r o x i m a t e l y 20 p e r c e n t o f t h e t o t a l OTC c h a n g e s p o p u l a t i o n . ) M c C o n n e l l s e p a r a t e d h i s r e s e a r c h i n t o f o u r p h a s e s . F i r s t , he p r e p a r e d d e s c r i p t i v e t a b u l a t i o n s f o r e a c h o f t h e t h r e e d a t a s e t s i n t e r m s o f s i g n i f i c a n t d i s a g r e e m e n t s p r e c e d i n g t h e r e p o r t e d c h a n g e s , and f o r t h e o c c u r r e n c e s o f u n q u a l i f i e d and o t h e r - t h a n - u n q u a l i f i e d o p i n i o n s . S e c o n d l y , M c C o n n e l l p e r f o r m e d s t a t i s t i c a l t e s t s w i t h t h e i n t e n t i o n o f e x a m i n i n g a n d c o m p a r i n g e a c h d a t a s e t r e g a r d i n g t h e f o l l o w i n g a r e a s : t h e e x i s t e n c e of s i g n i f i c a n t d i s a g r e e m e n t s p r e c e d i n g t h e a u d i t o r c h a n g e s , and w h e t h e r t h e s e were d i s c l o s e d by f o o t n o t e by t h e s u c c e s s o r a u d i t o r ; w h e t h e r an o t h e r - t h a n - q u a l i f i e d o p i n i o n p r e c e d e d t h e c h a n g e ; w h e t h e r t h e a u d i t o r c h a n g e was e i t h e r recommended o r a p p r o v e d by t h e c l i e n t ' s B o a r d o f D i r e c t o r s ; a n d , w h e t h e r t h e r e a s o n s f o r t h e a u d i t o r c h a n g e were- v o l u n t a r i l y - g i v e n . E a c h of' t h e s e r e s e a r c h i s s u e s were t e s t e d f o r s t a t i s t i c a l s i g n i f i c a n c e f o r e a c h p o p u l a t i o n e x a m i n e d , a n d a l s o b e t w e e n t h e t h r e e p o p u l a t i o n s . Thus a t o t a l o f t w e n t y - f i v e c h i - s q u a r e t e s t s were p e r f o r m e d i n o r d e r t o d e t e r m i n e w h e t h e r o r n o t s t a t i s t i c a l l y s i g n i f i c a n t d i f f e r e n c e s e x i s t e d among t h e t h r e e d a t a s e t s i n t e r m s o f t h e i s s u e s i n d i c a t e d a b o v e . 31 I n t h e t h i r d s e c t i o n o f h i s r e s e a r c h , M c C o n n e l l s o u g h t e v i d e n c e o f i n c r e a s i n g B i g E i g h t d o m i n a n c e by e x a m i n i n g e a c h d a t a s e t f o r a u d i t o r c h a n g e s t o a n d f r o m B i g E i g h t and n o n - B i g E i g h t a u d i t o r s . And l a s t l y , M c C o n n e l l e x a m i n e d a nd c o m p a r e d t h e e x t e n t o f a u d i t o r - c l i e n t c o n f l i c t i n e a c h o f t h e t h r e e d a t a s e t s . M c C o n n e l l ' s m a j o r r e s u l t s i n d i c a t e t h a t t h e a u d i t o r c h a n g e s by OTC f i r m s r e v e a l s i g n i f i c a n t l y l o w e r d i s a g r e e m e n t r a t e s t h a n f o r e i t h e r t h e NYSE o r AMEX c o m p a n i e s c h a n g i n g a u d i t o r s . A d d i t i o n a l l y , f r o m t h e a u d i t o r s ' p e r s p e c t i v e , B i g E i g h t f i r m s e x p e r i e n c e d s i g n i f i c a n t l y more d i s a g r e e m e n t s p r i o r t o a u d i t o r t e r m i n a t i o n t h a n d i d t h e s m a l l e r a u d i t i n g f i r m s . F u r t h e r m o r e , M c C o n n e l l f o u n d t h a t t h e NYSE f i r m s h a d t h e l e a s t number o f o t h e r - t h a n - u n q u a l i f i e d a u d i t o p i n i o n s p r e c e d i n g a u d i t o r c h a n g e s , w i t h OTC f i r m s e x p e r i e n c i n g t h e g r e a t e s t number o f o t h e r - t h a n -u n q u a l i f i e d o p i n i o n s . No s i g n i f i c a n t d i f f e r e n c e b e t w e e n B i g E i g h t a n d n o n - B i g E i g h t a u d i t o r s was f o u n d r e g a r d i n g t h e i n c i d e n c e o f o t h e r - t h a n - u n q u a l i f i e d o p i n i o n s p r e c e d i n g an a u d i t o r c h a n g e . From t h e r e s u l t s o f M c C o n n e l l ' s t h i r d p h a s e o f r e s e a r c h , he f o u n d t h a t t h e r e was n o t a. s i g n i f i c a n t e x o d u s f r o m n o n - B i g E i g h t t o B i g E i g h t a u d i t o r s , o r v i c e v e r s a . W i t h i n t h e d i f f e r e n t p o p u l a t i o n s , b o t h t h e NYSE and OTC f i r m s t e n d e d t o engage a B i g E i g h t f i r m i f t h e p r e d e c e s s o r was B i g E i g h t , o r h i r e a s m a l l e r f i r m i f t h e p r e d e c e s s o r was a n o n - B i g E i g h t a u d i t o r . O n l y i n t h e AMEX p o p u l a t i o n was t h e c h o i c e o f s u c c e s s o r n o t c o n d i t i o n a l 32 on t h e t h e p o s i t i o n o f t h e p r e c e d i n g a u d i t o r . F u r t h e r m o r e , M c C o n n e l l f o u n d t h a t t h e OTC c o m p a n i e s seemed t h e most i n c l i n e d t o m a i n t a i n t h e s t a t u s quo. As s t a t e d i n h i s monograph: The l o w e s t number o f n e t c h a n g e s b e t w e e n a u d i t o r t i e r s was o b s e r v e d among OTC r e g i s t r a n t s . F u r t h e r m o r e , w h e r e a s NYSE and AMEX a u d i t o r c h a n g e s r e s u l t e d i n n e t g a i n s f o r B i g E i g h t a u d i t o r s , t h e B i g E i g h t l o s t a n e t o f two OTC e n g a g e m e n t s . [ p . 131] M c C o n n e l l ' s s t u d y on a u d i t o r c h a n g e s r e p r e s e n t s t h e most a m b i t i o u s e m p i r i c a l i n v e s t i g a t i o n t o d a t e . He u s e d a v e r y l a r g e d a t a b a s e a n d he c a r e f u l l y a p p l i e d s t a t i s t i c a l m ethods t o a n a l y z e a number o f r e s e a r c h a r e a s . H owever, one i s s u e t h a t he d i d n o t e x a m i n e was t h e r a t e o f a u d i t o r c h a n g e s o v e r t i m e . T h i s o m i s s i o n i s . n o t s u r p r i s i n g i n t h a t , s i m i l a r t o Coe and Palmon [ 1 9 7 9 ] , M c C o n n e l l was n o t t e s t i n g any g e n e r a l t h e o r i e s . R a t h e r he h a s p r e s e n t e d a n d o r g a n i z e d a s i g n i f i c a n t amount o f e m p i r i c a l i n f o r m a t i o n i n c l u d i n g s t a t i s t i c a l a n a l y s e s o f c e r t a i n i s s u e s o f i n t e r e s t . A d d i t i o n a l l y , M c C o n n e l l ' s t i m e f r a m e was c o n s t r a i n e d by t h e l a c k o f d a t a o r by d a t a e r r o r s p r i o r t o 1974, t h u s l i m i t i n g t h e t i m e r a n g e o f h i s s t u d y t o a f i v e y e a r p e r i o d . The most r e c e n t s t u d y on a u d i t o r t u r n o v e r , by S c h w a r t z a n d Menon [ 1 9 8 5 ] , e x a m i n e d a u d i t o r c h a n g e s by f a i l i n g f i r m s . The a u t h o r s c o l l e c t e d a s a m p l e o f 132 NYSE and AMEX c o m p a n i e s t h a t d e c l a r e d b a n k r u p t c y d u r i n g t h e y e a r s 1974 t o 1982. U t i l i z i n g i n f o r m a t i o n f r o m a n n u a l r e p o r t s , Forms 1 0 - K ' s , a nd p r o x y s t a t e m e n t s , S c h w a r t z a n d Menon u s e d a ma t c h e d - p a d r s - t e s t t o compare t h e i n c i d e n c e o f a u d i t o r s w i t c h i n g b e t w e e n f a i l i n g a n d 33 h e a l t h y f i r m s . T h e i r r e s u l t s i n d i c a t e d t h a t f a i l i n g f i r m s had a s i g n i f i c a n t l y g r e a t e r t e n d e n c y t o s w i t c h a u d i t o r s t h a n d i d t h e h e a l t h i e r f i r m s . T h e y a l s o f o u n d t h a t f a i l i n g f i r m s t e n d e d t o c h o o s e a new a u d i t o r - t y p e ( t h a t i s , e i t h e r B i g E i g h t o r n o n - B i g E i g h t ) i n r e p l a c i n g a t e r m i n a t e d a u d i t o r . T h i s t e n d e n c y was s i g n i f i c a n t l y more p r o n o u n c e d f o r c o m p a n i e s c h a n g i n g f r o m non-B i g E i g h t t o B i g E i g h t a u d i t o r s . Thus t h e a u t h o r s c o n c l u d e d : [ T ] h e i n c e n t i v e s b e h i n d a u d i t o r s w i t c h i n g c a n v a r y d e p e n d i n g upon t h e f i n a n c i a l c o n d i t i o n o f t h e f i r m . T h i s s u g g e s t s a n e e d t o c o n t r o l f o r t h e p r e s e n c e o f c o r p o r a t e f i n a n c i a l d i s t r e s s w h i l e i n v e s t i g a t i n g t h e e f f e c t o f o t h e r p o s s i b l e v a r i a b l e s t h a t may be • a s s o c i a t e d w i t h t h e phenomenon o f a u d i t o r s w i t c h i n g . F o c u s i n g a t t e n t i o n on s i t u a t i o n a l o r c o n t e x t u a l v a r i a b l e s t h a t may i n f l u e n c e a u d i t o r s w i t c h i n g s h o u l d c o n t r i b u t e t o d e v e l o p i n g a t h e o r y o f a u d i t o r s w i t c h i n g . [ p . 2 6 0 ] F i n a l l y , S c h w a r t z and Menon f o u n d t h a t n e i t h e r a u d i t q u a l i f i c a t i o n s n o r management c h a n g e s were s t a t i s t i c a l l y a s s o c i a t e d w i t h a u d i t o r d i s p l a c e m e n t . They c o n j e c t u r e d t h a t s e r v i c e and f e e c o m p e t i t i o n may become r e l a t i v e l y more i m p o r t a n t i n a u d i t o r s e l e c t i o n f o r f i r m s e x p e r i e n c i n g f i n a n c i a l d i s t r e s s . The p r e c e d i n g r e v i e w o f t h e m a j o r r e s e a r c h s t u d i e s on a u d i t o r c h a n g e s i n d i c a t e s t h a t t h e r e h a s been c o n s i d e r a b l e i n t e r e s t i n t h i s t o p i c o v e r t h e p a s t two d e c a d e s . However, v i r t u a l l y a l l o f t h e work h a s b een e m p i r i c a l , w i t h l i t t l e a t t e n t i o n d i r e c t e d t o w a r d t h e d e v e l o p m e n t o f any u n d e r l y i n g t h e o r e t i c a l m o d e l s . F u r t h e r m o r e , much o f t h e a t t e n t i o n h a s been f o c u s s e d on e i t h e r t h e d o m i n a n c e o f t h e B i g E i g h t a u d i t i n g f i r m s , o r t h e p r o b a b i l i t y o f an a u d i t o r c h a n g e f o l l o w i n g t h e 34 i s s u a n c e o f an o t h e r - t h a n - u n q u a l i f i e d a u d i t o r o p i n i o n . O n l y Coe a n d P a l m on [ 1 9 7 9 ] i n v e s t i g a t e d a u d i t o r t u r n o v e r r a t e s where t h e y f o u n d o n l y l i m i t e d e v i d e n c e o f i n c r e a s e d a u d i t o r t u r n o v e r o v e r t i m e f o r B i g E i g h t a u d i t o r s . A d d i t i o n a l l y , t h e e v i d e n c e p r e s e n t e d r e g a r d i n g a u d i t f e e s m o t i v a t i n g a u d i t o r c h a n g e s h a s been i n c o n c l u s i v e . Thus t h e e m p i r i c a l p o r t i o n of t h i s t h e s i s r e f e r s t o o n l y a l i m i t e d p o r t i o n o f t h e work c i t e d a b o v e . N e v e r t h e l e s s , t h e e m p i r i c a l work d e s c r i b e d i n C h a p t e r F o u r must be s e e n a s b o t h a r e s u l t o f , and an e x t e n s i o n t o , t h e r e s e a r c h e f f o r t s c i t e d i n t h i s c h a p t e r . 35 C h a p t e r F o u r EMPIRICAL RESEARCH METHODS AND RESULTS I n t h i s c h a p t e r , an e m p i r i c a l s t u d y o f a u d i t o r t u r n o v e r r a t e s i s p r e s e n t e d . The s t u d y i n v o l v e d t h e c o l l e c t i o n a n d a n a l y s i s o f a u d i t o r c h a n g e i n f o r m a t i o n f o r a s a m p l e o f p u b l i c l y -l i s t e d f i r m s , o v e r a t i m e p e r i o d o f assumed i n c r e a s e d p r i c e r i v a l r y . S t a t i s t i c a l t e s t s were t h e n p e r f o r m e d t o d e t e r m i n e i f any t r e n d s i n a u d i t o r c h a n g e s e x i s t e d o v e r t h e f i f t e e n y e a r p e r i o d e x a m i n e d . T h u s , i n t h i s c h a p t e r , t h e m o t i v a t i o n f o r t h i s s t u d y i s r e v i e w e d , a nd t h e m a j o r a s s u m p t i o n s and r e s e a r c h p r o c e d u r e s a r e d e s c r i b e d . F i n a l l y , t h e e m p i r i c a l h y p o t h e s e s , s t a t i s t i c a l t e s t s a n d r e s u l t s a r e p r e s e n t e d . The l i t e r a t u r e r e v i e w p r e s e n t e d i n t h e p r e c e d i n g c h a p t e r p r o v i d e d an o v e r v i e w o f t h e r e s e a r c h i n t o a u d i t o r c h a n g e s ' o v e r t h e p a s t two d e c a d e s . The work d e t a i l e d h e r e s h o u l d be c o n s i d e r e d a s an e x t e n s i o n o f t h e s t u d i e s d i s c u s s e d i n C h a p t e r T h r e e . I n p a r t i c u l a r , a number o f t h e m e t h o d s e m p l o y e d h e r e r e s u l t f r o m t h e e a r l i e r e f f o r t s o f B u r t o n a n d R o b e r t s [ 1 9 6 7 ] , Coe a n d P a l m o n [ 1 9 7 9 ] , a n d S c h w a r t z a nd Menon [ 1 9 8 5 ] . However, much o f t h e p a s t r e s e a r c h h a s n o t p u r s u e d t h e t e s t i n g o f any h y p o t h e s e s ; r a t h e r , t h e y h a v e been l a r g e l y d e s c r i p t i v e s t u d i e s , r e p o r t i n g on c e r t a i n a s p e c t s o f a u d i t o r c h a n g i n g b e h a v i o r . The s t u d y p r e s e n t e d h e r e d i f f e r s i n t h a t t h e i n t e n t i o n i s n o t t o s i m p l y g e n e r a t e more d e s c r i p t i v e m a t e r i a l on a u d i t o r t u r n o v e r . I n s t e a d , t h e h y p o t h e s e s t e s t e d e x t e n d f r o m t h e t h e o r i e s d e v e l o p e d i n t h e SNS a r t i c l e r e v i e w e d i n C h a p t e r Two. The 3 6 t h e o r e t i c a l f r a m e w o r k t h a t m o t i v a t e s t h i s e m p i r i c a l s t u d y i s b r i e f l y s u m m a r i z e d b e l o w . Summary o f T h e o r e t i c a l H y p o t h e s e s A u d i t o r i n d e p e n d e n c e may be c o m p r o m i s e d when p r i c e r i v a l r y i s i n t r o d u c e d i n t o a u d i t i n g m a r k e t s . A d i s e q u i l i b r i u m r e s u l t s , where a u d i t o r s c a n n o t s i m u l t a n e o u s l y m a i n t a i n t h e i r e x i s t i n g e c o n o m i c r e n t s a n d i n d e p e n d e n c e f r o m t h e i r c l i e n t s . T h e r e f o r e , t h i s d i s e q u i l i b r i u m i m p l i e s t h e p o s s i b l e e r o s i o n o f a u d i t o r i n d e p e n d e n c e , d i m i n i s h e d r e n t s t h r o u g h d e c r e a s i n g f e e s , a n d , c e t e r i s p a r i b u s , i n c r e a s e d a u d i t o r t u r n o v e r . C l i e n t f i r m s w i l l s w i t c h a u d i t o r s i f i n c u m b e n t s do n o t m a t c h t h e i r r i v a l s ' l o w e r b i d s b e c a u s e o f e i t h e r i m p e r f e c t i n f o r m a t i o n r e g a r d i n g t h e l o w e r b i d a m o u n t s , o r b e c a u s e i n c u m b e n t a u d i t o r s r a t i o n a l l y d e c i d e t o f o r e g o some c l i e n t a c c o u n t s r a t h e r t h a n r i s k i n g f e e r e d u c t i o n s on t h e i r r e m a i n i n g s t o c k o f c l i e n t s . As n o t a l l a u d i t o r s w i l l r i s k n o n i n d e p e n d e n c e , t h e p r i m a r y e f f e c t o f p r i c e r i v a l r y s h o u l d be t h e e r o s i o n o f e c o n o m i c r e n t s t h r o u g h d i m i n i s h e d f e e s . H owever, a s f e e d a t a i s l a r g e l y u n a v a i l a b l e , s u c h an e x a m i n a t i o n w a r r a n t s a r e s e a r c h e n d e a v o r b e y o n d t h e s c o p e o f t h i s r e s e a r c h p r o j e c t . T h e r e f o r e , t h i s s t u d y e x a m i n e s t h e s e c o n d a r y e f f e c t o f p r i c e r i v a l r y on a u d i t o r t u r n o v e r . Once r i v a l r y d r i v e s p r i c e s down t o t h e c o m p e t i t i v e e q u i l i b r i u m , a u d i t o r i n d e p e n d e n c e w i l l be r e s t o r e d a n d b o t h f e e s a n d a u d i t o r t u r n o v e r s h o u l d r e m a i n r e l a t i v e l y c o n s t a n t . T h u s , i f t h e p r i m a r y m o t i v a t i o n f o r a u d i t o r s e l e c t i o n i s p r i c e , a n d i f 37 a u d i t m a r k e t s c a n be s u c c e s s f u l l y s e g m e n t e d i n t o s u b - m a r k e t s o f a u d i t o r s o f f e r i n g s u b s t i t u t a b l e a u d i t s e r v i c e s , t h e n w i t h t h e i n t r o d u c t i o n o f p r i c e r i v a l r y we w o u l d e x p e c t t o o b s e r v e an i n c r e a s e d r a t e o f a u d i t o r c h a n g e s . The a b o v e summary n o t o n l y s u g g e s t s t h e g e n e r a l d i r e c t i o n o f t h e e m p i r i c a l work p e r f o r m e d h e r e , b u t i t a l s o c o n t a i n s t h e m a j o r a s s u m p t i o n s u s e d i n t h i s r e s e a r c h p r o j e c t . E a c h o f t h e s e a s s u m p t i o n s must be d i s c u s s e d i n t u r n . A s s u m p t i o n s E m p l o y e d i n t h e E m p i r i c a l S t u d y The f i r s t m a j o r a s s u m p t i o n e m p l o y e d i n t h i s s t u d y s t a t e s t h a t p r i c e i s t h e p r i m a r y f a c t o r u s e d by a u d i t e e s i n t h e s e l e c t i o n o f an a u d i t o r . As was d e m o n s t r a t e d i n C h a p t e r T h r e e , t h e e m p i r i c a l r e s u l t s p e r t a i n i n g t o t h e r e a s o n s f o r a u d i t o r c h a n g e s have been m i x e d . Whereas B u r t o n and R o b e r t s ' r e s u l t s [ 1 9 6 7 ] c o n f i r m e d t h a t f e e c o m p e t i t i o n was an u n i m p o r t a n t f a c t o r i n a u d i t o r s e l e c t i o n p r i o r t o t h e 1972 AICPA r u l e c h a n g e , s u b s e q u e n t s t u d i e s by B e d i n g f i e l d a n d L o e b [ 1 9 7 4 ] a n d S c h w a r t z a n d Menon [ 1 9 8 5 ] c o n c l u d e d t h a t p r i c e c o n s i d e r a t i o n s were i m p o r t a n t i n a t l e a s t some a u d i t o r c h a n g e s . F u r t h e r m o r e , t h e e v i d e n c e r e g a r d i n g o t h e r c a u s e s f o r a u d i t o r s w i t c h i n g , s u c h a s t h e r o l e o f o t h e r - t h a n - u n q u a l i f i e d a u d i t o p i n i o n s p r e c e d i n g an a u d i t o r c h a n g e , h a v e a l s o been i n c o n c l u s i v e . T h u s , f r o m t h e s t u d i e s p u b l i s h e d t o d a t e , we c a n n o t c o n c l u d e w i t h c e r t a i n t y what c o n s t i t u t e s t h e p r i m a r y m o t i v a t i o n i n a u d i t o r s e l e c t i o n . T h e r e f o r e , i n t h e a b s e n c e , o f c o n c r e t e e v i d e n c e to. t h e c o n t r a r y , t h e common m i c r o - e c o n o m i c a s s u m p t i o n o f p r i c e a s t h e p r i m a r y 38 f a c t o r i n p r o d u c t s e l e c t i o n i s e m p l o y e d i n t h i s r e s e a r c h s t u d y . The v a l i d i t y o f s u c h a s i m p l i f y i n g a s s u m p t i o n must r e m a i n u n t e s t e d a t t h i s t i m e . The s e c o n d a s s u m p t i o n u s e d i n t h i s s t u d y i m p l i e s t h a t a u d i t i n g m a r k e t s c a n be s e g m e n t e d i n t o s u b - m a r k e t s where t h e a u d i t o r s a r e o f f e r i n g n e a r - p e r f e c t s u b s t i t u t e s w i t h i n t h e s e s u b -m a r k e t s . T h i s a s s u m p t i o n i s s u p p o r t e d by r e c e n t r e s e a r c h i n d i c a t i n g t h a t p r o d u c t d i f f e r e n t i a t i o n e x i s t s w i t h i n t h e g e n e r a l m a r k e t f o r a u d i t s e r v i c e s . 2 5 I n t h e U.S. a u d i t i n g m a r k e t , where a u d i t s e r v i c e s a r e p e r f o r m e d e x c l u s i v e l y by C e r t i f i e d P u b l i c A c c o u n t a n t s ( C P A s ) , a common d i v i s i o n i s made be t w e e n t h e s e r v i c e s o f f e r e d by t h e B i g E i g h t o r n a t i o n a l a u d i t i n g f i r m s , a n d b e t w e e n t h e s m a l l e r , l o c a l a n d r e g i o n a l , a u d i t o r s . The n a t i o n a l a u d i t i n g f i r m s a r e o f s u f f i c i e n t s c o p e an d s i z e t h a t e a c h may s i n g u l a r l y u n d e r t a k e a m a j o r a u d i t o f any o f t h e l a r g e s t i n t e r n a t i o n a l c o r p o r a t e c l i e n t s . On t h e o t h e r h a n d , t h e l o c a l o r r e g i o n a l a u d i t i n g f i r m s a r e g e n e r a l l y u n a b l e t o a u d i t a ny s i g n i f i c a n t number o f t h e l a r g e s t c l i e n t s . T h u s , t h e d o m i n a t i o n o f B i g E i g h t a u d i t o r s i s most p r o n o u n c e d i n t h e m a r k e t f o r t h e l a r g e s t c o r p o r a t e c l i e n t a c c o u n t s . G i v e n t h e s i z e a n d s c o p e d i f f e r e n t i a l s b e t w e e n t h e n a t i o n a l and n o n - n a t i o n a l a u d i t i n g f i r m s , i t may n o t be a p p r o p r i a t e t o e x a m i n e o n l y t h e t o t a l ( u n - s e g m e n t e d ) a u d i t o r c h a n g e s i n o u r a n a l y s i s o f a u d i t o r t u r n o v e r . T h e r e f o r e , an a s s u m p t i o n u s e d h e r e i s t h a t we c a n s u c c e s s f u l l y s u b d i v i d e t h e o v e r a l l m a r k e t f o r a u d i t s i n t o s u b - m a r k e t s o f a u d i t o r s o f f e r i n g s u b s t i t u t a b l e 39 a u d i t s e r v i c e s . One s u c h d i v i s i o n t h a t i s made h e r e i s b e t w e e n t h e B i g E i g h t a n d n o n - B i g E i g h t a u d i t o r s . The t h i r d m a j o r a s s u m p t i o n i m p l i c i t w i t h i n t h i s r e s e a r c h p r o j e c t i s t h a t we c a n i d e n t i f y a n d e x a m i n e a p e r i o d o f t i m e w h i c h c o n t a i n s an o b s e r v a b l e c h a n g e i n f e e c o m p e t i t i o n . R e c a l l t h a t we a r e s e a r c h i n g t o d i s c o v e r i f any t r e n d s i n a u d i t o r c h a n g i n g e x i s t d u r i n g a p e r i o d o f i n c r e a s e d p r i c e r i v a l r y . Our t h e o r y p r e d i c t s t h a t r i v a l r y w i l l i n c r e a s e a u d i t o r t u r n o v e r u n t i l t h e c o m p e t i t i v e p r i c e i s a c h i e v e d . I n t h i s s t u d y , we assume t h a t t h e r e c e n t r e m o v a l o f AICPA p r o h i b i t i o n s on c o m p e t i t i v e b i d d i n g , a d v e r t i s i n g a n d d i r e c t s o l i c i t a t i o n h ave a c t e d a s i n v i t a t i o n s f o r i n c r e a s e d p r i c e r i v a l r y . As t h e s e s a n c t i o n s were removed i n 1972, 1978 a n d 1979 r e s p e c t i v e l y , we w o u l d e x p e c t t o o b s e r v e some i n c r e a s e i n a u d i t o r t u r n o v e r d u r i n g t h e 1 9 7 0 ' s . T h u s , o u r a n a l y s i s o f a u d i t o r c h a n g e s e x a m i n e s t h e r a t e o f a u d i t o r t u r n o v e r f r o m 1969 t o 1983. The f i n a l a s s u m p t i o n e m p l o y e d i n t h i s e m p i r i c a l s t u d y c o n c e r n s t h e b e h a v i o r o f t h e r a t e o f a u d i t o r c h a n g e s o n c e t h e c o m p e t i t i v e e q u i l i b r i u m h a s been a t t a i n e d . Whereas we w o u l d e x p e c t some i n d i c a t i o n o f i n c r e a s e d a u d i t o r t u r n o v e r d u r i n g a p e r i o d o f p r i c e r i v a l r y , a u d i t o r t u r n o v e r s h o u l d r e m a i n r e l a t i v e l y c o n s t a n t a t e q u i l i b r i u m . W i t h i d e n t i c a l p r i c i n g a n d no e c o n o m i c r e n t s t o p r o t e c t , a u d i t o r s o p e r a t i n g a t t h e c o m p e t i t i v e e q u i l i b r i u m h a v e no i n c e n t i v e s t o b e h a v e non i n d e p e n d e n t l y , a n d r i s k any c o s t s a s s o c i a t e d w i t h n o n i n d e p e n d e n t a c t i o n s . H owever, t h i s d o e s n o t n e c e s s a r i l y i m p l y z e r o a u d i t o r 40 t u r n o v e r a t e q u i l i b r i u m . I f we assume t h a t n o t a l l a u d i t o r s u n i f o r m l y a g r e e a s t o what c o n s t i t u t e s i n d e p e n d e n t v e r s u s n o n i n d e p e n d e n t b e h a v i o r , t h e n t h i s i m p l i e s t h a t t h e c o s t s o f n o n i n d e p e n d e n c e a r e s p e c i f i c t o i n d i v i d u a l a u d i t o r s . 2 6 T h e r e f o r e t h e c l i e n t c o m p a n i e s , a l t h o u g h f a c i n g i d e n t i c a l f e e s t r u c t u r e s , may engage i n a u d i t o r s w i t c h i n g a s t h e y s e a r c h f o r i n d e p e n d e n t a u d i t o r s who a g r e e w i t h them on t h e s e c o n t e n t i o u s r e p o r t i n g i s s u e s . S u c h b e h a v i o r m i g h t r e s e m b l e t h e c u r r e n t l y d i s p u t e d phenomenon o f " o p i n i o n s h o p p i n g . " T h u s , a t t h e c o m p e t i t i v e e q u i l i b r i u m we w o u l d e x p e c t t o f i n d some c o n s t a n t , p o s i t i v e r a t e o f a u d i t o r t u r n o v e r . S o u r c e s o f D a t a I n o r d e r t o e x a m i n e a u d i t o r c h a n g e s o v e r t i m e , a number o f p o s s i b l e d a t a s o u r c e s were c o n s i d e r e d f o r t h i s r e s e a r c h s t u d y . One p o t e n t i a l d a t a s e t w o u l d i n c l u d e a l l a u d i t o r c h a n g e s f o r p u b l i c l y - l i s t e d f i r m s a s r e c o r d e d i n t h e SEC News D i g e s t . S u c h a d a t a s e t was u s e d by M c C o n n e l l [ 1 9 8 3 ] f o r t h e f i v e y e a r p e r i o d e n d i n g i n 1978, where he f o u n d a t o t a l o f a p p r o x i m a t e l y 3,300 a u d i t o r c h a n g e s . I n o r d e r t o o b t a i n s u c h a d a t a s e t , t h e d a i l y News D i g e s t w o u l d h a v e t o be r e v i e w e d o v e r a s u f f i c i e n t t i m e p e r i o d s u c h t h a t t r e n d a n a l y s i s c o u l d be p e r f o r m e d . However, a s t h e News D i g e s t d o e s n o t p r o v i d e a u d i t o r d e t a i l s , f u r t h e r e x a m i n a t i o n o f t h e SEC Forms 8-K w o u l d be r e q u i r e d . S u c h an e x t e n s i v e d a t a s e t was n o t c o n s i d e r e d f o r t h i s p r o j e c t a s a f u l l s e t o f SEC Forms 8-K a r e n o t a v a i l a b l e l o c a l l y . N e v e r t h e l e s s , s u c h an e x t e n s i o n o f M c C o n n e l l ' s work w o u l d be a welcomed a d d i t i o n t o t h e e x i s t i n g body o f l i t e r a t u r e . 2 7 41 A n o t h e r p o s s i b l e s o u r c e o f d a t a f o r a u d i t o r c h a n g e i n f o r m a t i o n i s a v a i l a b l e f o r t h e NYSE, AMEX a n d OTC f i r m s l i s t e d i n t h e Moody's I n d u s t r i a l M a n u a l s . The s t u d i e s by B u r t o n and R o b e r t s [ 1 9 6 7 ] a nd Coe a n d P a l m o n [ 1 9 7 9 ] u s e d t h e Moody's M a n u a l s a s t h e i r p r i m a r y s o u r c e s o f d a t a . T h e s e m a n u a l s p r o v i d e g e n e r a l f i n a n c i a l i n f o r m a t i o n , i n c l u d i n g a u d i t o r l i s t i n g s , f o r a l a r g e number o f i n d u s t r i a l f i r m s on an a n n u a l b a s i s . However, t h e r e a r e a number o f d i s a d v a n t a g e s a s s o c i a t e d w i t h u s i n g t h e Moody's M a n u a l s . F i r s t , t h e y o n l y r e c o r d i n f o r m a t i o n f o r t h e l a r g e s t a n d most a c t i v e l y t r a d e d f i r m s . Thus e v e n a sa m p l e s e l e c t e d f r o m t h e Moody's OTC I n d u s t r i a l M a n u a l s w i l l n o t c o n t a i n s m a l l e r c o m p a n i e s t h a t c h a n g e a u d i t o r s . T h i s i s s i g n i f i c a n t i n t h a t M c C o n n e l l [ 1 9 8 3 ] showed t h a t OTC f i r m s have t h e g r e a t e s t o v e r a l l r a t e o f a u d i t o r c h a n g e s (where h i s sample o f OTC c o m p a n i e s i n c l u d e d f i r m s o f a l l s i z e s , n o t j u s t t h o s e i n c l u d e d i n t h e Moody's M a n u a l s ) . F u r t h e r m o r e , r e p o r t i n g " g a p s " o c c u r i n t h e m a n u a l s when l i s t e d c o m p a n i e s f a i l t o p r o v i d e i n f o r m a t i o n i n a n y g i v e n y e a r . And f i n a l l y , a u d i t o r i n f o r m a t i o n p r o c u r e d f r o m t h e Moody's M a n u a l s w i l l n o t i n d i c a t e m u l t i p l e a u d i t o r c h a n g e s w i t h i n a s i n g l e y e a r . 2 8 N o t w i t h s t a n d i n g t h e d i s a d v a n t a g e s l i s t e d a b o v e , t h e Moody's OTC I n d u s t r i a l M a n u a l s were s e l e c t e d a s s o u r c e m a t e r i a l f o r t h i s s t u d y . I n l a r g e p a r t , t h i s c h o i c e was made b e c a u s e no o t h e r l o c a l l y a v a i l a b l e s o u r c e o f d a t a was d i s c o v e r e d . 2 9 A d d i t i o n a l l y , t h e u s e o f t h e Moody's m a t e r i a l a l l o w e d f o r c o m p a r i s o n w i t h t h e t i m e - s e r i e s r e s u l t s i n d i c a t e d by Coe a n d P a l m o n [ 1 9 7 9 ] . 42 The d a t a s e t was r e s t r i c t e d t o OTC f i r m s b e c a u s e we assumed t h a t t h e m a r k e t of OTC a u d i t s w o u l d h a v e been t h e most c o m p e t i t i v e ( c o m p a r e d w i t h t h e NYSE an d AMEX m a r k e t s ) d u r i n g a p e r i o d o f c h a n g i n g m a r k e t s t r u c t u r e . T h i s a s s u m p t i o n seems r e a s o n a b l e i n t h a t t h e e v i d e n c e p r e s e n t e d by p r e v i o u s r e s e a r c h e r s h a s i n d i c a t e d t h a t t h e B i g E i g h t d o m i n a n c e was l e s s p r o n o u n c e d i n t h e m a r k e t f o r OTC a u d i t s . 3 0 Thus we assumed t h a t , on a v e r a g e , OTC c o m p a n i e s e n c o u n t e r e d f e w e r t r a n s a c t i o n s c o s t s i n a u d i t o r s w i t c h i n g as c o m p a r e d w i t h t h e l a r g e r f i r m s l i s t e d on e i t h e r t h e NYSE o r AMEX. A d d i t i o n a l l y , M c C o n n e l l r e p o r t e d t h a t b e t w e e n 1974 a n d 1978, t h e l a r g e s t number o f a u d i t o r c h a n g e s were made by t h e OTC f i r m s . And f i n a l l y , i n a c c o r d a n c e w i t h M c C o n n e l l ' s f i n d i n g s r e g a r d i n g B i g E i g h t v e r s u s n o n - B i g E i g h t t i e r s w i t c h e s , we assumed t h a t , on a v e r a g e , OTC c o m p a n i e s were l e s s l i k e l y t o c h a n g e f r o m one s u b - m a r k e t of a u d i t o r s t o a n o t h e r . T h u s , we w o u l d e x p e c t t o f i n d r e l a t i v e l y more " i n -g r o u p " s w i t c h e s by OTC f i r m s t h a n t h o s e made by c o m p a n i e s l i s t e d on t h e two m a j o r e x c h a n g e s . G i v e n o u r a s s u m p t i o n o f s e g r e g a t i n g t h e a u d i t i n g m a r k e t i n t o s u b - m a r k e t s , we b e l i e v e d t h a t an e x a m i n a t i o n o f OTC c o m p a n i e s w o u l d y i e l d t h e r i c h e s t s o u r c e o f a u d i t o r c h a n g e i n f o r m a t i o n . R e s e a r c h M e t h o d s A u d i t o r c h a n g e d a t a were c o l l e c t e d f o r a s a m p l e o f OTC f i r m s r e p o r t i n g d u r i n g t h e f i f t e e n y e a r p e r i o d f r o m 1969 t o 1983. T h i s t i m e p e r i o d seemed s u f f i c i e n t l y l o n g t o c a p t u r e any t r e n d s i n a u d i t o r t u r n o v e r p r e c e d i n g a n d f o l l o w i n g t h e r e m o v a l o f t h e A I C P A p r o h i b i t i o n s on b i d d i n g , a d v e r t i s i n g a n d 43 s o l i c i t a t i o n i n 1972, 1978 and 1979. A s a m p l e o f 200 OTC c o m p a n i e s was r a n d o m l y s e l e c t e d f r o m OTC f i r m s t h a t were s i m u l t a n e o u s l y l i s t e d i n t h e 1970 and 1984 Moody's OTC  I n d u s t r i a l M a n u a l s . The s a m p l e s i z e r e p r e s e n t e d a p p r o x i m a t e l y 41 p e r c e n t o f a l l OTC c o m p a n i e s t h a t h a d a u d i t o r a n d g e n e r a l f i n a n c i a l i n f o r m a t i o n l i s t e d f o r t h e y e a r s o f 1969 a n d 1 9 8 3 . 3 1 R e c a l l t h a t i n t h i s s t u d y o u r i n t e n t i o n i s t o i s o l a t e a u d i t o r c h a n g e s r e s u l t i n g f r o m f a l l i n g p r i c e s c a u s e d by a c h a n g e i n m a r k e t s t r u c t u r e , a n d t o e l i m i n a t e t h o s e c h a n g e s a p p a r e n t l y m o t i v a t e d by o t h e r n o n - p r i c e d e t e r m i n a n t s . T h u s , t h i s c r i t e r i o n o f s i m u l t a n e o u s l i s t i n g s was u s e d i n o r d e r t o c o n t r o l f o r a u d i t o r c h a n g e s m o t i v a t e d by s e v e r e f i n a n c i a l d i s t r e s s a n d / o r b a n k r u p t c i e s . A d d i t i o n a l l y , s u c h a c o n s t r a i n t c o n t r o l s f o r c h a n g e s c a u s e d by c l i e n t c o m p a n i e s e x p e r i e n c i n g s u f f i c i e n t g r o w t h t o move on t o a l a r g e r e x c h a n g e , a nd a l s o f o r t h o s e c h a n g e s r e s u l t i n g f r o m company m e r g e r s where a name c h a n g e was i n v o l v e d . 3 2 The a u d i t o r l i s t i n g s f o r e a c h o f t h e 200 s a m p l e f i r m s were c o l l e c t e d f o r t h e f i f t e e n y e a r s u n d e r r e v i e w . A l t h o u g h a l l o f t h e 200 OTC c o m p a n i e s were l i s t e d i n b o t h t h e 1970 and 1984 Moody's M a n u a l s , a number o f f i r m s h a d l a r g e r e p o r t i n g - " g a p s , " where t h e c o m p a n i e s f a i l e d t o r e p o r t t h e i r f i n a n c i a l i n f o r m a t i o n t o Moody's f o r s e v e r a l y e a r s . An e f f o r t was made t o g e t a u d i t o r l i s t i n g i n f o r m a t i o n f r o m o t h e r s o u r c e s , a n d we assumed t h a t f o r c o m p a n i e s where t h e a u d i t o r l i s t i n g r e m a i n e d u n c h a n g e d s u r r o u n d i n g t h e "gap," t h a t no a u d i t o r c h a n g e t o o k p l a c e . 44 N e v e r t h e l e s s , n i n e c o m p a n i e s were e l i m i n a t e d f r o m t h e s a m p l e a s t h e i r r e p o r t i n g " g a p s " w ere c o n s i d e r e d t o o l a r g e . 3 3 A c o m p l e t e l i s t i n g o f t h e 191 s a m p l e f i r m s i s p r o v i d e d i n A p p e n d i x B. The a u d i t o r change i n f o r m a t i o n on t h e r e m a i n i n g 191 OTC c o m p a n i e s was t h e n f u r t h e r e x a m i n e d and a n a l y z e d . F o r t h e p u r p o s e s o f t h i s s t u d y , an " a u d i t o r c h a n g e " was d e f i n e d a s an i d e n t i f i a b l e c h a n g e i n a u d i t o r s t h a t was a p p a r e n t l y m o t i v a t e d o n l y by p r i c e c o n s i d e r a t i o n s . Thus a n y a u d i t o r s w i t c h r e s u l t i n g f r o m a CPA f i r m m e r g e r was e x c l u d e d f r o m t h e c o l l e c t i o n o f a u d i t o r c h a n g e s . A c c o r d i n g l y , a l l p o s s i b l e c h a n g e s were c l o s e l y e x a m i n e d t o d e t e r m i n e i f t h e c h a n g e i n a u d i t o r r e s u l t e d f r o m an a u d i t o r m e r g e r . 3 " S i m i l a r l y , t h e f i n a n c i a l h i s t o r i e s o f a l l c o m p a n i e s i n d i c a t i n g a u d i t o r c h a n g e s were, e x a m i n e d t o a s c e r t a i n i f a n y o t h e r p e r t i n e n t e v e n t s may have m o t i v a t e d t h e a u d i t o r s w i t c h . S u c h e x o g e n o u s f a c t o r s c o u l d i n c l u d e c l i e n t company m e r g e r s , m a j o r l a w s u i t s , v o l u n t a r y C h a p t e r XI p r o c e e d i n g s , o r d i s p u t e s o v e r a c c o u n t i n g m e t h o d s . E v e n t s l i s t e d s u r r o u n d i n g f i v e c hanges- p r o m p t e d t h e r e m o v a l o f t h e s e i n d i v i d u a l c h a n g e s f r o m t h e t o t a l number o f a u d i t o r c h a n g e s c o l l e c t e d . 3 5  Summary o f D e s c r i p t i v e S t a t i s t i c s A f t e r a p p l y i n g t h e a b o v e c r i t e r i a , t h e r e s u l t i n g number o f a u d i t o r c h a n g e s t h a t o c c u r r e d o v e r t h e f i f t e e n y e a r s t o t a l l e d 159. The l i s t i n g o f t h e s e c h a n g e s , by y e a r a n d by f i r m , i s p r e s e n t e d i n A p p e n d i x C. However, t w e n t y - t h r e e o f t h e s e c h a n g e s c o u l d n o t be p o s i t i v e l y i d e n t i f i e d a s t o w h e t h e r o r n o t t h e y were c a u s e d by a u d i t o r m e r g e r s . 3 6 The t o t a l number o f a n n u a l 45 a u d i t o r c h a n g e s , a l o n g w i t h t h e c a l c u l a t e d a u d i t o r t u r n o v e r r a t e s , a r e p r e s e n t e d i n T a b l e I . The d a t a a r e s e g r e g a t e d f o r i n c l u s i o n o r e x c l u s i o n o f t h e s e u n i d e n t i f i e d p o s s i b l e m e r g e r s . The a v e r a g e number o f y e a r l y c h a n g e s a n d t h e a v e r a g e a n n u a l a u d i t o r t u r n o v e r r a t e s a r e a l s o p r e s e n t e d . A s s u m i n g t h a t a l l o f t h e t w e n t y - t h r e e u n i d e n t i f i e d c h a n g e s were n o t c a u s e d by m e r g e r s , t h e a v e r a g e a n n u a l t u r n o v e r r a t e was 5.95 p e r c e n t . A s s u m i n g a " w o r s t c a s e " s i t u a t i o n where a l l o f t h e t w e n t y - t h r e e c h a n g e s r e s u l t e d f r o m a u d i t o r m e r g e r s , t h e a v e r a g e r a t e was 5.09 p e r c e n t . B o t h o f t h e a b o v e t u r n o v e r r a t e s a r e s i g n i f i c a n t l y h i g h e r t h a n any o f t h e r a t e s c a l c u l a t e d by Coe a n d Palmon [ 1 9 7 9 ] f o r NYSE, AMEX o r OTC c o m p a n i e s . The a b s o l u t e h i g h e s t t u r n o v e r r a t e f o u n d by Coe and Palmon was 3.42 p e r c e n t , w h i c h was f o r c h a n g e s f r o m n o n - B i g E i g h t t o B i g E i g h t a u d i t o r s f o r AMEX f i r m s , a n d i n c l u d e d a l l CPA f i r m m e r g e r s . When a u d i t o r m e r g e r s were e x c l u d e d , Coe and P a l m o n ' s h i g h e s t a n n u a l t u r n o v e r r a t e was 3.21 p e r c e n t f o r t o t a l AMEX c h a n g e s . 3 7 T a b l e I I s u m m a r i z e s o u r f i n d i n g s c o m p a r e d w i t h t h e OTC da t a -c o l l e c t e d by Coe a n d P a l m o n . E v e n i n c l u d i n g a l l c h a n g e s r e s u l t i n g f r o m CPA f i r m m e r g e r s , Coe a n d P a l m o n f o u n d a t o t a l o f o n l y 66 c h a n g e s f r o m a s a m p l e o f 115 OTC c o m p a n i e s o v e r a t w e n t y - f o u r y e a r p e r i o d . I n c o n t r a s t , o u r f i n d i n g s o f 159 c h a n g e s ( a s shown i n T a b l e I I , t h e t o t a l i s i n c r e a s e d i s i n c r e a s e d t o 168 c h a n g e s i f a l l m e r g e r s a r e i n c l u d e d ) f o r 191 f i r m s o v e r f i f t e e n i s s i g n i f i c a n t l y h i g h e r . N e v e r t h e l e s s , t h e a b s o l u t e number o f c h a n g e s d i s c o v e r e d i n b o t h s t u d i e s i s r e m a r k a b l y s m a l l . 46 The f r e q u e n c y o f a u d i t o r c h a n g e s by i n d i v i d u a l c o m p a n i e s i s p r e s e n t e d i n T a b l e I I I . E i g h t y - f i v e c o m p a n i e s ( o r 44.5 p e r c e n t o f t h e t o t a l 191 f i r m s ) d i d n o t c h a n g e a u d i t o r s a t a l l d u r i n g t h e f i f t e e n y e a r p e r i o d . A t o t a l o f 94 f i r m s c h a n g e d a u d i t o r s o nce o r t w i c e d u r i n g t h e p e r i o d e x a m i n e d , w i t h o n l y t w e l v e OTC c o m p a n i e s l i s t i n g more t h a n t h r e e a u d i t o r s o v e r t h e f i f t e e n y e a r s . Thus t h e m a j o r i t y o f OTC f i r m s i n t h i s s a m p l e were n o t i n c l i n e d t o c h a n g e a u d i t o r s o f t e n , w i t h t h e a v e r a g e number o f a u d i t o r c h a n g e s a t l e s s t h a n one (.83) p e r company. W h i l e we h a v e no i n f o r m a t i o n on m u l t i p l e c h a n g e s w i t h i n any g i v e n y e a r , t h e a b o v e e v i d e n c e d o e s n o t a p p e a r t o s u p p o r t t h e n o t i o n t h a t t h e s e f i r m s e n g a g e d i n e i t h e r " a u d i t " o r " o p i n i o n " s h o p p i n g d u r i n g t h e y e a r s u n d e r r e v i e w . H owever, s u c h a c o n c l u s i o n c a n o n l y be c o n s i d e r e d a s c o n j e c t u r a l w i t h o u t f u r t h e r e v i d e n c e and p r o p e r t e s t i n g . G i v e n o u r a s s u m p t i o n r e g a r d i n g a u d i t m a r k e t s e g m e n t a t i o n f o r p r o d u c t d i f f e r e n t i a t i o n , T a b l e I V p r e s e n t s a n n u a l and a v e r a g e a u d i t o r change* d a t a f o r t h e f o l l o w i n g c a t e g o r i e s : -a u d i t o r c h a n g e s w i t h i n t h e B i g E i g h t f i r m s , c h a n g e s w i t h i n t h e n o n - B i g E i g h t f i r m s , a n d t h e c o m b i n e d i n - g r o u p s w i t c h e s o f c h a n g e s w i t h i n B i g E i g h t a nd n o n - B i g E i g h t a u d i t o r s . I n 1969, B i g E i g h t f i r m s a u d i t e d 113 ( o r 59.2 p e r c e n t ) o f t h e 191 s a m p l e OTC c o m p a n i e s ( w i t h t h e r e m a i n i n g 78 c o m p a n i e s a u d i t e d by non-E i g h t f i r m s ) . I n 1983, t h e B i g E i g h t a u d i t o r s s e r v i c e d 121 OTC f i r m s ( o r 63.4 p e r c e n t ) o f t h e s a m p l e c o m p a n i e s . Hence t h e B i g E i g h t f i r m s e x p e r i e n c e d a n e t g a i n o f e i g h t c l i e n t s o v e r t h e f i f t e e n y e a r p e r i o d e x a m i n e d . A d d i t i o n a l l y , o n l y f o u r a u d i t o r 47 c h a n g e s f r o m n o n - B i g E i g h t t o B i g E i g h t f i r m s were i d e n t i f i e d a s r e s u l t i n g f r o m CPA f i r m m e r g e r s ( w i t h an a d d i t i o n a l s i x u n i d e n t i f i e d c h a n g e s ) , w i t h a t o t a l o f 26 c o n f i r m e d c h a n g e s f r o m n o n - B i g E i g h t t o B i g E i g h t a u d i t o r s . Thus some movement f r o m t h e n o n - B i g E i g h t t o B i g E i g h t f i r m s d i d o c c u r . The a v e r a g e a n n u a l t u r n o v e r r a t e s f o r t h e s e g m e n t e d d a t a a r e a l s o i n d i c a t e d i n T a b l e I V , and have been c a l c u l a t e d i n t h e f o l l o w i n g manner: t o t a l number o f c h a n g e s 1 x , number o f c o m p a n i e s a u d i t e d 14 by a u d i t o r - t y p e i n 1969 where a u d i t o r - t y p e r e p r e s e n t s e i t h e r B i g E i g h t o r n o n - B i g E i g h t a u d i t o r s . T h i s c a l c u l a t i o n o f a n n u a l r a t e s c o n f o r m s w i t h t h a t u s e d by Coe a n d P a l m o n and a l l o w s f o r c o m p a r i s o n b e t w e e n t h e two s t u d i e s . I n s p e c t i o n o f T a b l e s I I a n d I V r e v e a l s t h a t a l l o f t h e OTC t u r n o v e r r a t e s i n d i c a t e d i n t h i s s t u d y a r e s i g n i f i c a n t l y h i g h e r t h a n t h o s e r e p o r t e d by Coe and P a l m o n . F o r m a l T e s t s f o r T r e n d s i n A u d i t o r T u r n o v e r To t e s t f o r i n c r e a s i n g t r e n d s i n a u d i t o r c h a n g e s o v e r t i m e , a s e t o f r e g r e s s i o n a n a l y s e s were p e r f o r m e d w i t h t h e d e p e n d e n t v a r i a b l e r e p r e s e n t i n g t h e a n n u a l number of a u d i t o r c h a n g e s p e r a u d i t o r - t y p e , a n d t h e i n d e p e n d e n t v a r i a b l e i n d i c a t i n g t h e f o u r t e e n r e p o r t i n g p e r i o d s f r o m 1969 t o 1983. T h e s e t e s t s were p e r f o r m e d u s i n g t h e r e g r e s s i o n r o u t i n e s a v a i l a b l e on the-M i c h i g a n I n t e r a c t i v e D a t a A n a l y s i s S y s t e m (MIDAS) u s i n g a 48 s i g n i f i c a n c e l e v e l o f 5 p e r c e n t ( . 0 5 ) . The n u l l a n d a l t e r n a t i v e h y p o t h e s e s were s t y l e d a s f o l l o w s : 1. H 0 : F o r t h e t o t a l 159 OTC a u d i t o r c h a n g e s , t h e r e was no s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s and t i m e . H, : F o r t h e t o t a l 159 OTC a u d i t o r c h a n g e s , t h e r e was a s t a t i s t i c a l l y s i g n i f i c a n t ' p o s i t i v e r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s and t i m e . 2. H 0 : F o r t h o s e OTC a u d i t o r c h a n g e s f r o m a B i g E i g h t t o a n o t h e r B i g E i g h t a u d i t o r , t h e r e was no s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s and t i m e . H, : F o r t h o s e OTC a u d i t o r c h a n g e s f r o m a B i g E i g h t t o a n o t h e r B i g E i g h t a u d i t o r , t h e r e was a s t a t i s t i c a l l y s i g n i f i c a n t p o s i t i v e r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s a n d t i m e . 3. H 0 : F o r t h o s e OTC a u d i t o r c h a n g e s f r o m a N o n - B i g E i g h t t o a n o t h e r N o n - B i g E i g h t a u d i t o r , t h e r e was no s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s and t i m e . H, : F o r t h o s e OTC a u d i t o r c h a n g e s f r o m a N o n - B i g E i g h t t o a n o t h e r N o n - B i g E i g h t a u d i t o r , t h e r e was a s t a t i s t i c a l l y s i g n i f i c a n t p o s i t i v e r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s a n d t i m e . 4. H 0 : F o r t h e sum o f OTC a u d i t o r c h a n g e s w i t h i n t h e B i g E i g h t a n d N o n - B i g E i g h t a u d i t o r s , t h e r e was no s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s and t i m e . H, : F o r t h e sum o f OTC a u d i t o r c h a n g e s w i t h i n t h e B i g E i g h t a n d N o n - B i g E i g h t a u d i t o r s , t h e r e was a s t a t i s t i c a l l y s i g n i f i c a n t p o s i t i v e r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s a n d t i m e . Two a d d i t i o n a l t e s t s f o r t r e n d s i n a u d i t o r c h a n g e s were p e r f o r m e d . As o u r d a t a i n d i c a t e d some movement f r o m n o n - B i g E i g h t t o B i g E i g h t a u d i t o r s , t h e f o l l o w i n g h y p o t h e s e s were t e s t e d ( a g a i n a t t h e 5 p e r c e n t l e v e l o f s i g n i f i c a n c e ) : 49 5. H 0 : F o r t h o s e OTC a u d i t o r c h a n g e s f r o m a B i g E i g h t t o a N o n - B i g E i g h t a u d i t o r , t h e r e was no s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s and t i m e . H, : F o r t h o s e OTC a u d i t o r c h a n g e s f r o m a B i g E i g h t t o a N o n - B i g E i g h t a u d i t o r , t h e r e was a s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s and t i m e . 6. H 0 : F o r t h o s e OTC a u d i t o r c h a n g e s f r o m a N o n - B i g E i g h t t o a B i g E i g h t a u d i t o r , t h e r e was no s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s and t i m e . H, : F o r t h o s e OTC a u d i t o r c h a n g e s f r o m a N o n - B i g E i g h t t o a B i g E i g h t a u d i t o r , t h e r e was a s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s and t i m e . I t s h o u l d be n o t e d t h a t t h e s e two h y p o t h e s e s were s t y l e d t o t e s t f o r e i t h e r i n c r e a s i n g o r d e c r e a s i n g t u r n o v e r . As. o u r t h e o r y d o e s n o t a t t e m p t t o p r e d i c t t r e n d s i n c h a n g e s b e t w e e n a u d i t o r - t y p e s , t h e t e s t s a r e i n c l u d e d f o r c o m p l e t e n e s s a n d i n t e r e s t o n l y , a n d t h e r e s u l t s s h o u l d h a v e no b e a r i n g on o u r c o n c l u s i o n s r e g a r d i n g a u d i t o r t u r n o v e r . The r e s u l t s o f t h e s i x t e s t s d e s c r i b e d a b o v e a r e f u l l y d o c u m e n t e d i n A p p e n d i x D, a n d a r e s u m m a r i z e d b e l o w . R e s u l t s o f R e g r e s s i o n T e s t s A c c o r d i n g t o o u r h y p o t h e s i s d i s c u s s e d e a r l i e r , we w o u l d e x p e c t t o f i n d some i n c r e a s e i n a u d i t o r t u r n o v e r d u r i n g t h e f i f t e e n y e a r s e x a m i n e d ( a n d t h u s a p o s i t i v e c o e f f i c i e n t a s s o c i a t e d w i t h o u r t i m e v a r i a b l e ) . A l t h o u g h a p e r c e p t i b l e i n c r e a s e m i g h t n o t be a p p a r e n t i n t h e t o t a l a n n u a l a u d i t o r c h a n g e s , o u r t h e o r y p r e d i c t s t h a t an i n c r e a s i n g t r e n d s h o u l d be 50 a p p a r e n t w i t h i n t h e s e g m e n t e d s u b - m a r k e t s ( a n d t h u s p e r c e p t i b l e i n t e s t s 2 t o 4 ) . Whereas Coe a n d Palmon f o u n d an i n c r e a s i n g t r e n d i n a u d i t o r c h a n g e s w i t h i n t h e B i g E i g h t a u d i t i n g f i r m s , o u r r e s u l t s d i d n o t c o n f i r m t h e i r f i n d i n g s . I n f a c t , no s i g n i f i c a n t r e l a t i o n s h i p s b e t w e e n t h e number o f a u d i t o r c h a n g e s a n d t i m e were f o u n d , e x c e p t f o r an i n c r e a s i n g t r e n d i n c h a n g e s f r o m n o n - B i g E i g h t t o B i g E i g h t a u d i t o r s . F o r t h e s e c h a n g e s , t h e p o s i t i v e c o e f f i c i e n t a s s o c i a t e d w i t h t h e t i m e v a r i a b l e was s i g n i f i c a n t a t 0.25 p e r c e n t (.0025) w i t h an r - s q u a r e d v a l u e o f .54737. A l l o f t h e o t h e r r e g r e s s i o n t e s t s f a i l e d t o i n d i c a t e a ny s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p b e t w e e n t h e number o f a u d i t o r c h a n g e s a n d t i m e . W h i l e t h e p o s i t i v e r e l a t i o n s h i p b e t w e e n c h a n g e s f r o m n o n -B i g E i g h t t o B i g E i g h t a u d i t o r s s u p p o r t s o u r e a r l i e r e v i d e n c e o f some e x o d u s o f c l i e n t c o m p a n i e s f r o m s m a l l e r t o t h e n a t i o n a l a u d i t i n g f i r m s , t h i s r e s u l t i s o n l y t a n g e n t i a l t o o u r g e n e r a l h y p o t h e s i s . T hus w h i l e t h i s r e s u l t i s somewhat i n t e r e s t i n g , we must c o n c l u d e t h a t t h e e v i d e n c e p r e s e n t e d h e r e d o e s n o t s u p p o r t o u r t h e o r y o f i n c r e a s i n g a u d i t o r t u r n o v e r d u r i n g an assumed p e r i o d o f i n c r e a s e d p r i c e r i v a l r y . The i m p l i c a t i o n s o f t h i s o v e r a l l r e s u l t , a n d r e c o m m e n d a t i o n s f o r f u r t h e r r e s e a r c h a r e d i s c u s s e d i n t h e f o l l o w i n g c h a p t e r . 51 C h a p t e r F i v e SUMMARY OF RESULTS AND IMPLICATIONS FOR FURTHER RESEARCH Summary of T e s t R e s u l t s I n t h e p r e c e d i n g c h a p t e r , t h e m o t i v a t i o n a n d g e n e r a l r e s u l t s o f an e m p i r i c a l s t u d y on a u d i t o r t u r n o v e r r a t e s were d e s c r i b e d . Whereas t h e t h e o r e t i c a l f r a m e w o r k p r o v i d e d by t h e SNS a r t i c l e i m p l i e d t h a t a u d i t o r c h a n g e r a t e s s h o u l d i n c r e a s e d u r i n g a p e r i o d o f p r i c e r i v a l r y , o u r e m p i r i c a l s t u d y f a i l e d t o s u p p o r t t h i s h y p o t h e s i s . A l t h o u g h o u r t u r n o v e r r a t e s were h i g h e r t h a n t h o s e r e c o r d e d by Coe a n d Palmon [ 1 9 7 9 ] , b o t h s t u d i e s g e n e r a l l y f o u n d no s i g n i f i c a n t r e l a t i o n s h i p b e t w e e n a u d i t o r t u r n o v e r a n d t i m e . The r e s u l t s o f t h e r e g r e s s i o n t e s t s p e r f o r m e d i n t h i s s t u d y f a i l e d t o r e j e c t t h e h y p o t h e s e s o f no c h a n g e i n a u d i t o r t u r n o v e r o v e r t h e f i f t e e n y e a r p e r i o d e x a m i n e d . The d a t a c o l l e c t e d s u p p o r t e d t h e n o t i o n t h a t a u d i t o r t u r n o v e r r e m a i n e d r e l a t i v e l y c o n s t a n t d u r i n g t h a t t i m e p e r i o d . A d d i t i o n a l l y , s e g m e n t a t i o n o f t h e d a t a i n t o s u b d i v i s i o n s c o n t a i n i n g c h a n g e s w i t h i n t h e B i g - E i g h t a u d i t o r s a n d c h a n g e s w i t h i n t h e n o n - B i g E i g h t a u d i t o r s d i d n o t a l t e r t h e b a s i c r e s u l t o f r e l a t i v e l y c o n s t a n t a u d i t o r c h a n g e s o v e r t i m e . O n l y t h e c h a n g e s f r o m n o n - B i g E i g h t t o B i g E i g h t a u d i t o r s i n d i c a t e d any s t a t i s t i c a l l y s i g n i f i c a n t r e l a t i o n s h i p t o t i m e . T h e r e a r e a number of p o t e n t i a l e x p l a n a t i o n s a s t o why t h i s s t u d y d i d n o t p r o d u c e t h e e x p e c t e d r e s u l t s o f i n c r e a s e d a u d i t o r t u r n o v e r o v e r t h e f i f t e e n y e a r s e x a m i n e d . E a c h o f t h e s e p o s s i b l e r e a s o n s must be e x a m i n e d i n t u r n . 52 P o s s i b l e E x p l a n a t i o n s f o r R e s u l t s o f S t a t i s t i c a l T e s t s The g e n e r a l r e s u l t o f c o n s t a n t a u d i t o r t u r n o v e r c o u l d i m p l y t h a t i n c r e a s e d p r i c e r i v a l r y d i d n o t o c c u r d u r i n g t h e f i f t e e n y e a r s e x a m i n e d . E i t h e r t h e A I C P A ' s r e m o v a l o f p r o h i b i t i o n s d i d n o t a c t a s c a t a l y s t s f o r i n c r e a s e d p r i c e r i v a l r y , t h u s n e g a t i n g a p r i m a r y a s s u m p t i o n e m p l o y e d i n t h i s s t u d y , o r t h e s t i m u l i p r o v i d e d by t h e t h r e e r u l e c h a n g e s were t o o weak t o be d e t e c t e d by o u r t e s t s . T h u s , t h e m a j o r e f f e c t o f t h e AICPA r u l e c h a n g e s may be t h a t i n c u m b e n t a u d i t o r s d e c r e a s e d f e e s o v e r t h i s t i m e p e r i o d s u c h t h a t any r e s i d u a l e f f e c t t o a u d i t o r t u r n o v e r was m i n i m a l . A l t h o u g h i t seems u n l i k e l y t h a t t h e p r o h i b i t i o n s r e m o v a l h a d no e f f e c t on a u d i t o r s e l e c t i o n , i t i s q u i t e p l a u s i b l e t h a t t h e e f f e c t t o a u d i t o r c h a n g e s was- more m i n o r t h a n e x p e c t e d . 3 8 , 3 9 A n o t h e r p o s s i b l e r e a s o n f o r f i n d i n g r e l a t i v e l y c o n s t a n t a u d i t o r t u r n o v e r r a t e s i s t h a t , a c c o r d i n g t o t h e SNS m o d e l , t h e c o m p e t i t i v e e q u i l i b r i u m f o r OTC f i r m s may h a v e a l r e a d y been a t t a i n e d b e f o r e t h e t i m e p e r i o d e x a m i n e d . F o r e x a m p l e , a l t h o u g h t h e f o r m a l s a n c t i o n s f o r b i d d i n g c o m p e t i t i v e b i d d i n g were removed i n 1972 (due t o t h e a n t i t r u s t s u i t f i l e d by t h e U.S. F e d e r a l J u s t i c e D e p a r t m e n t ) , t h e A I C P A C o u n c i l i s s u e d a p u b l i c s t a t e m e n t i n 1967 i n d i c a t i n g t h a t t h e r u l e p r o h i b i t i n g b i d c o m p e t i t i o n w o u l d no l o n g e r be s t r i c t l y e n f o r c e d . Thus i t i s p o s s i b l e t h a t o u r t i m e p e r i o d d o e s n o t e x t e n d f a r enough t o c a p t u r e e a r l i e r e f f e c t s t o a u d i t o r t u r n o v e r r a t e s . (The a b s o l u t e h i g h number o f t o t a l c h a n g e s f r o m 1969 t o 1970 m i g h t s u p p o r t t h i s 53 c o n c l u s i o n ) . " 0 F u r t h e r m o r e , g i v e n o u r a s s u m p t i o n o f h i g h e r l e v e l s o f c o m p e t i t i v e n e s s i n t h e OTC m a r k e t s d u r i n g a p e r i o d o f c h a n g i n g m a r k e t s t r u c t u r e s , we do n o t know i f s u c h l e v e l s o f c o m p e t i t i v e n e s s e x i s t e d p r i o r t o t h e i n t r o d u c t i o n of i n c r e a s e d p r i c e r i v a l r y . Thus a m a j o r s h o r t c o m i n g o f t h i s m o d e l i s t h a t we h a v e no way t o d i s t i n g u i s h w h e t h e r t h e c o m p e t i t i v e e q u i l i b r i u m h a s been a c h i e v e d w i t h o u t a c c e s s t o f e e i n f o r m a t i o n ( o r a v e r a g e t o t a l c o s t d a t a f o r a l l f i r m s ) . T h e r e f o r e , t h e a t t a i n m e n t o f t h e c o m p e t i t i v e e q u i l i b r i u m r e m a i n s a s one p o s s i b l e e x p l a n a t i o n f o r t h e e m p i r i c a l f i n d i n g s p r e s e n t e d . A n o t h e r p o s s i b l e e x p l a n a t i o n f o r f a i l i n g t o d i s c o v e r t h e e x p e c t e d r e s u l t s o f i n c r e a s e d a u d i t o r t u r n o v e r i n v o l v e s o u r a s s u m p t i o n s r e g a r d i n g p r o d u c t d i f f e r e n t i a t i o n . We assumed t h a t s e g r e g a t i n g t h e o v e r a l l a u d i t i n g m a r k e t i n t o s u b - m a r k e t s o f B i g E i g h t v e r s u s n o n - B i g E i g h t c o u l d a p p r o x i m a t e m a r k e t s where t h e p a r t i c i p a n t s were o f f e r i n g n e a r p e r f e c t s u b s t i t u t e s . S u c h a p a r t i t i o n i n g may be t o o c o a r s e t o r e v e a l any u n d e r l y i n g t r e n d s w i t h i n m a r k e t s where t h e p r o d u c t s o r s e r v i c e s a r e a c t u a l l y p e r c e i v e d t o be n e a r l y i d e n t i c a l . T h e r e f o r e , a t l e a s t t h e o r e t i c a l l y , f i n e r s e g r e g a t i o n ( w h i c h m i g h t i n c l u d e i n d u s t r y s p e c i a l i z a t i o n a n d / o r r e g i o n a l e x p e r t i s e ) c o u l d u n c o v e r t r e n d s i n a u d i t o r c h a n g e s n o t i n d i c a t e d by t h e t e s t s p e r f o r m e d w i t h i n t h i s s t u d y . H owever, g i v e n t h e s m a l l a b s o l u t e number o f c h a n g e s f o u n d i n t h i s r e s e a r c h p r o j e c t , s u c h f u r t h e r s e g m e n t a t i o n w o u l d be u n l i k e l y t o p r o d u c e any a d d i t i o n a l i n f o r m a t i o n . 54 A n o t h e r l i k e l y e x p l a n a t i o n f o r o u r e m p i r i c a l r e s u l t s stems f r o m t h e f a c t t h a t t h e r e were s i g n i f i c a n t p r o b l e m s w i t h t h e d a t a s e t u s e d i n t h i s s t u d y . By u s i n g t h e Moody's M a n u a l s we i m m e d i a t e l y l i m i t e d o u r a n a l y s e s o f a u d i t o r c h a n g e s t o a n a r r o w s e t o f l a r g e r OTC f i r m s , t h u s n e g l e c t i n g t h e numerous s m a l l e r OTC f i r m s t h a t a r e n o t l i s t e d i n Moody's. T h i s i s s i g n i f i c a n t i n t h a t M c C o n n e l l [ 1 9 8 3 ] d i s c o v e r e d a s i g n i f i c a n t l y l a r g e r a b s o l u t e number o f OTC a u d i t o r c h a n g e s when he e x a m i n e d a l l c h a n g e s r e p o r t e d t o t h e SEC. F u r t h e r m o r e , o u r a d d i t i o n a l c o n t r o l s p r o v i d i n g f o r a s t a b l e s e t o f c o m p a n i e s l i s t e d i n t h e OTC M a n u a l s t h r o u g h o u t t h e f i f t e e n y e a r p e r i o d may have f u r t h e r d i s t o r t e d o u r r e s u l t s . And l a s t l y , w i t h o u t a l s o l o o k i n g a t t h e NYSE and AMEX a u d i t o r c h a n g e i n f o r m a t i o n f o r t h a t p e r i o d , we have e l i m i n a t e d a l a r g e s e t o f p o t e n t i a l l y i n f o r m a t i v e d a t a . A r e a s f o r S u b s e q u e n t R e s e a r c h F u r t h e r work w o u l d be r e q u i r e d t o r e s o l v e t h e a b o v e m e n t i o n e d p r o b l e m s c o n t a i n e d w i t h i n t h i s s t u d y . To e n s u r e t h a t a l l o f t h e e f f e c t s r e s u l t i n g , f r o m i n c r e a s e d - b i d c o m p e t i t i o n f o l l o w i n g t h e 1967 AICPA p u b l i c a n n ouncement were c a p t u r e d , c o l l e c t i o n o f a u d i t o r c h a n g e i n f o r m a t i o n w o u l d be r e q u i r e d f o r t h e t h r e e y e a r s f r o m 1967 t o 1969, and f o r a number o f y e a r s p r e c e d i n g 1967. The Moody's M a n u a l s f o r t h e s e y e a r s a r e p u b l i c l y a v a i l a b l e ( a l t h o u g h n o t a v a i l a b l e l o c a l l y ) . T h i s a d d i t i o n a l work c o u l d i d e n t i f y i f , f o r t h i s s a m p l e o f OTC f i r m s , a s h o r t p e r i o d o f i n c r e a s e d a u d i t o r t u r n o v e r o c c u r r e d f o l l o w i n g t h e 1967 a n n o u n c e m e n t . A d d i t i o n a l l y , t h e s a m p l e s i z e o f OTC f i r m s c o u l d be e x p a n d e d t o i n c l u d e a l l c o m p a n i e s r e p o r t i n g i n 55 t h e Moody's M a n u a l s o v e r t h e e x t e n d e d p e r i o d o f e x a m i n a t i o n ( r e c a l l t h a t o u r s a m p l e s i z e r e p r e s e n t e d a p p r o x i m a t e l y 41 p e r c e n t o f t h o s e f i r m s s i m u l t a n e o u s l y l i s t e d i n b o t h t h e f i r s t a n d f i n a l y e a r s ) . However, i t i s u n l i k e l y t h a t e x p a n d i n g t h e number o f OTC f i r m s i n t h i s manner w o u l d a l t e r t h e r e s u l t s f o u n d i n t h i s s t u d y . U n f o r t u n a t e l y , s u c h e m b e l l i s h m e n t s t o t h i s r e s e a r c h p r o j e c t w o u l d n o t s o l v e t h e b a s i c l i m i t a t i o n s e n c o u n t e r e d due t o t h e d a t a s e t we u s e d . G i v e n t h e l a r g e a b s o l u t e number o f a u d i t o r c h a n g e s f o u n d by M c C o n n e l l [ 1 9 8 3 ] , i t i s a p p a r e n t t h a t by r e s t r i c t i n g o u r e x a m i n a t i o n t o o n l y t h o s e OTC f i r m s l i s t e d i n t h e Moody's M a n u a l s , we have e l i m i n a t e d a v e r y r i c h s o u r c e o f a u d i t o r c h a n g e i n f o r m a t i o n . Thus a more c o m p l e t e e x a m i n a t i o n o f a u d i t o r t u r n o v e r o v e r t i m e w o u l d r e q u i r e a p r o j e c t s i m i l a r i n s c o p e t o t h a t p r o d u c e d by M c C o n n e l l , where a v e r y l a r g e number o f c h a n g e s c o u l d be c o l l e c t e d a n d a n a l y z e d f o r t r e n d a n a l y s e s . U n f o r t u n a t e l y , a c c o r d i n g t o M c C o n n e l l , t h e SEC i n f o r m a t i o n on a u d i t o r c h a n g e s f o r t h e y e a r s 1971 t o 1973 c o n t a i n e d numerous c l a s s i f i c a t i o n a n d d a t a e r r o r s , t h u s s u b s t a n t i a l l y i n c r e a s i n g t h e p o t e n t i a l w o r k l o a d f o r a n a l y s e s o f c h a n g e s i n t h a t p e r i o d . N e v e r t h e l e s s , a u d i t o r c hange i n f o r m a t i o n c o u l d be p r o c u r e d f o r a l l f i r m s r e p o r t i n g t o t h e SEC f r o m 1971 t o t h e p r e s e n t . E x a m i n a t i o n o f s u c h a d a t a s e t w o u l d be s t r o n g l y p r e f e r r e d o v e r t h e c o l l e c t i o n a s m a l l e r s u b s e t o f c o m p a n i e s , a s i s a v a i l a b l e t h r o u g h t h e Moody's M a n u a l s . 56 F i n a l l y , f u r t h e r r e s e a r c h s h o u l d a d d r e s s t h e i s s u e o f d e t e r m i n i n g when t h e c o m p e t i t i v e e q u i l i b r i u m h a s been a c h i e v e d . . The o b v i o u s m e thod t o do t h i s w o u l d be t o a v o i d t h i s s e c o n d a r y s e t o f a u d i t o r c h a n g e i n f o r m a t i o n , a n d e x a m i n e t h e e x p e c t e d p r i m a r y e f f e c t o f p r i c e r i v a l r y on a u d i t f e e s . As d i s c u s s e d e a r l i e r i n t h i s t h e s i s , t h e s t a n d a r d e f f e c t o f t h e i n t r o d u c t i o n o f r i v a l r y i n t o a m a r k e t i s t o d r i v e p r i c e s ( i n o u r c a s e , a u d i t f e e s ) down t o t h e c o m p e t i t i v e e q u i l i b r i u m . T hus i f a u d i t f e e s c o u l d be o b s e r v e d o v e r a t i m e p e r i o d t h a t c o n t a i n e d i n c r e a s e d r i v a l r y , we w o u l d e x p e c t t o s e e a g e n e r a l f e e d e c l i n e u n t i l t h e c o m p e t i t i v e e q u i l i b r i u m was a c h i e v e d . The c o l l e c t i o n o f f e e d a t a o v e r a s u f f i c i e n t l y l o n g p e r i o d o f t i m e w o u l d p r o v e v e r y i n t e r e s t i n g , a l t h o u g h g i v e n t h a t f e e d a t a i s l a r g e l y u n a v a i l a b l e p u b l i c l y , t h e t a s k a d m i t t e d l y w o u l d be an o n e r o u s o n e . " 1 T h i s c h a p t e r h a s s u m m a r i z e d t h e b a s i c r e s u l t s o f o u r e m p i r i c a l t e s t s , a n d p r o v i d e d some s u g g e s t i o n s f o r f u r t h e r r e s e a r c h w o r k . W h i l e an e x t e n s i o n o f t h i s r e s e a r c h p r o j e c t m i g h t g e n e r a t e some a d d i t i o n a l i n f o r m a t i o n , more i n t e r e s t i n g r e s u l t s a r e l i k e l y t o be a c h i e v e d i f f u t u r e r e s e a r c h e r s e x a m i n e e i t h e r a s i g n i f i c a n t l y l a r g e r d a t a s e t o f a u d i t o r c h a n g e s , o r c o n c e n t r a t e t h e i r r e s e a r c h e f f o r t s on t h e p r i m a r y e f f e c t o f i n c r e a s e d r i v a l r y on a u d i t f e e s . 57 C h a p t e r S i x SUMMARY AND CONCLUSIONS I n t h i s t h e s i s , we h a v e e x a m i n e d some o f t h e r e l a t i o n s h i p s b e t w e e n t h e m a r k e t s t r u c t u r e o f a u d i t i n g , a u d i t o r i n d e p e n d e n c e , a n d t h e r a t e o f a u d i t o r c h a n g e s o v e r t i m e . The g e n e r a l m o t i v a t i o n f o r t h i s r e s e a r c h stemmed f r o m t h e p e r s i s t e n t a l l e g a t i o n s f o u n d i n a c c o u n t i n g l i t e r a t u r e t h a t i n c r e a s e d l e v e l s o f c o m p e t i t i o n i n a u d i t i n g somehow c o m p r o m i s e t h e i n d e p e n d e n c e o f p u b l i c a u d i t o r s . As s u c h a l l e g a t i o n s h a v e s u r f a c e d a n d r e s u r f a c e d numerous t i m e s o v e r t h e p a s t two d e c a d e s , i t a p p e a r e d t h a t t h i s i s s u e c o u l d n o t be s e t t l e d w i t h o u t t h e c o n s t r u c t i o n o f an u n d e r l y i n g t h e o r e t i c a l m o d e l . A n e c d o t a l e v i d e n c e a n d e m p i r i c a l s t u d i e s on u s e r s ' p e r c e p t i o n s o f a u d i t o r i n d e p e n d e n c e h a d f a i l e d t o p r o v i d e s u f f i c i e n t e v i d e n c e s u c h t h a t r e s e a r c h e r s ( b o t h a c a d e m i c a n d l e g i s l a t i v e ) were u n a n i m o u s r e g a r d i n g t h e a n s w e r t o t h e f o l l o w i n g q u e s t i o n : Does c o m p e t i t i o n i n a u d i t i n g p r o m o t e o r i n h i b i t a u d i t o r i n d e p e n d e n c e ? The r e s e a r c h d e s c r i b e d i n t h e f i r s t p a r t o f t h i s t h e s i s a d d r e s s e s t h e q u e s t i o n p o s e d a b o v e . I n c o l l a b o r a t i o n w i t h two o t h e r r e s e a r c h e r s , t h e a u t h o r e x a m i n e d how t h e m a r k e t s t r u c t u r e o f a u d i t i n g may a f f e c t a u d i t o r i n d e p e n d e n c e . The r e s u l t o f t h i s e f f o r t was t h e p a p e r e n t i t l e d " M a r k e t S t r u c t u r e and A u d i t o r I n d e p e n d e n c e , " by S t e i n , N i e l s e n a n d S i m u n i c ( S N S ) , w h i c h was s u m m a r i z e d i n C h a p t e r Two, and i s f u l l y r e p r o d u c e d i n A p p e n d i x A. I n t h i s a r t i c l e , we c o n c l u d e d t h a t t h e a t t a i n m e n t o f the-c o m p e t i t i v e e q u i l i b r i u m i n a u d i t i n g p r o v i d e s s u f f i c i e n t 58 c o n d i t i o n s f o r a u d i t o r i n d e p e n d e n c e . F u r t h e r m o r e , we a n a l y z e d t h e e f f e c t s o f i n c r e a s e d l e v e l s o f c o m p e t i t i o n ( o r r i v a l r y b e t w e e n c o m p e t i n g a u d i t o r s ) on a u d i t o r i n d e p e n d e n c e a n d f o u n d t h a t i n d e p e n d e n c e may be c o m p r o m i s e d u n t i l t h e c o m p e t i t i v e e q u i l i b r i u m i s a c h i e v e d . However, a s n o t a l l a u d i t o r s w i l l r i s k b e i n g n o n i n d e p e n d e n t , we w o u l d e x p e c t r i v a l r y t o d e c r e a s e a u d i t o r s ' f e e s a s c l i e n t c o m p a n i e s r e p l a c e i n c u m b e n t a u d i t i n g f i r m s w i t h new a u d i t o r s o f f e r i n g i d e n t i c a l s e r v i c e s a t a l o w e r p r i c e . And f u r t h e r e x t e n d i n g t h e SNS h y p o t h e s e s , we w o u l d a l s o e x p e c t t o d i s c o v e r an i n c r e a s i n g r a t e o f a u d i t o r t u r n o v e r d u r i n g t h i s p e r i o d o f r i v a l r o u s d i s e q u i l i b r i u m . The e f f e c t o f i n c r e a s e d r i v a l r y on a u d i t o r t u r n o v e r was e x a m i n e d i n t h e s e c o n d p o r t i o n o f t h i s t h e s i s . A f t e r a r e v i e w o f t h e e x i s t i n g l i t e r a t u r e on a u d i t o r c h a n g e s , an e m p i r i c a l s t u d y o f OTC a u d i t o r c h a n g e s was p e r f o r m e d . F o r t h i s s t u d y , a u d i t o r i n f o r m a t i o n was c o l l e c t e d f o r a s a m p l e o f 191 c o m p a n i e s l i s t e d i n t h e Moody's OTC I n d u s t r i a l M a n u a l s f r o m 1969 t o 1983. A s s u m i n g t h a t AICPA- r u l e changes- i n 1972,, 1978 a n d 19.79 p r o m p t e d i n c r e a s e d p r i c e r i v a l r y i n t h e a u d i t i n g m a r k e t s , o u r t h e o r y w o u l d p r e d i c t t h a t i n c r e a s e d a u d i t o r t u r n o v e r s h o u l d be o b s e r v a b l e d u r i n g t h a t t i m e p e r i o d . R e g r e s s i o n t e s t s p e r f o r m e d on t h e s a m p l e d a t a i n d i c a t e d no i d e n t i f i a b l e i n c r e a s e i n a u d i t o r c h a n g i n g b e h a v i o r . And a l t h o u g h t h e number of a u d i t o r c h a n g e s r e c o r d e d , a n d t h e r a t e s o f a u d i t o r t u r n o v e r c o m p u t e d , were s i g n i f i c a n t l y h i g h e r t h a n t h o s e r e p o r t e d by Coe and Palmon [ 1 9 7 9 ] , t h e a b s o l u t e number o f 59 c h a n g e s r e c o r d e d was r e m a r k a b l y s m a l l . The o n l y s i g n i f i c a n t t r e n d d i s c o v e r e d i n d i c a t e d an i n c r e a s i n g movement o f OTC f i r m s f r o m n o n - B i g E i g h t t o B i g E i g h t a u d i t i n g f i r m s . F i n a l l y , r e a s o n s f o r f a i l i n g t o d i s c o v e r o u r e x p e c t e d r e s u l t s were e x p l o r e d . E i t h e r o u r m o d e l p r e d i c t i n g d i m i n i s h e d f e e s a n d i n c r e a s e d a u d i t o r t u r n o v e r i s i n c o r r e c t , o r o u r a s s u m p t i o n s e m p l o y e d a n d / o r t h e d a t a s e t e x a m i n e d were i n a d e q u a t e . G i v e n t h e n a t u r e o f t h e r e s e a r c h p r o b l e m , and t h e c o n t i n u i n g i n t e r e s t i n t h e s e i s s u e s , f u r t h e r r e f i n e m e n t s t o t h e m o d e l l i n g a n d a d d i t i o n a l t e s t i n g o f t h e s e h y p o t h e s e s i s recommended. H o w e v e r , f u t u r e r e s e a r c h e r s may f i n d r i c h e r r e s u l t s by e x a m i n i n g e i t h e r a l a r g e r d a t a s e t o f a u d i t o r c h a n g e s , o r t h r o u g h t h e c o l l e c t i o n o f a u d i t f e e d a t a . 60 TABLE I TOTAL AUDITOR CHANGES AND TURNOVER RATES 1969-1983 1969- 70 1970- 71 1971- 72 1 972-73 1973-74 1 974-75 1975- 76 1976- 77 1977- 78 1 978-79 1979- 80 1980- 81 1981- 82 1982- 83 E x c l u d i n g I d e n t i f i e d A u d i t o r M e r g e r s No. o f Changes 18 1 3 1 3 12 7 8 1 3 10 13 10 12 8 1 1 1 1 9, 6, 6, 6, 3, 4, 6, 5, 6, 42 81 81 28 66 19 81 24 28 5.24 6.28 4.19 5.76 5.76 E x c l u d i n g A l l I d e n t i f i e d a n d P o s s i b l e A u d i t o r M e r g e r s No. o f Ch a n g e s % 1 3 9 1 1 10 6 8 1 3 10 1 3 9 1 1 6 1 0 7 6, 4, 5, 5, 3, 4, 6, 5, 6, 81 71 76 24 1 4 19 28 24 28 4.71 5.76 3.14 5.24 3.66 TOTALS 159 1 36 A v e r a g e s 1 1 .36 5.95 9.71 5.09 S o u r c e : Moody's I n v e s t o r S e r v i c e s , I n c . OTC I n d u s t r i a l M a n u a l s . 1970-1984. 61 TABLE I I SUMMARY OF OTC AUDITOR CHANGE RESULTS N i e l s e n Coe a n d Palmon 1. T o t a l Number o f OTC F i r m s 191 1 1 5 2. Time P e r i o d s E x a m i n e d :Number o f Change P e r i o d s E x a m i n e d 1969-1983 1 4 1952-1975 24 3. T o t a l Number o f A u d i t o r C h a n ges : A n n u a l T u r n o v e r R a t e 1 68* 6.28% 66 2.39% 4. T o t a l Number o f A u d i t o r C h a n ges E x c l u d i n g A l l P o s s i b l e M e r g e r s r A n n u a l T u r n o v e r R a t e 1 36 5.09% 37 1 .34% * F o r c o m p a r i s o n w i t h Coe a n d P a l m o n ' s r e s u l t , t h i s amount i n c l u d e s a l l c h a n g e s i d e n t i f i e d i n t h e r o u g h d a t a , e x c e p t f o r c h a n g e s s u c h a s " H a s k i n s a n d S e l l s " t o " D e l o i t t e , H a s k i n s and S e l l s . " S o u r c e : Moody's I n v e s t o r S e r v i c e s , I n c . OTC I n d u s t r i a l M a n u a l s . 1970-1984. 62 TABLE I I I FREQUENCY OF AUDITOR CHANGES BY COMPANY Number o f A u d i t o r C h a n g e s Number o f C o m p a n i e s P e r c e n t a g e s (%) 0 85 44.5 1 59 30.9 2 35 18.3 3 9 4.7 4 2 1 . 1 5 1 .5 TOTALS 191 100.0% S o u r c e : Moody's I n v e s t o r S e r v i c e s , I n c . OTC I n d u s t r i a l M a n u a l s . 1970-1984. 63 TABLE I V SEGMENTED AUDITOR CHANGES 1969-1983 C h a n g e s w i t h i n B i g E i g h t A u d i t o r s C h a n g e s w i t h i n N o n - B i g E i g h t A u d i t o r s * T o t a l I n - g r o u p A u d i t o r Changes 1969- 70 1970- 71 1 971-72 1 972-73 1973- 74 1974- 75 1 975-76 1 976-77 1 977-78 1 978-79 1979- 80 1980- 81 1981- 82 1 982-83 TOTALS 3 4 3 4 1 2 1 2 3 2 5 2 3 2 37 A v e r a g e A n n u a l T u r n o v e r R a t e 2.34? 1 1 5 4 5 4 4 4 4 4 5 3 4 3 3 63 5.77% 14 9 7 9 5 6 5 6 7 7 8 6 6 •5 100 3.74% A v e r a g e A n n u a l T u r n o v e r R a t e (Coe & Palmo n ) .92 .80% .87% I n c l u d e s 17 u n i d e n t i f i e d c h a n g e s . I f t h e s e a r e removed, t h e a v e r a g e a n n u a l t u r n o v e r r a t e i s 4.21%. S o u r c e : Moody's I n v e s t o r 1970-1984. S e r v i c e s , I n c . OTC I n d u s t r i a l M a n u a l s , 64 FOOTNOTES 1. T h i s p a p e r e x a m i n e s some o f t h e i s s u e s p e r t a i n i n g t o t h e p u b l i c a u d i t i n g i n d u s t r y i n t h e U n i t e d S t a t e s . The s t r u c t u r e o f t h e i n d u s t r y , i n c l u d i n g t h e o v e r a l l demand f o r p u b l i c a u d i t s , t h e - l e v e l s o f c o m p e t i t i v e n e s s a n d t h e l e g i s l a t i v e o r r e g u l a t o r y e n v i r o n m e n t , i s n o t a b l y d i f f e r e n t i n C a n ada t h a n t h a t f o u n d i n t h e U.S. However, l i t t l e a t t e n t i o n has been d i r e c t e d t o w a r d t h e s t r u c t u r e and c o n d u c t o f C a n a d i a n p u b l i c a u d i t o r s , w i t h v i r t u a l l y no a c a d e m i c o r p r o f e s s i o n a l r e s e a r c h d e v o t e d t o t h e s e i s s u e s . C e r t a i n l y t h e l a c k o f a v a i l a b l e C a n a d i a n d a t a hampers any s u c h r e s e a r c h e f f o r t . 2. " O p i n i o n - s h o p p i n g , " o r when a c l i e n t company e i t h e r makes m u l t i p l e a u d i t o r c h a n g e s o r p r o p o s a l s w i t h t h e i n t e n t i o n o f p r o c u r i n g a more " c o m p l i a n t " a u d i t o r i s one o f t h e i s s u e s u n d e r r e v i e w by t h e House S u b c o m m i t t e e . The S u b c o m m i t t e e h a s c a l l e d f o r h e a r i n g s t o e x a m i n e b o t h t h e o v e r a l l q u a l i t y a n d e f f e c t i v e n e s s o f f i n a n c i a l d i s c l o s u r e s i n t h e U.S. A c c o r d i n g t o C h a i r m a n J o h n D. D i n g a l l , t h e h e a r i n g s w i l l a l s o f o c u s on t h e " e f f e c t i v e n e s s o f i n d e p e n d e n t a c c o u n t a n t s who a u d i t p u b l i c l y owned c o r p o r a t i o n s " a n d t h e p e r f o r m a n c e o f t h e S e c u r i t i e s a n d E x c h a n g e C o m m i s s i o n i n m e e t i n g i t s a u d i t i n g a n d a c c o u n t i n g r e s p o n s i b i l i t i e s . " [ " C o n g r e s s i o n a l S u b c o m m i t t e e C o n v e n e s . . . ," p. 12] The h e a r i n g s commenced F e b r u a r y 20,- 1985 a n d a r e e x p e c t e d t o c o n t i n u e t h r o u g h o u t 1985. 3. F o r an e x c e l l e n t o v e r v i e w o f t h e i s s u e s i n v o l v e d , s e e B u c k l e y a n d Weston [ 1 9 8 0 ] . 4. A r e v i e w o f t h e c o m p l e t e body o f r e s e a r c h on a u d i t o r i n d e p e n d e n c e i s t o o l o n g t o be w a r r a n t e d h e r e . H o w e v e r , a s h o r t l i s t o f r e c e n t r e s e a r c h i s p r o v i d e d on t h e f i r s t page o f A p p e n d i x A. 5. F o r a f u l l d i s c u s s i o n o f t h e s e c o n f l i c t s , s e e Goldman and B a r l e v [ 1 9 7 4 ] and N i c h o l s and P r i c e [ 1 9 8 3 ] . 6. The a b o v e d i s c u s s i o n on t h e r o l e o f t h e p u b l i c a u d i t o r a s s u m e s t h a t p e r f e c t i n f o r m a t i o n d o e s n o t e x i s t . I n f a c t , an o u t s i d e a u d i t o r ' s o p i n i o n w o u l d h a v e no v a l u e i f p e r f e c t i n f o r m a t i o n was a v a i l a b l e t o a l l p a r t i e s . As i n f o r m a t i o n a s y m m e t r i e s do e x i s t ( f o r e x a m p l e , b e t w e e n o w n e r s and m a n a g e r s w i t h i n t h e f i r m , and b e t w e e n t h e f i r m and t h i r d p a r t y u s e r s ) , t h e u s e f u l n e s s o f t h e p u b l i c a u d i t o r i s m a i n t a i n e d . T h i s a s s u m p t i o n o f i m p e r f e c t i n f o r m a t i o n i s u s e d t h r o u g h o u t t h e a n a l y s e s c o n t a i n e d i n t h i s t h e s i s . 7. S u c h a r g u m e n t s c o u l d be p e r c e i v e d a s s e l f - s e r v i n g when w r i t t e n by p r a c t i c i n g a u d i t o r s who a r e i n t e r e s t e d i n 65 m a i n t a i n i n g e l e v a t e d l e v e l s o f m a r k e t c o n c e n t r a t i o n . H owever, t h e f o l l o w i n g e x a m p l e i s by S t e r l i n g [ 1 9 7 3 ] , a n o t a b l e a c c o u n t i n g a c a d e m i c who c l e a r l y h a s no p e r s o n a l s e l f - i n t e r e s t i n v o l v e d . S t e r l i n g s t a t e d : The m a j o r p r o b l e m f a c i n g p u b l i c a c c o u n t i n g t o d a y i s i t s l a c k o f p o wer. . . [ w h i c h ] i s l e s s e n e d f u r t h e r by t h e e x i s t e n c e o f c o m p e t i t i o n among a c c o u n t i n g f i r m s . R e s i g n a t i o n f r o m an engagement m i g h t be an e f f e c t i v e means o f e n f o r c e m e n t i f i t were n o t f o r t h e f a c t t h a t o t h e r f i r m s may t a k e t h e engagement and i s s u e an o p i n i o n . [ p . 6 6 ] 8. F o r e x a m p l e , s e e W a t t s a n d Zimmerman [ 1 9 8 1 ] a n d D e A n g e l o [ 1 9 8 1 a ] . T h e s e a u t h o r s h a v e d e f i n e d a u d i t q u a l i t y t o be t h e m a r k e t - a s s e s s e d j o i n t p r o b a b i l i t y t h a t an a u d i t o r w i l l b o t h d i s c o v e r a n d r e p o r t a b r e a c h i n t h e c l i e n t ' s a c c o u n t i n g s y s t e m . Thus one m e a s u r e o f a u d i t o r i n d e p e n d e n c e i s t h e a s s e s s e d p r o b a b i l i t y of an a u d i t o r r e p o r t i n g a d i s c o v e r e d b r e a c h . 9. C o n s i s t e n t w i t h s t a n d a r d m i c r o - e c o n o m i c t h e o r y , t h e c o m p e t i t i v e p r i c e i n c l u d e s a n o r m a l r e t u r n t o c a p i t a l . 10. See C h a p t e r Two f o r a f u l l d i s c u s s i o n o f t h i s m e c h a n i s m . 11. As w i l l b e . d i s c u s s e d i n C h a p t e r Two, r i v a l r o u s a c t i o n s c a n i n c l u d e o t h e r f o r m s o f n o n - p r i c e c o m p e t i t i o n . I n t h i s p a p e r we f o c u s on t h e e f f e c t s o f i n c r e a s e d f e e c o m p e t i t i o n ( o r p r i c e r i v a l r y ) . 12. E ven i f t h e i n c r e a s e d r i v a l r y was b a s e d on n o n - p r i c e d e t e r m i n a n t s s u c h a s p r o d u c t d i f f e r e n t i a t i o n , we w o u l d e x p e c t t o o b s e r v e i n c r e a s e d t u r n o v e r i f i n c u m b e n t s r e f u s e t o i n c r e a s e o r a l t e r t h e i r p a c k a g e o f s e r v i c e s r e n d e r e d a t a c o n s t a n t p r i c e . S i m i l a r a r g u m e n t s r e g a r d i n g i n f o r m a t i o n a s y m m e t r i e s w o u l d e x p l a i n why i n c u m b e n t s do n o t m a t c h t h e i r r i v a l s ' p r o p o s a l s f o r i n c r e a s e d s e r v i c e s . 13. The i n t e r e s t e d r e a d e r i s d i r e c t e d t o A p p e n d i x A f o r t h e e n t i r e t e x t o f t h e SNS a r t i c l e . 14. The work i n t h i s t h e s i s , i n l a r g e p a r t , i s p r e m i s e d upon t h e a n a l y s e s p r e s e n t e d i n t h e S e p t e m b e r , 1985 v e r s i o n o f t h e SNS p a p e r . We h a v e s i n c e r e c e i v e d numerous comments on t h a t v e r s i o n , a n d Mr. S t e i n h a s d e c i d e d t o p u r s u e t h i s t o p i c - a r e a i n h i s d o c t o r a l d i s s e r t a t i o n . The a u t h o r s a c k n o w l e d g e t h a t t h e SNS a r t i c l e c o n t a i n s c e r t a i n p r o b l e m a r e a s , i n c l u d i n g t h e l a c k o f a p r e c i s e d e f i n i t i o n o f a u d i t o r i n d e p e n d e n c e . N e v e r t h e l e s s , f o r t h e p u r p o s e s o f t h i s t h e s i s e n d e a v o r , t h e a n a l y s e s a n d c o n c l u s i o n s o f t h e e x i s t i n g SNS p a p e r f o r m t h e f r a m e w o r k f o r t h e work p r e s e n t e d h e r e . 66 15. I n t h i s p a p e r we assume t h a t t h e m a r k e t f o r a u d i t s p r e f e r s a u d i t o r i n d e p e n d e n c e ( o r a t l e a s t t h e a p p e a r a n c e o f i n d e p e n d e n c e ) o v e r n o n i n d e p e n d e n c e . A l t h o u g h we a c k n o w l e d g e t h a t a s u b - m a r k e t f o r a u d i t o r n o n i n d e p e n d e n c e e x i s t s , we assume t h a t a r e p u t a t i o n f o r n o n i n d e p e n d e n c e i s g e n e r a l l y deemed an a u d i t o r c o s t and n o t a b e n e f i t . 16. F o r t h e s a k e o f c o n v e n i e n c e , none o f t h e e q u a t i o n s e m p l o y e d by SNS w i l l be r e p r o d u c e d h e r e . A g a i n , t h e i n t e r e s t e d r e a d e r i s d i r e c t e d t o A p p e n d i x A. 17. G i v e n t h e e x i s t e n c e o f d i f f e r e n c e s i n a u d i t o r s ' o p i n i o n s r e g a r d i n g w h e t h e r o r n o t a p a r t i c u l a r a c t i o n q u a l i f i e s a s " i n d e p e n d e n t , " we w o u l d a l s o e x p e c t t o s e e d i f f e r i n g l e v e l s o f a u d i t o r s ' a s s e s s m e n t s a s t o t h e c o s t s o f n o n i n d e p e n d e n c e . T h i s i s s u e i s d i s c u s s e d f u r t h e r i n C h a p t e r F o u r . 18. The a s s u m p t i o n of an o l i g o p o l i s t i c m a r k e t s t r u c t u r e w o u l d c o n f o r m w i t h much o f t h e a n e c d o t a l e v i d e n c e c i t e d t h r o u g h o u t t h e 1970's. C e r t a i n l y p r i c e c o m p e t i t i o n was r e s t r i c t e d u n t i l t h e a n t i t r u s t s u i t i n 1972, and a l l e g a t i o n s o f t h e c o n t i n u e d l a c k o f p r i c e c o m p e t i t i v e n e s s e x t e n d e d i n t o t h e m i d - 1 9 7 0 ' s . S u c h a l l e g a t i o n s l a r g e l y m o t i v a t e d t h e S e n a t e S u b c o m m i t t e e ( M e t c a l f C o m m i s s i o n ) i n v e s t i g a t i o n . 19. O n l y two r e c e n t s t u d i e s h a v e c o l l e c t e d a u d i t f e e d a t a . F o r h i s d o c t o r a l d i s s e r t a t i o n , S i m u n i c [ 1 9 8 0 ] c o l l e c t e d f e e d a t a f o r a s a m p l e o f 397 U.S. f i r m s by d i s t r i b u t i n g q u e s t i o n n a i r e s t o a t o t a l o f 1,207 c o m p a n i e s . F r a n c i s [ 1 9 8 4 ] r e p l i c a t e d much o f S i m u n i c ' s s t u d y u s i n g p u b l i c l y a v a i l a b l e A u s t r a l i a n d a t a w h i c h i n c l u d e d a u d i t f e e d a t a . 20. I n 1971 t h e SEC i s s u e d S e c u r i t i e s A c t R e l e a s e No. 34-9344 w h i c h r e v i s e d Forms 8-K t o r e q u i r e t h e r e p o r t i n g o f a c h a n g e i n t h e p r i n c i p a l a u d i t o r o f a r e g i s t r a n t . The r e q u i r e m e n t s t a t e d t h a t f i r m s were t o d i s c l o s e any s i g n i f i c a n t a c c o u n t i n g o r a u d i t i n g d i s a g r e e m e n t s w i t h f o r m e r a u d i t o r s o c c u r r i n g i n t h e e i g h t e e n months p r e c e d i n g t h e a u d i t o r c h a n g e . S u b s e q u e n t amendments t o t h i s r e q u i r e m e n t i n c l u d e d an e x t e n s i o n o f t h e d i s a g r e e m e n t p e r i o d t o t w e n t y - f o u r m o n t h s , t h e m a n d a t o r y d i s c l o s u r e a s t o w h e t h e r t h e a u d i t o r c h a n g e was recommended o r a p p r o v e d by t h e f i r m ' s B o a r d o f D i r e c t o r s , and a r e c o m m e n d a t i o n t h a t f i r m s v o l u n t a r i l y d i s c l o s e t h e r e a s o n s f o r t h e a u d i t o r c h a n g e . 2 1 . T h i s s e c t i o n o f Coe a n d P a l m o n ' s p a p e r i s e x t r e m e l y c o n f u s i n g . A l t h o u g h t h e a u t h o r s s t a t e d t h a t t h e y f o u n d no r e l a t i o n s h i p b e t ween t h e r a t e o f a u d i t o r c h a n g e s a n d time-[ p . 5 ] , t h e y t h e n r e f e r r e d ( i n c o r r e c t l y ) t o t h e i r t o t a l a n n u a l t u r n o v e r d a t a , i n d i c a t i n g t h a t t u r n o v e r r a t e s d i d i n c r e a s e o v e r t i m e , e s p e c i a l l y d u r i n g t h e f i n a l s i x y e a r s 67 o f t h e s a m p l e p e r i o d . I t i s o n l y w i t h v e r y c a r e f u l i n s p e c t i o n t h a t t h e r e a d e r c a n c o n c l u d e t h a t Coe a n d Palmon f o u n d o n l y E i g h t a u d i t o r t u r n o v e r r a t e s i n c r e a s i n g o v e r t i m e , a n d t h a t t h i s r e s u l t was n o t d o c u m e n t e d i n t h e m a t e r i a l p r e s e n t e d . I n h i s r e v i e w o f t h i s Coe a n d Palmon p a p e r , M c C o n n e l l [ 1 9 8 3 ] i n d i c a t e d h i s own c o n f u s i o n when he s t a t e d t h a t t h e y d i d f i n d i n c r e a s i n g a u d i t o r t u r n o v e r r a t e s . G i v e n Coe and P a l m o n ' s p r o b l e m s o f e x p o s i t i o n , M c C o n n e l l ' s o v e r s i g h t i s u n d e r s t a n d a b l e . 22. I t s h o u l d be n o t e d t h a t t h e c r e d i b i l i t y o f s u c h s e l f -r e p o r t i n g i s q u e s t i o n a b l e . The SEC a d d r e s s e d t h i s p r o b l e m by a l s o r e q u i r i n g c o m p a n i e s t o i n c l u d e w r i t t e n s t a t e m e n t s f r o m t h e i r f o r m e r a u d i t o r s i n d i c a t i n g w h e t h e r t h e y a g r e e d o r d i s a g r e e d w i t h t h e SEC r e g i s t r a n t ' s s t a t e m e n t s r e g a r d i n g p r e v i o u s a u d i t o r - c l i e n t d i s a g r e e m e n t s . 23. The a u d i t o r s i d e n t i f i e d a s h a v i n g a t e n d e n c y t o q u a l i f y o p i n i o n s were A r t h u r Young & Co., C o o p e r s & L y b r a n d , and To u c h e R o s s & Co. 24. G i v e n t h a t n e a r l y 80 p e r c e n t o f t h e 3,300 a u d i t o r c h a n g e s i d e n t i f i e d ( t h r o u g h e x a m i n a t i o n o f t h e d a i l y SEC News  D i g e s t p u b l i c a t i o n ) were made by OTC c o m p a n i e s , M c C o n n e l l l i m i t e d h i s a n a l y s i s o f OTC c h a n g e s t o a l a r g e s a m p l e s e t . 25. F o r e x a m p l e , see D e A n g e l o [ 1 9 8 1 b ] , D o p u c h a n d S i m u n i c [ 1 9 8 2 ] , a n d S i m u n i c a nd S t e i n [ 1 9 8 4 ] . 26. F o r e x a m p l e , i f t h e r e i s s u f f i c i e n t d i s a g r e e m e n t i n t h e a p p r o p r i a t e r e p o r t i n g m e t h o d t o be u s e d f o r an i n d i v i d u a l c l i e n t , one a u d i t o r may p e r c e i v e an a c t i o n as n o n i n d e p e n d e n t , and w i l l t h e r e f o r e a s s e s s a h i g h e r c o s t t o u s i n g t h a t a c c o u n t i n g m ethod c o m p a r e d t o a n o t h e r a u d i t o r who v i e w s t h e same a c t i o n a s i n d e p e n d e n t ( a n d w i l l a s s e s s z e r o c o s t s o f n o n i n d e p e n d e n c e . 27. T h i s a u t h o r a p p r o a c h e d M c C o n n e l l w i t h t h e i d e a o f e x t e n d i n g h i s d a t e b a s e s u c h t h a t some t r e n d a n a l y s e s c o u l d be p e r f o r m e d . However, M c C o n n e l l d e c l i n e d . 28. E x a m i n a t i o n o f M c C o n n e l l ' s d a t a f o r m u l t i p l e a u d i t o r c h a n g e s r e v e a l s t h a t t h i s i s n o t a s i g n i f i c a n t p r o b l e m . 29. Who A u d i t s A m e r i c a p r o v i d e s a u d i t o r l i s t i n g s a n d a u d i t o r c h a n g e i n f o r m a t i o n f o r most o f .the same c o m p a n i e s l i s t e d i n t h e Moody's M a n u a l s . H o w e v e r , i t s f i r s t e d i t i o n was p u b l i s h e d i n 1976, p r o v i d i n g a t maximum o n l y n i n e y e a r s of d a t a . F u r t h e r m o r e , M c C o n n e l l [ 1 9 8 3 ] f o u n d a s u f f i c i e n t number o f d a t a e r r o r s i n Who A u d i t s A m e r i c a t o c o n c l u d e t h a t i t was an u n r e l i a b l e p r i m a r y s o u r c e o f i n f o r m a t i o n . G i v e n t h e ab o v e p r o b l e m s , c o u p l e d w i t h t h e f a c t t h a t Who  A u d i t s A m e r i c a i s n o t a v a i l a b l e l o c a l l y , t h i s p u b l i c a t i o n was n o t c h o s e n a s t h e p r i m a r y d a t a s o u r c e f o r t h i s s t u d y . 68 30. F o r e x a m p l e , s e e Coe and Palmon [ 1 9 7 9 ] a nd M c C o n n e l l [ 1 9 8 3 . ] 3 1 . The s a m p l e s i z e o f 200 f i r m s was b a s e d on an i n f o r m a l a s s e s s m e n t o f t h e m a r g i n a l b e n e f i t s / c o s t s o f s a m p l i n g , a n d t h a t t h i s amount a t l e a s t e q u a l l e d Coe and P a l m o n ' s 1979 s a m p l e s i z e o f 115 OTC f i r m s . 32. An u n f o r t u n a t e r e s u l t o f i m p o s i n g s u c h a c o n s t r a i n t i s t h a t t h e s a m p l e s e t t h e n c o n s i s t s o f " s t a g n a n t " c o m p a n i e s ; t h a t i s , t h e s e a r e f i r m s e x p e r i e n c i n g i n s u f f i c i e n t g r o w t h t o "move o n " t o t h e l a r g e r e x c h a n g e s . The i m p l i c a t i o n s o f t h i s c o n s t r a i n t a r e d i s c u s s e d i n C h a p t e r F i v e . 33. The f o l l o w i n g OTC c o m p a n i e s were r e m o v e d f r o m t h e s a m p l e b e c a u s e o f l a r g e r e p o r t i n g " g a p s " : D i g i t a l P r o d u c t s C o r p o r a t i o n E l C h i c o C o r p o r a t i o n Humphrey, I n c o r p o r a t e d MPC E d u c a t i o n a l S y s t e m s , I n c o r p o r a t e d M e t a l l u r g i c a l I n d u s t r i e s , I n c o r p o r a t e d M o t o r C o i l s M a n u f a c t u r i n g C o r p o r a t i o n P r o f e s s i o n a l C a r e S e r v i c e s , I n c o r p o r a t e d R e c t i s e l C o r p o r a t i o n S t e r l i n g Computer S y s t e m s , I n c o r p o r a t e d . 34. F o r a l l o f t h e r e c o r d e d a u d i t o r c h a n g e s , an e f f o r t was made t o g e t i n f o r m a t i o n on t h e c o n t i n u e d e x i s t e n c e o f t h e p r e d e c e s s o r a u d i t o r . I f t h e " o l d " a u d i t o r was l i s t e d s u b s e q u e n t t o t h e i n d i c a t e d c h a n g e i n o u r s a m p l e o f OTC c h a n g e s , i n Who A u d i t s A m e r i c a , o r i n an a p p r o p r i a t e l o c a l t e l e p h o n e d i r e c t o r y , t h e n we assumed t h a t no m e r g e r t o o k p l a c e . A s i n d i c a t e d b e l o w , t w e n t y - t h r e e c h a n g e s c o u l d n o t be p o s i t i v e l y i d e n t i f i e d a s t o w h e t h e r an a u d i t o r m e r g e r o c c u r r e d . 35. The f o l l o w i n g f i v e a u d i t o r c h a n g e s were e l i m i n a t e d f r o m t h e t o t a l c o l l e c t i o n o f c h a n g e s b e c a u s e o f t h e r e a s o n s l i s t e d b e l o w : 1983 a u d i t o r c h a n g e by P a u l H a r r i s S t o r e s , I n c o r p o r a t e d . The company o r g a n i z e d a m a j o r r e f i n a n c i n g p a c k a g e t h a t y e a r a n d s i m u l t a n e o u s l y c h a n g e d f r o m a n o n - B i g E i g h t a u d i t o r t o a B i g E i g h t a u d i t o r . 1981 a u d i t o r c h a n g e by S o u t h S t a t e O i l and Gas Company. The o p i n i o n r e n d e r e d by t h e s u c c e s s o r a u d i t o r i n d i c a t e s a m a t e r i a l a c c o u n t i n g c h a n g e where t h e o i l f i e l d p u m p i n g u n i t s i n v e n t o r y i s r e v a l u e d a t a s i g n i f i c a n t l y h i g h e r v a l u e t h a n was r e p o r t e d by t h e p r e d e c e s s o r . 1983 a u d i t o r c h a n g e by U n i t e d S t a t e s S u r g i c a l C o r p o r a t i o n . C h a nges i n a c c o u n t i n g p o l i c i e s d u r i n g 1982 a n d 1983 l e d t o l a w s u i t s i n i t i a t e d by 69 t h e SEC a g a i n s t t h e c l i e n t company. 1977 a n d 1981 a u d i t o r c h a n g e s by Van Dyk R e s e a r c h C o r p o r a t i o n . The company s w i t c h e d b a c k and f o r t h b e t w e e n two a u d i t o r s d u r i n g a p e r i o d o f C h a p t e r XI p r o c e e d i n g s . An e a r l i e r c h a n g e was n o t r e m o v e d f r o m t h e t o t a l c h a n g e s c o l l e c t e d . 36. The AICPA l i b r a r y i n New Y o r k was c o n t a c t e d r e g a r d i n g t h e s t a t u s o f t h e s e p o s s i b l e c h a n g e s / m e r g e r s . However, t h e A I C P A l i b r a r i a n s were u n a b l e t o p r o v i d e t h e n e c e s s a r y i n f o r m a t i o n i n t i m e f o r t h i s t h e s i s s u b m i s s i o n . 37. The d i f f e r e n c e b e t w e e n o u r c o m p u t e d r a t e s and t h o s e p r e s e n t e d by Coe a n d Palmon i s p u z z l i n g . U n f o r t u n a t e l y , Coe and P a l m o n d i d n o t p r o v i d e s e g r e g a t e d a n n u a l t u r n o v e r r a t e s f o r OTC f i r m s , and h e n c e we c a n n o t compare t h e two d a t a s e t s . G i v e n t h a t t h e r e i s a s e v e n y e a r o v e r l a p (1969 t o 1 9 7 5 ) , s u c h a c o m p a r i s o n w o u l d h a v e been i n f o r m a t i v e . 38. I n a r e c e n t p a p e r on a c c o u n t i n g s e r v i c e s f o r s m a l l c l i e n t s , O ' K e e f e a n d B a r e f i e l d [ 1 9 8 5 ] f o u n d t h a t an a v e r a g e o f 35 p e r c e n t o f t h e v e r y s m a l l m a n u f a c t u r i n g f i r m s i n t h e i r s a m p l e r e c e i v e d u n s o l i c i t e d p r o p o s a l s i n 1982 a n d 1983 f r o m n o n i n c u m b e n t a u d i t i n g f i r m s . A s s u m i n g t h a t t h e s e f i r m s r e c e i v e d no u n s o l i c i t e d p r o p o s a l s p r i o r t o 1979, t h i s e v i d e n c e s u p p o r t s t h e n o t i o n t h a t t h e AICPA r u l e c h a n g e s h a d some e f f e c t on a u d i t o r s e l e c t i o n . 39. One m i g h t c o n j e c t u r e t h a t an i n c r e a s i n g m a r k e t f o r a u d i t s m i g h t s u f f i c i e n t l y dampen t h e e x p e c t e d r e s u l t s o f p r i c e r i v a l r y . H o w e v e r , most o b s e r v e r s o f a u d i t i n g m a r k e t s c o n c u r t h a t t h e o v e r a l l m a r k e t f o r a u d i t s h a s r e m a i n e d g e n e r a l l y s t a b l e o v e r t h e p a s t two d e c a d e s . L e g i s l a t i o n i n t r o d u c e d i n t h e p a s t d e c a d e p e r t a i n i n g t o t h e a u d i t r e q u i r e m e n t s f o r f i n a n c i a l i n s t i t u t i o n s a n d m u n i c i p a l i t i e s h a s n o t s i g n i f i c a n t l y a l t e r e d t h e s i z e o f t h e a u d i t i n g m a r k e t . 40. I t i s a l s o p o s s i b l e t h a t o t h e r ( e x o g e n o u s ) c r i t e r i a u s e d i n a u d i t o r s e l e c t i o n h a v e d e l a y e d t h e e f f e c t s o f i n c r e a s e d r i v a l r y on a u d i t o r t u r n o v e r . Thus i t i s p l a u s i b l e t h a t t h e t i m e p e r i o d e x a m i n e d may n o t e x t e n d l o n g e nough a f t e r t h e 1978 a n d 1979 r u l e c h a n g e s t o c a p t u r e t h e m a j o r e f f e c t s t o a u d i t o r c h a n g e s . However, a n e c d o t a l e v i d e n c e t h a t t h i s a u t h o r h a s r e c e i v e d f r o m p r o f e s s i o n a l a u d i t o r s i n d i c a t e s t h a t c h a n g e s i n t h e r a t e o f a u d i t o r t u r n o v e r were n o t i c e a b l e by t h e e a r l y 1 9 8 0 ' s . 4 1 . We a c k n o w l e d g e t h a t t h e c o l l e c t i o n o f f e e d a t a a l o n e may be i n s u f f i c i e n t t o d e t e r m i n e i f t h e c o m p e t i t i v e e q u i l i b r i u m h a s been r e a c h e d . F o r e x a m p l e , c o s t a n d c a p i t a l i n v e s t m e n t d a t a may a l s o be r e q u i r e d t o d e t e r m i n e l e v e l s o f p r o f i t a b i l i t y . 70 BIBLIOGRAPHY A m e r i c a n I n s t i t u t e o f C e r t i f i e d P u b l i c A c c o u n t a n t s . R e p o r t ,  C o n c l u s i o n s a n d R e c o m m e n d a t i o n s o f t h e C o m m i s s i o n o f  A u d i t o r s ' R e s p o n s i b i l i t i e s . A I C P A , 1978. A n t l e , R. " A u d i t o r I n d e p e n d e n c e . " J o u r n a l o f A c c o u n t i n g  R e s e a r c h , V o l . 22, S p r i n g , 1984. A r n e t t , H. a n d P. Danos. CPA F i r m V i a b i l i t y . U n i v e r s i t y o f M i c h i g a n , 1979. Beams, F.A. a n d L.N. K i l l o u g h . " A u d i t I n d e p e n d e n c e — A n E x t e n s i o n o f t h e C o n c e p t . " N a t i o n a l P u b l i c A c c o u n t a n t , V o l . 15, Dec. 1970. B e d i n g f i e l d , J . and S.E. L o e b . " A u d i t o r C h a n g e s An E x a m i n a t i o n . " J o u r n a l o f A c c o u n t a n c y , V o l . 137, M a r c h , 1 974. B o l t e n , S.E. a n d J.H. C r o c k e t t J r . "How I n d e p e n d e n t a r e t h e I n d e p e n d e n t A u d i t o r s ? " F i n a n c i a l A n a l y s t s J o u r n a l , V o l . 35, Nov./Dec. 1979. B u c k l e y , J . a n d F. W e s t o n . R e g u l a t i o n a n d t h e A c c o u n t i n g  P r o f e s s i o n . L i f e t i m e L e a r n i n g P u b l i c a t i o n s , 1980. B u r t o n , J.C. a n d W. R o b e r t s . "A S t u d y o f A u d i t C h a n g e s . " J o u r n a l o f A c c o u n t a n c y , V o l . 123, A p r i l , 1967. C a r p e n t e r , C.G. and R.H. S t r a w s e r . " D i s p l a c e m e n t o f A u d i t o r s When C l i e n t s Go P u b l i c . " J o u r n a l o f A c c o u n t a n c y , V o l . 131, J u n e , 1971. Coe, T. a n d D. P a l m o n . "Some E v i d e n c e o f t h e M a g n i t u d e o f A u d i t o r T u r n o v e r . " U n p u b l i s h e d M a n u s c r i p t , New Y o r k U n i v e r s i t y , 1979. Coe, T. a n d D. P a l m o n . " A u d i t o r I n d e p e n d e n c e : Type o f A u d i t O p i n i o n s a n d A u d i t o r D i s m i s s a l . " U n p u b l i s h e d M a n u s c r i p t , New Y o r k U n i v e r s i t y , 1980. " C o n g r e s s i o n a l S u b c o m m i t t e e C o n v e n e s H e a r i n g s i n t o SEC, A c c o u n t i n g P r o f e s s i o n . " J o u r n a l o f A c c o u n t a n c y , V o l . 159, A p r i l , . 1985. Chow, C. a n d S. R i c e . " Q u a l i f i e d A u d i t O p i n i o n s a n d A u d i t o r S w i t c h i n g . " A c c o u n t i n g R e v i e w , V o l . 57, A p r i l , 1982. D a n o s , P. a n d J.W. E i c h e n s e h e r . " A u d i t I n d u s t r y D y n a m i c s : F a c t o r s A f f e c t i n g C h a n g e s i n C l i e n t - I n d u s t r y M a r k e t S h a r e s . " J o u r n a l o f A c c o u n t i n g R e s e a r c h , V o l . 20, Autumn, 1982. 71 D e A n g e l o , L . E . " A u d i t o r I n d e p e n d e n c e , 'Low B a l l i n g , ' a nd D i s c l o s u r e R e g u l a t i o n . " J o u r n a l o f A c c o u n t i n g and E c o n o m i c s , V o l . 3, A u g u s t , 1981[aTi D e A n g e l o , L . E . " A u d i t o r S i z e a n d A u d i t Q u a l i t y . " J o u r n a l o f  A c c o u n t i n g a n d E c o n o m i c s , V o l . 3, December, 1981 [ b ] . D o p u c h , N. a n d D. S i m u n i c . " C o m p e t i t i o n i n A u d i t i n g : An A s s e s s m e n t . " F o u r t h Symposium on A u d i t i n g R e s e a r c h , U n i v e r s i t y o f I l l i n o i s , 1982. F r a n c i s , J.R. "The E f f e c t o f A u d i t F i r m S i z e on A u d i t P r i c e s . " J o u r n a l o f A c c o u n t i n g a n d E c o n o m i c s , V o l . 6, A u g u s t , 1984. F r i e d , D. a n d A. S c h i f f . "CPA S w i t c h e s and A s s o c i a t e d M a r k e t R e a c t i o n s . " A c c o u n t i n g R e v i e w , V o l . 56, A p r i l , 1981. G o ldman, A. a n d B. B a r l e v . "The A u d i t o r - F i r m C o n f l i c t o f I n t e r e s t s : I t s I m p l i c a t i o n s f o r I n d e p e n d e n c e . " A c c o u n t i n g  R e v i e w , V o l . 49, O c t o b e r , 1974. G o n e d e s , N. a n d R. K i h l s t r o m . "On t h e Q u a l i t y a n d Q u a n t i t y o f A u d i t i n g S e r v i c e s U n d e r A l t e r n a t i v e M a r k e t S t r u c t u r e s . " U n p u b l i s h e d M a n u s c r i p t , U n i v e r s i t y o f P e n n s y l v a n i a , 1982. H a r r i s , S.P. t e d . ] Who A u d i t s A m e r i c a . D a t a F i n a n c i a l P r e s s , F i r s t E d . , 1976. H a r r i s , S.P. [ e d . ] Who A u d i t s A m e r i c a . D a t a F i n a n c i a l P r e s s , 8 t h E d . , May, 1982. K a y , R.S. a n d N.A. L a v i n . " E n h a n c i n g A u d i t o r s ' I n d e p e n d e n c e by R e d u c i n g a n d I n c r e a s i n g I n d e p e n d e n c e . " A c c o u n t i n g  Forum, V o l . 49, May, 1979. K napp, M.C. " A u d i t C o n f l i c t : An E m p i r i c a l S t u d y o f t h e P e r c e i v e d A b i l i t y o f A u d i t o r s t o R e s i s t Management P r e s s u r e . " A c c o u n t i n g R e v i e w , V o l . 60, A p r i l , 1985. L a v i n , D. " P e r c e p t i o n s o f t h e I n d e p e n d e n c e o f t h e A u d i t o r . " A c c o u n t i n g R e v i e w , V o l . 5 1 , J a n u a r y , 1976. M c C o n n e l l , D.K. J r . P u b l i c Company A u d i t o r C h a n g e s a n d B i g  E i g h t F i r m s . UMI R e s e a r c h P r e s s , 1983. M c C o n n e l l , D.K. J r . " A u d i t o r Changes a n d R e l a t e d -D i s a g r e e m e n t s , " A u d i t i n g , V o l . 3, S p r i n g , 1984. Moody's I n v e s t o r s S e r v i c e s , I n c . OTC I n d u s t r i a l M a n u a l s . 1970 - 1984. N i c h o l s , D.R. a n d D.B. S m i t h . " A u d i t o r C r e d i b i l i t y a n d A u d i t o r C h a n g e s . " J o u r n a l o f A c c o u n t i n g R e s e a r c h , V o l . 2 1 , A utumn, 1983. 72 O ' K e e f e , T. a n d R. B a r e f i e l d . " P u r c h a s e s o f A c c o u n t i n g S e r v i c e s by S m a l l C l i e n t s : D e s c r i p t i o n and A n a l y s i s . " U n p u b l i s h e d M a n u s c r i p t , U n i v e r s i t y o f O r e g o n , 1985. O l s o n , W. "What i s A u d i t o r I n d e p e n d e n c e ? " J o u r n a l o f  A c c o u n t a n c y , V o l . 149, A p r i l , 1980. P a n y , K. " E f f e c t s o f G i f t s , D i s c o u n t s a n d C l i e n t S i z e on P e r c e i v e d A u d i t o r I n d e p e n d e n c e . " A c c o u n t i n g R e v i e w , Vo'l. 55, J a n . , 1980. P e n n e y , L.H. "The S i g n i f i c a n c e o f M e r g e r s o f A c c o u n t i n g F i r m s . " J o u r n a l o f A c c o u n t a n c y , V o l . 112, Nov. 1961. P o und G.D. a n d J.R. F r a n c i s , " A c c o u n t i n g S e r v i c e s M a r k e t : T h e o r y and E v i d e n c e . " J o u r n a l o f B u s i n e s s , F i n a n c e and  A c c o u n t ing,, V o l . 8, Autumn, 1981. S a v o i e , L.M. " C l i e n t - A u d i t o r R e l a t i o n s h i p : I s More I n d e p e n d e n c e N e e d e d ? " The CPA, V o l . 2, May, 1972. S c h w a r t z , K.B. and K. Menon. " A u d i t o r S w i t c h e s by F a i l i n g F i r m s . " A c c o u n t i n g R e v i e w , V o l . 60, A p r i l , 1985. S h o c k l e y , R.A._ " P e r c e p t i o n s o f A u d i t o r ' s I n d e p e n d e n c e : An E m p i r i c a l A n a l y s i s . " A c c o u n t i n g R e v i e w , V o l . 56, O c t o b e r , 1981. S h o c k l e y , R.A. " P e r c e p t i o n s o f A u d i t I n d e p e n d e n c e : A C o n c e p t u a l M o d e l . " J o u r n a l o f A c c o u n t i n g , A u d i t i n g a n d F i n a n c e , V o l . 5, W i n t e r , 1982. S h o c k l e y , R.A. and R.N. H o l t . "A B e h a v i o r a l I n v e s t i g a t i o n o f S u p p l i e r D i f f e r e n t i a t i o n i n t h e M a r k e t f o r A u d i t S e r v i c e s . " J o u r n a l o f A c c o u n t i n g R e s e a r c h , V o l . 2 1 , Autumn, 1983. S i m u n i c , D.A. "The P r i c i n g o f A u d i t S e r v i c e s : T h e o r y a n d E v i d e n c e . " J o u r n a l o f A c c o u n t i n g R e s e a r c h , V o l . 18, S p r i n g , 1980. S i m u n i c , D.A. " A u d i t i n g , C o n s u l t i n g , and A u d i t o r I n d e p e n d e n c e . " J o u r n a l o f A c c o u n t i n g R e s e a r c h , V o l . 22, Autumn, 1984. S i m u n i c , D.A. and M. S t e i n . " P r o d u c t D i f f e r e n t i a t i o n i n A u d i t i n g : A S t u d y o f A u d i t o r E f f e c t s i n t h e M a r k e t f o r New I s s u e s . " U n p u b l i s h e d M a n u s c r i p t , U n i v e r s i t y o f B r i t i s h C o l u m b i a , 1984. S t e i n , M. , A. N i e l s e n , and D. S i m u n i c . " M a r k e t S t r u c t u r e a n d A u d i t o r I n d e p e n d e n c e . " U n p u b l i s h e d M a n u s c r i p t ' , p r e s e n t e d a t t h e U n i v e r s i t i e s o f B r i t i s h C o l u m b i a , O r e g o n a n d W a s h i n g t o n J o i n t A c c o u n t i n g R e s e a r c h W o r k s h o p , S e p t e m b e r , 1985. 73 S t e r l i n g , R o b e r t . " A c c o u n t i n g Power." J o u r n a l o f A c c o u n t a n c y , V o l . 135, J a n u a r y , 1973. U n i t e d S t a t e s S e n a t e . R e p o r t o f t h e S u b c o m m i t t e e on R e p o r t s ,  A c c o u n t i n g a nd Management o f t h e C o m m i t t e e on Go v e r n m e n t  O p e r a t i o n s . U.S. P r i n t i n g O f f i c e , 1977. W a t t s , R.L. a n d J . L . Zimmerman. "The M a r k e t s f o r I n d e p e n d e n c e a n d I n d e p e n d e n t A u d i t o r s . " U n p u b l i s h e d M a n u s c r i p t , U n i v e r s i t y o f R o c h e s t e r , 1981. W a t t s , R.L. and J . L . Zimmerman. "Agency P r o b l e m s , A u d i t i n g , a n d t h e T h e o r y o f t h e F i r m : Some E v i d e n c e . " J o u r n a l o f Law  a n d E c o n o m i c s , V o l . 26, O c t . , 1983. Z e f f , S.A. and R.L. Fossum. "An A n a l y s i s o f L a r g e A u d i t C l i e n t s . " A c c o u n t i n g R e v i e w , V o l . 42, A p r i l , 1967. APPENDIX A MARKET STRUCTURE AND AUDITOR INDEPENDENCE M. Stein, A. Nielsen, and D. Simunic The University of B r i t i s h Columbia June 1985 75 1. DJTRODUCTION It is commonly agreed that an auditor should be independent of his client. Further, the auditor should also have the appearance of independence to third parties, above actually being independent. However, a l l auditors may not always be independent, and in the past decade considerable attention has been focussed on issues pertaining to auditor independence. Some of the research to date includes examination of the underlying auditor-client conflict [Goldman and Barlev (1974), Nichols and Price (1976)], the possible relationship between auditor turnover and independence [Burton and Roberts (1967), Chew and Rice (1982), Nichols and Smith (1983)], and the effect of pricing policies or auditor size on audit quality [DeAngelo (1981a), (1981b)]. Additionally, the current debate over the provision of management advisory services by auditors stems from the alleged negative impact on auditor independence that such services may imply [eg. Simunic (1984)]. Similarly, in recent years there has been extensive debate regarding the market structure of public accounting. 1 Allegations of market concentration have often maintained that the markets for audits are structured oligopolistically, especially in the market for large clients. For example, the Report of the U.S. Senate Subcommittee (Metcalf Report) concluded that there is insufficient competition in audit markets, 2 particularly among the largest national firms. On the other hand, the AICEA Commission on Auditor's Responsibilities (Cohen Commission) asserted that excessive price competition in extant markets for audits jeopardizes the quality of audits provided. Beyond the Cohen Commission's claim regarding audit quality, there has been limited research on the relationship between auditor independence and market structure. Gonedes and Kihlstrom (1982) investigated the 76 effect of market structure on audit quality, but thei r concept of "quality" i s largely undefined, and cannot be d i r e c t l y applied to auditor independence. The a n p i r i c a l evidence regarding market structure and the perception of auditor independence has been mixed. Shockley (1981, p. 785) studied the perceptions of CPA's and f i n a n c i a l statement users with respect to the independence of audit firms. He concluded that "audit firms operating in highly competitive environments ... are perceived as having a higher r i s k of losing independence." However i n a recent study, Knapp (1985) found no conclusive evidence that auditors' perceived independence i s undermined i n a highly competitive market for audits. Knapp's results indicate that the le v e l of competitiveness for audit services "does not have a major influence on user's perceptions of auditor's a b i l i t y to r e s i s t management pressure." (1985, p. 209) The actual or perceived effect of market structure on auditor independence remains unclear. I t i s within t h i s general context that we offer our model demonstrating how various market conditions provide incentives for either auditor independence or nonindependence. We show that a s u f f i c i e n t condition for auditor independence i s the attainment of the competitive price i n the audit market. We do not address the empirical questions of the current degree of competition i n extant audit markets, nor whether auditors are independent. Our purpose i s to c l a r i f y the issues, provide a d e f i n i t i o n of auditor independence which f a c i l i t a t e s analysis, and show how the d i s t i n c t i o n between competition and r i v a l r y i s necessary to understand claims that price competition leads to impaired independence. The remainder of the paper i s organized as follows. In Section 2 we define auditor independence and introduce our model. We then introduce economic rents (Section 3) and demonstrate hew market structure affects 77 independence (Section 4). The costs of nonindependence are detailed in Section 5, and Section 6 analyzes the alleged loss of independence due to r iva lry . Cur conclusions and a brief summary are provided in Section 7. 2. A MODEL OF AUDITOR INDEPENDENCE We start by assuming that auditors are u t i l i t y maximizers over wealth. Also, we assume that a l l audits are homogeneous and are accomplished by a common technology. Further the audits are s ta t i s t i ca l ly independent in the sense that the normal costs of each audit do not affect 3 one another. We define the following notation: F-j_(aj) = auditor i ' s fee for the audit of cl ient j , C (a^) = the normal cost of audit j , D^(aj) = the separable cost to auditor i of taking a nonindependent action with respect to cl ient j , Tj = the net cost to the cl ient j of switching auditors. An auditor is independent of his cl ient i f the auditor's actions are not influenced by the preferences of the cl ient. However, since auditor fees are channelled through the corporation there is a potential confl ict between auditors and managers. Managers may have de facto control over fees while auditors must report on the performance of managers.^ Recognizing this confl ict , we ask the following question: When is i t in the auditor's economic interest to be independent of his client? Our answer comes in two varieties. The f i r s t i s when the auditor i s worse off by being nonindependent. We c a l l this incentive independence. The second i s when the auditor has sufficient bargaining power to resist the c l ient ' s requests for nonindependent action. This we term bargaining independence. More formally, the auditor is better off being independent i f the following inequalities hold: 78 F i(a j) - C(a^) > 0 (1) F i(a j) - C(aj) - D i(a j) < 0 (2) In our analysis, we restrict ourselves to a discussion of auditor 5 wealth. We assume that more wealth is preferred to less, and that the normal cost of an audit includes a normal return to the auditor's effort. This is important as the wage paid to the auditor is just sufficient at the margin for the auditor to be indifferent between auditing and other non-auditing activities. Equation (1) indicates that the auditor prefers (weakly) an independent audit of client j to not having the client. Equation (2) indicates that not having the client is preferred (weakly) to a nonindependent audit. Immediately, two key points of our analysis can be seen. First, i f we assume that the costs of nonindependence are always nonnegative, then a necessary condition for nonindependence occurs when equation (1) holds s t r i c t l y . If equation (1) is false or holds with equality, then equation (2) w i l l hold and the auditor would prefer to drop the client rather than incur the costs of nonindependence. In most of what follows we can think of the auditor as facing the following choice problem: MAX U[w(q)] = max[u(w(q1)), u(w(q 2)), u(w(q3))] qeQ where U(w) is the u t i l i t y of wealth and q-^ , q 2, q 3 are the auditor's choices (with respect to a particular client) of, respectively, audit independently, audit nonindependently, or do not audit. For example, i f equation (1) and (2) hold, then the auditor faces the following choice: MAX [F-C, F-C-D, 0] and chooses the independent audit since F-C > 0 > F-C-D.7 79 The auditor may also be independent i f the following inequalities hold: ^ O j ) - CO j ) > 0 (1) F 1(a j) < F i(a j) + Tj, Vi=2 . . . M. (3) Here we have made auditor one the incumbent auditor, and this set of conditions implies that the incumbent prefers the audit to not auditing, and (from equation (3)) the client's threat to defect is not credible. The incumbent auditor can resist the client even i f : F 1 - C(a.) - D 1(a j) > 0 (4) p should hold, since a profit maximizing client would not switch auditors. The two preceeding sets of conditions are very different in flavour. The f i r s t indicates the auditor prefers independence, whereas the second set indicates that the auditor can bargain for independence. When equations (1) and (2) hold, the auditor is incentive independent. Cn the other hand, the auditor w i l l be nonindependent i f equations (1) and (4) hold s t r i c t l y and equation (3) is false. Equation (1) is likely to hold i f the market structure allows the auditor to earn economic rents. Furthermore, the magnitude of D is clearly important in whether equation (2) w i l l hold. If i t is believed that D is very large, then auditors w i l l essentially always be independent. As the size of D may also be associated with the existence of rents, and because D can also determine whether equation (4) w i l l hold, there appears to be a strong connection between auditor independence and the earning of rents in audit markets. 3. ECONOMIC RENTS Economic rents are defined as returns in excess of the normal return to an asset. Typically, economic rents are earned on assets whose supply 80 is limited, and the rent is the difference in the asset's value between its best and best alternative use. Rents are of interest in economic policy as their existence may indicate imperfect competition in a given market. In particular, rents can often occur in markets where significant barriers to entry exist thus limiting supply. The market for audits, with the professional requirements necessary for supplier entry, is a candidate for economic rents. In our model, an economic rent exists with respect to a particular audit i f the inequality in equation (1) s t r i c t l y holds (i.e. the fee s t r i c t l y exceeds a l l normal costs). DeAngelo [1981b] also discussed how the existence of rents could affect auditor independence. However, her rents are generated by auditor-specific efficiency gains, not by market structure. DeAngelo contended that while client-specific rents reduce auditor independence with respect to a particular client, the sum total of a l l other client rents act as a collateral bond against nonindependence. Her results are consistent with those presented here. However, we believe our results to be more general as we provide conditions under which rents may or may not lead to auditor nonindependence. Unlike DeAngelo, we are concerned with economic rents generated by market structure. These rents are endogenously determined and thus accrue to a l l auditors. Since the loss of existing rents could be a major component of nonindependence costs, these costs may be expected to vary directly with the size of the rents. If this is correct, then the collateral bond is also endogenously created by market structure, and independence would exist regardless of market structure. We investigate this issue in the next three sections. 81 4. MARKET STRUCTURE AND INDEPENDENCE In this section we analyze how market structure influences auditor independence. There are four paradigm cases which demonstrate the key issues involved. We look at what happens under monopoly and competition, subdividing in each instance for the institutional arrangement where audits are compelled (e.g. legislatively imposed) and where they are optional. Later, we briefly introduce the intermediate case of oligopoly. CASE 1: MONOPOLY, MANDATORY AUDIT At f i r s t glance this case may appear to be the arrangement where the auditor has the maximum leverage to enforce independence. There are no substitutes for the auditor's service and the clients are compelled to buy from a single supplier. This situation is described by equation (3): F 1 < F 2 + T (3) where we can think of T as being indefinitely large. This would seem to ensure the auditor of bargaining independence. The client has no credible threat of defection and the auditor shares this information. However, because the audit is mandatory, the auditor must audit. In effect, this changes the auditor's choices, as the option of withdrawing from the audit with outcome zero is no longer available. The choice faced by the auditor i s : MAX [F-C-E, F-C-D, -»] (5) qeQ where E are the costs of remaining independent. These costs can be thought of as nonreimbursable costs which a disgruntled client can impose upon the auditor through noncooperation. The costs associated with D in this case are the expected costs of loss of the monopoly charter. For instance, i f the auditor's actions are deemed to be nonindependent, this 82 could invite governmental intervention which would reduce the monopolist's wealth.^ These two costs act in opposing ways. If E is large (relative to D), the auditor w i l l maximize (5) by being independent. If D is large then the auditor w i l l sacrifice some independence.1^ The key result for the mandated monopoly case is that the client and auditor are bound to one another. Thus by limiting the auditor's choice set, nonindependence becomes, possible. Note that the preceeding analysis does not refer to equation (1). Here the existence of rents is irrelevant as the choice faced by the auditor does not allow any action to protect rents. CASE 2: MDNOPOLY, NamNCATORY AUDIT In this case both the auditor and the client can choose the no audit option. Therefore the auditor w i l l be independent i f either equations (1) and (2) hold; or alternatively, i f equations (1) and (3) hold, where the right hand side of (3) is now interpreted as the cost of the alternative to the monopoly-provided audit. 1 1 If equation (1) f a i l s to hold, then the auditor w i l l choose the no audit option. However, we have not eliminated the possibility of nonindependence. Using the standard microeconomic formula, a monopolist sets price according to the equation: 1_ F[l - n ] = C (6) 12 where TI is the price elasticity of demand and C is marginal cost. Equation (6) generally implies that equation (1) w i l l s t r i c t l y hold. This provides for the possibility that equation (4) w i l l also hold; whether (4) w i l l hold depends upon'the size of D. Large costs of nonindependence wi l l enforce independent action. As DeAngelo [1981b] pointed out, one major 83 component of D may be the loss of rents on other clients. If the lost aggregate rents are large (in an expected value sense), then D may be 13 sufficiently large to bring the auditor bade to independence. Before moving to the next case, we should comment upon the relationship between equations (6) and (3). The elasticity in (6) w i l l be related to the availability of substitutes in (3). The auditor w i l l charge higher prices in those cases where the alternatives are most expensive. This has the effect of keeping the difference between the right and l e f t hand sides of equation (3) small. While (3) holds the auditor w i l l be independent, i f the auditor has mispriced his service due to some uncertainty about the right hand side of (3), and i f (4) also holds, he may not be able to resist client pressure for nonindependent action. CASE 3: COMPETITION, MANDATORY AUDIT Under competition, equation (1) holds with equality. This implies that i t is never preferred by the auditor to bear any costs of nonindependence, and the auditor w i l l be incentive independent. As with the case of a mandated monopoly, we s t i l l have the problem of nonreimbursable noncooperation costs. Unlike monopoly however, in competition the auditor has a counter. The auditor can force the client to change auditors and bear the transactions costs, Tj. Thus i f the client uses the threat of noncooperation to induce auditor nonindependence, the 14 auditor can use the threat of forcing the client to change auditors. In a competitive market where there are no rents and with mandatory audits, auditors cannot afford to bear the costs of nonindependence. Therefore we might expect to. see a mechanism for shedding these nuisance clients, such as an audit report qualification. If we compare this to the 84 monopoly case, the difference is the existence of rents under monopoly. The rents allow soire room to go along with the client. Even with imperfect competition, the auditor would find use for qualifying those audits which cannot be shed. An empirical implication would be that audit reports are more readily qualified the smaller the rents. CASE 4: COMPETITION, NONMANDATORY AUDITS Again, equation (1) holds with equality. The auditor is indifferent between auditing and not auditing a particular client. The auditor w i l l tolerate no nonindependence, as i t is costly and inhibits the making of a normal return. Thus equation (2) holds along with (1) and the auditor is incentive independent. CASE 5: OLIGOPOLY Oligopoly is an intermediate case between monopoly and competition. For our purposes what is important is that with an oligopolistic market structure, equation (1) is likely to hold s t r i c t l y , given that oligopolistic auditors face a downward sloping demand curve for their product. Equation (1) implies the existence of rents and the possibility of nonindependence. The remaining analysis would proceed along the lines of the monopoly case. However, in general, the rents to each auditor w i l l be smaller than in the monopoly case, and hence there should be fewer instances where equations (1) and (4) hold simultaneously. We shall return to a further analysis of the oligopoly case when we discuss competition and rivalry. 85 SUMMARY The results of this section can be summarized as follows: competitive pricing leads to incentive independence, whereas non-competitive pricing allows for the possibility of nonindependence. Whether auditor independence w i l l be maintained depends upon the magnitude of D. If D is large, incentive independence results. On the other hand, i f D is small then either bargaining independence occurs when client defection is costly, or auditors w i l l be nonindependent i f clients require i t . Outside of the monopoly, mandatory audit case we conclude that  competitive pricing is sufficient to ensure independence and rents are  necessary for nonindependence. 5. THE COSTS OF NONINDEPENDENCE In the previous section we saw how the magnitude of nonindependence costs (D) was v i t a l to the determination of auditor independence. In this section we explore how market structure and nonindependence costs may be related. DeAngelo [1981b] asserted that a primary cost of nonindependence i s the loss of rents from other clients. That i s , D (a.) = J F (a ) - C(a ) (7) where N is the set of clients held by auditor one. Presumably information about the loss of auditor one's independence w i l l cause his other clients to seek an independent auditor. Thus D-^ a..) w i l l be large when the auditor is collecting many rents. This is the basis for DeAngelo's collateral bond. 86 The collateral bond leads to the curious result that while individual rents create an opportunity for nonindependence (our equation (1)), the aggregate loss of rents w i l l force equation (2) to hold and thus incentive independence is achieved. This mechanism is important in that market structure can determine the existence and magnitude of the rents. It is a straight-forward step to see how large rents increase the size of D and thus strengthen the collateral bond. We have a number of criticisms of the collateral bond. First, the size of the potential loss may not be sufficiently large to ensure independence. Recall that nonindependence may be continuous, and small variations from auditor independence may not have serious results. Auditors may take small deviations from an independent action. Even i f these deviations are material, frequently there is enough judgment required in auditing decisions to obscure the impact of the nonindependent action. Thus the probability of actual detection of nonindependence may be very small. Furthermore, equation (7) defines the maximum penalty for auditor nonindependence. In reality, firms do not lose a l l of their clients because of a single indiscrete act. And finally, the cost D should be expressed in terms of an expectation. If the probability of getting caught is small, then the accompanying penalties may not be sufficiently large to deter nonindependent action. Therefore when the above factors are combined, the auditor may view D to be sufficiently small such that equation (4) holds for a particular audit. The size of D is an empirical issue and we can see no reason to a priori restrict its range. 87 Another criticism of the collateral bond is that competitive pricing provides a better mechanism to ensure auditor independence. If equation (1) holds with equality then (2) must hold and incentive independence is guaranteed. There is no need to rely upon bargaining independence when rents exist and D is small. We believe the appeal of the collateral bond argument for limiting competition rests with a particular type of transitional condition in the market to which we now turn. 6. COMPETITION AND RI\ALRY The distinction between competition and rivalry is often overlooked in discussions of market structure and independence. By rivalry we mean the inter-firm opportunism and exploitation of opportunities that ultimately lead to economic efficiency. Rivalry is competing. Cn the other hand, by competition we mean the state of competitive equilibrium characterized by the absence of economic profits. We feel that the failure to make this distinction leads to the kind of confusion where anti-competitive behavior is seen as preserving independence. The argument that competition (actually rivalry) impedes independence is summarized below by Shockley [1981, p. 787] As competition for audit clients increases, client's opportunities and incentives to replace incumbent auditors also increase. Reasons for the change may range from minimization of audit fees to a search for a more compliant auditor. Regardless, auditors' dependence on their clients may increase i f they believe that other auditing firms would be happy to accept the engagement should a client become displeased. To understand the motivation for the above argument, let us suppose that the market for audits is organized oligopolistically, and there is no rivalry among the auditors."^ 88 We w i l l maintain our previous assumptions used -in Section 2. Auditors w i l l be independent i f either the conditions for incentive or bargaining independence hold. Incentive independence rests upon the costs of nonindependence being large, whereas bargaining independence depends upon equation (3): F x < F 2 + T. (3) With no rivalry, F^^ equals F 2, and i f the net transactions cost of switching auditors is positive, then equation (3) w i l l hold. What is important to note is that we are describing a market situation where there are positive rents and yet no loss of independence. There are several troubling economic points. As in a l l cases of imperfect competition there are price and quantity distortions. The market is being restricted and there is no reason to believe that a socially optimal amount of auditing is occurring. Additionally, the virtue of independence is being maintained as a result of collusive, and therefore generally unstable, arrangements between suppliers. The lack of price rivalry supports the mechanism necessary to ensure both incentive and bargaining independence. Now, let us suppose that price rivalry is introduced to the market such that nonincumbent firms have incentives to charge lower fees than incumbent auditors. The following relationship may hold: F l ( a j ) > ^ ^ j * + T j * ( 8 ) Auditors can no longer prevent client defection. If we assume that clients desire some type of nonindependence and equations (4) and (8) hold, then the auditor cannot resist the client's request. This illustrates the claim that increased rivalry can weaken independence. But one should recognize that the problem arises only because the incumbent auditor is simultaneously attempting to hold on to independence and 89 rents. If the incumbent auditor reduces his fee to meet the competitor's, then equation (3 ) w i l l hold and bargaining independence is restored. Falling fees also affect incentive independence. If we use a prime to denote the lower fee structure under rivalry, then: D l ( a k } = I F l ( a k ) " C ( a k ) > I F ' l ( a k ) " C ( a k } = D ' l ( a k ) * ( 9 ) k eN k €N k^j However, independence may not be affected as the lower fee structure has reduced the excess of [F-C]. If there is sufficient linearity then the decrease in D w i l l just offset the decrease in [F-C] and incentive independence wi l l hold. Thus the introduction of rivalry could produce the appearance of nonindependence as those auditors attempting to maintain rents cannot also maintain independence. Furthermore, with more rivalry, clients w i l l expect more cooperation to support the previous level of higher fees. We can see how the existence of rents and the desire to maintain them provide pressure for auditor nonindependence during this period of disequilibrium. However, once rivalry forces fees to the competitive price, there w i l l be no further price cutting and incentive independence w i l l hold thus guaranteeing auditor independence. SUMMARY AND CONCLUSIONS The independence of auditors is c r i t i c a l to society and to the auditing profession. In this paper we have demonstrated how market structure and auditor independence may be related. We developed the notions of incentive and bargaining independence and illustrated how each is applicable under various market structures. We also demonstrated how the existence of rents could compromise independence and how different market structures are compatible with the existence of 90 rents. We then analyzed a d i s e q u i l i b r i u m s i t u a t i o n perhaps d e s c r i p t i v e of a u d i t i n g markets i n recent years and showed how a u d i t o r independence would be perceived during the e q u i l i b r a t i n g process. In conclusion, our a n a l y s i s argues s t r o n g l y f o r the b e n e f i t s o f competition i n the a u d i t i n g market. In the past, the pr o f e s s i o n i n s t i t u t e d r u l e s to l i m i t entry and r e s t r i c t r i v a l r y . These r u l e s may have added t o the perceived "professionalism" of a u d i t o r s , but at the same time created conditions which can give r i s e to economic rents. Since the existence of such rents i s necessary (although not s u f f i c i e n t ) f o r aud i t o r s to lose t h e i r independence, the s o c i e t a l good of a u d i t o r independence i s more l i k e l y to be achieved i f a u d i t i n g markets are co m p e t i t i v e l y organized. 91 APPENDIX A FOOTNOTES 1 For an overview of the issues involved, see Buckley & Weston (1980). 2 Empirical evidence with respect to actual levels of competition does not support the Senate's allegation of insufficient competition (Simunic, 1980). 3 See Simunic and Stein (1985) for the significance of this assumption. Also, note that we model action in one period only. However, since most of what we are concerned with occurs at the beginning of the period, we do not believe this assumption to be restrictive. 4 Audit committees consisting of outside directors may mitigate this problem, although to the extent the auditor must rely upon the goodwill and cooperation of management, the potential conflict remains. 5 We have suppressed issues of uncertainty. To do this one can think of the D-'s as being expressed in certainty equivalent units. As usual U'(w) > 0. 6 We exclude the possibility that unscrupulous auditors could save enough in production costs by supplying a low quality audit to make nonindependent costs negative. This assumption is based upon a legal environment where such cheating is heavily sanctioned. This is in contrast to the Klein and Leffler (1981) model of product quality in the absence of such legal sanctions. In that model quasi-rents are required in order to provide incentives for suppliers to produce a high quality product. 7 We hold F constant in our analysis because we assume that the fee offered by the auditor is determined by prevailing market conditions. The fee offered is not discriminatory in the sense the auditor offers the same fee to a l l similar clients. We do not allow the fee to increase as compensation for auditor nonindependence. We are interested in whether a given fee provides incentives for nonindependence and believe i t to be t r i v i a l l y true that the auditor can always be bribed to be nonindependent. 8 Without equation (3) holding, the payoff to an independent action would be zero, which in view of (4) makes the nonindependent audit the preferred action. 9 For example, the government could undertake any of the following: revoke the auditor's license, reduce his fees, mandate auditing procedures, impose fines, institute third party l i a b i l i t y , etc. 10 The costs E and D may well be continuous in the auditor's actions. Thus i t is possible to observe small deviations from independence where the auditor equates the derivatives of these costs with respect to his action. While we have modelled the auditor's choice as being discrete, i t is sometimes useful to think of the continuous choice 92 analogue. In this case, as nonindependence is not a l l or none, i t is possible to have small D's thus allowing equation (2) to hold. 11 For instance, substitutes may be a surety bond to insure creditors, or a large purchase of shares by managers to signal to shareholders. 12 Recall that' TI = - - 2 - $ • ' q dp 13 Again, i f we allow some continuous amount of nonindependence, then i t is possible that the auditor w i l l choose some optimum where D i s positive although small. 14 Going somewhat beyond our model, i t is clear that even i f in a given period the auditor gets "stuck" with a noncooperative client, the client w i l l be passed on in the next period. The client w i l l have to bear a succession of transactions costs and financial markets w i l l learn that i t is the client and not the auditor who is unreliable. 15 This could accord with the situation where there are few providers of audit services and professional ethics codes prohibit activities such as advertising which promote rivalry. 93 APPENDIX A REFERENCES American Institute of Certified Public Accountants, 1978, Report, conclusions and recommendations of the Commission on Auditors' Responsibilities. Buckley, J. and F. Weston, 1980, Regulation and the accounting profession (Lifetime Learning Publications, Belmont, CA). Burton, J. and W. Roberts, 1967, A study of auditor changes, Journal of Accountancy, April, 31-36. Chow, C. and S. Rice, 1982, Qualified audit opinions and auditor switching, Accounting Review, April, 326-335. DeAngelo, L., 1981a, Auditor independence, 'low balling,' and disclosure regulation, Journal of Accounting and Economics, Aug. 113-127. DeAngelo, L. 1981b, Auditor size and audit quality, Journal of Accounting and Economics, Dec., 183-199. Goldman, A. and B. Barlev, 1974, The auditor-firm conflict of interests: Its implications for independence, Accounting Review, Oct., 707-18. Gonedes, N. and R. Kihlstrom, 1982, Cn the quality and quantity of auditing services under alternative market structures, Unpublished manuscript (University of Pennsylvania, Philadelphia, Eft). Klein, B. and K. Leffler, 1981, The role of market forces in assuring contractual performance, Journal of P o l i t i c a l Economy, Aug., 615-641. Knapp, M., 1985, Audit Conflict: An empirical study of the perceived ab i l i t y of auditors to resist management pressure, Accounting Review, Ap r i l , 202-211. Nichols, D. and K. Price, 1976, The auditor-firm conflict: An analysis using concepts of exchange theory, Accounting Review, Apr i l , 335-346. Nichols, D. and D. Smith, 1983, Auditor credibility and auditor changes, Journal of Accounting Research, Autumn, 534-544. Shockley, R., 1981, Perceptions of auditor's independence: An empirical analysis, Accounting Review, Oct., 785-800. Simunic, D., 1980, The pricing of audit services: Theory and evidence, Journal of Accounting Research, Spring, 161-190. Simunic, D., 1984, Auditing, consulting, and auditor independence, Journal of Accounting Research, Autumn, 679-702. Simunic, D. and M. Stein, 1985, Audit risk in a client portfolio context, Unpublished manuscript (University of British Columbia, Vancouver, B.C.). 94 United States Senate, 1977, Report of the Subcommittee on- Reports, Accounting and Management of the Committee on Government Operations (U.S. Government Printing Office, Washington, D.C.). Watts, R. and J. Zimmerman, 1981, The markets for independence and independent auditors, Unpublished manuscript (University of Rochester, Rochester, N.Y.). A p p e n d i x B : L I S T OF SAMPLE OTC COMPANIES Academy C o m p u t i n g C o r p o r a t i o n A e r o S y s t e m s , I n c o r p o r a t e d A i r C a r g o E q u i p m e n t C o r p o r a t i o n A l a b a m a B y - P r o d u c t s C o r p o r a t i o n A l g o r e x C o r p o r a t i o n A l l i e d S e c u r i t y , I n c o r p o r a t e d A l l o y M e t a l P r o d u c t s , I n c o r p o r a t e d A l p i n e G e o p h y s i c a l A s s o c i a t e s , I n c o r p o r a t e d A m e r i c a n M e d i c a l S e r v i c e s , I n c o r p o r a t e d A m e r i c a n N u c l e u r C o r p o r a t i o n A m e r i c a n R e c r e a t i o n C e n t e r s , I n c o r p o r a t e d A u r i c C o r p o r a t i o n A z t e c M a n u f a c t u r i n g Company B a k e r M a n u f a c t u r i n g Company B a r r i n g e r R e s o u r c e s , I n c o r p o r a t e d B e l F u s e , I n c o r p o r a t e d B i g P i n e y O i l a n d Gas Company B i o s p h e r i c s , I n c o r p o r a t e d B l a c k Angus S y s t e m s , I n c o r p o r a t e d B o s t o n Sand a nd G r a v e l Company B r o u g h t o n F o o d s Company Buck E n g i n e e r i n g Company, I n c o r p o r a t e d B u t l e r N a t i o n a l C o r p o r a t i o n C a l u m e t I n d u s t r i e s , I n c o r p o r a t e d C a m p b e l l M a n u f a c t u r i n g Company, I n c o r p o r a t e d C a r o l i n a M i l l s , I n c o r p o r a t e d C e n t r e x C o r p o r a t i o n C e n t u r y P a p e r s , I n c o r p o r a t e d C e r v e c e r i a C o r o n a , I n c o r p o r a t e d C h a r v o z - G a r s e n C o r p o r a t i o n Chatham M a n u f a c t u r i n g Company C l a y t o n C o r p o r a t i o n C o c h r a n e F u r n i t u r e Company, I n c o r p o r a t e d C o m m u n i c a t i o n s I n d u s t r i e s , I n c o r p o r a t e d C o m p u ter Usage Company, I n c o r p o r a t e d C o m s h a r e , I n c o r p o r a t e d C o n n o h i o , I n c o r p o r a t e d C o n t r o l L a s e r C o r p o r a t i o n C o r d i s C o r p o r a t i o n C y b e r m a t i c s , I n c o r p o r a t e d C y c l o t r o n C o r p o r a t i o n D.A.B. I n d u s t r i e s , I n c o r p o r a t e d D a y l i g h t I n d u s t r i e s , I n c o r p o r a t e d D e k a l b A g R e s e a r c h , I n c o r p o r a t e d Dewey E l e c t r o n i c s C o r p o r a t i o n D i s c o v e r y O i l L i m i t e d D o l l a r G e n e r a l C o r p o r a t i o n D u A r t F i l m L a b o r a t o r i e s , I n c o r p o r a t e d D y n a s i l C o r p o r a t i o n o f A m e r i c a E.B.S. D a t a P r o c e s s i n g , I n c o r p o r a t e d E d u c a t i o n a l D e v e l o p m e n t C o r p o r a t i o n E d u c a t i o n a l T e c h n o l o g y , I n c o r p o r a t i o n E l c o I n d u s t r i e s , I n c o r p o r a t e d E l e c t r o n i c C o n t r o l S y s t e m s , I n c o r p o r a t e d E l w e l l - P a r k e r S y s t e m s , I n c o r p o r a t e d E v a n s (Bob) F a r m s , I n c o r p o r a t e d F a b r i c W h o l e s a l e r s , I n c o r p o r a t e d F a n n i n g E n t e r p r i s e s , I n c o r p o r a t e d F e l t e r s Company F i n e P r o d u c t s Company, I n c o r p o r a t e d F l e e t L e a s i n g , I n c o r p o r a t e d F l u o r o c a r b o n Company F u n t i m e , I n c o r p o r a t e d G & K S e r v i c e s , I n c o r p o r a t e d Gam Rad, I n c o r p o r a t e d Gap I n s t r u m e n t s C o r p o r a t i o n G e n e r a l K i n e t i c s , I n c o r p o r a t e d G e r i a t r i c a n d M e d i c a l C e n t e r s , I n c o r p o r a t e d G o d d a r d I n d u s t r i e s , I n c o r p o r a t e d G r a c o , I n c o r p o r a t e d G u a r d i a n P a c k a g i n g C o r p o r a t i o n G u l f E n e r g y a n d D e v e l o p m e n t C o r p o r a t i o n H a l l m a r k D a t a S y s t e m s , I n c o r p o r a t e d Hamburger H a m l e t s , I n c o r p o r a t e d H a v e r t y F u r n i t u r e C o m p a n i e s , I n c o r p o r a t e d H e r m e t i t e C o r p o r a t i o n H e r s h e y C r e a m e r y Company H i c k o r y F u r n i t u r e Company H i l l B r o t h e r s , I n c o r p o r a t e d H y d r o F l a m e C o r p o r a t i o n H y t e k I n t e r n a t i o n a l C o r p o r a t i o n I n d u s t r i a l A c o u s t i c s Company, I n c o r p o r a t e d I n f o d a t a S y s t e m s , I n c o r p o r a t e d I n t e r - C o n t i n e n t a l S e r v i c e s C o r p o r a t i o n I n t e r - P o l y m e r I n d u s t r i e s , I n c o r p o r a t e d I n t e r n a t i o n a l P a c k i n g s C o r p o r a t i o n I n t e r t h e r m , I n c o r p o r a t e d I s o m e t C o r p o r a t i o n J a c o E l e c t r o n i c s , I n c o r p o r a t e d J e r r i c o , I n c o r p o r a t e d J o h n s o n E l e c t r o n i c s , I n c o r p o r a t e d J o n e s and V i n i n g , I n c o r p o r a t e d K a l v a r C o r p o r a t i o n K e t t e r i n g I n d u s t r i e s , I n c o r p o r a t e d Keweenaw L a n d A s s o c i a t i o n , L i m i t e d K r a t o s , I n c o r p o r a t e d L a d y B a l t i m o r e F o o d s , I n c o r p o r a t e d L a k e S h o r e , I n c o r p o r a t e d L e w i s ( P a l m e r G.) Company, I n c o r p o r a t e d L i f e S c i e n c e s , I n c o r p o r a t e d L i n d l y a n d Company, I n c o r p o r a t e d L o g a n C l a y P r o d u c t s Company L o s A l a m i t o s R a c e C o u r s e MSI E l e c t r o n i c s , I n c o r p o r a t e d M a g n e t i c C o n t r o l s Company Mark T w a i n M a r i n e , I n c o r p o r a t e d M a t h e m a t i c a l A p p l i c a t i o n s G r o u p , I n c o r p o r a t e d Maxon I n d u s t r i e s , I n c o r p o r a t e d Medex, I n c o r p o r a t e d M e t a l l u r g i c a l I n d u s t r i e s , I n c o r p o r a t e d M e t r o - T e l C o r p o r a t i o n M i c h a e l s ( J . ) , I n c o r p o r a t e d M i l e H i g h K e n n e l C l u b M i l e s - S a m u e l s o n , I n c o r p o r a t e d M i l l e r I n d u s t r i e s , I n c o r p o r a t e d Mogen D a v i d K o s h e r Meat P r o d u c t s C o r p o r a t i o n M o n a r c h Cement Company N a t i o n a l B e r y l l i a C o r p o r a t i o n N e t w o r k D a t a P r o c e s s i n g C o r p o r a t i o n New D i m e n s i o n s i n E d u c a t i o n , I n c o r p o r a t e d New Y o r k T e s t i n g L a b o r a t o r i e s , I n c o r p o r a t e d NMC C o r p o r a t i o n N o r t h A m e r i c a n B i o l o g i c a l s , I n c o r p o r a t e d O f f s h o r e N a v i g a t i o n , I n c o r p o r a t e d Ohmart C o r p o r a t i o n O n e i t a K n i t t i n g M i l l s O p p e n h e i m e r I n d u s t r i e s , I n c o r p o r a t e d O s h k o s h B'Gosh, I n c o r p o r a t e d Osrow P r o d u c t s Company, I n c o r p o r a t e d P a c k a g i n g S y s t e m s C o r p o r a t i o n P a s q u a l e F o o d s , I n c o r p o r a t e d P a u l H a r r i s S t o r e s , I n c o r p o r a t e d P e e r l e s s M a n u f a c t u r i n g Company P h o t o - C o n t r o l C o r p o r a t i o n P h o t o - M a r k e r C o r p o r a t i o n P l a s m i n e C o r p o r a t i o n P o l y p l a s t e x U n i t e d , I n c o r p o r a t e d Power D e s i g n s , I n c o r p o r a t e d P r o g r a m m i n g a n d S y s t e m s , I n c o r p o r a t e d P u l a s k i F u r n i t u r e C o r p o r a t i o n P u r i t a n - B e n n e t t C o r p o r a t i o n RPS P r o d u c t s , I n c o r p o r a t e d R a d i a t i o n S y s t e m s , I n c o r p o r a t e d R a d i o F r e q u e n c y Company, I n c o r p o r a t e d R e f a c T e c h n o l o g y D e v e l o p m e n t C o r p o r a t i o n R e u t e r , I n c o r p o r a t e d Rex P l a s t i c s , I n c o r p o r a t e d R o s p a t c h C o r p o r a t i o n R o y a l p a r I n d u s t r i e s , I n c o r p o r a t e d S a n / B a r E l e c t r o n i c s C o r p o r a t i o n S a x t o n P r o d u c t s , I n c o r p o r a t e d S c a n - O p t i c s , I n c o r p o r a t e d S c o p e , I n c o r p o r a t e d S e n e c a O i l Company S h e r b u r n e C o r p o r a t i o n S i r c o I n t e r n a t i o n a l C o r p o r a t i o n S l o a n T e c h n o l o g y C o r p o r a t i o n S o l i d C o n t r o l s , I n c o r p o r a t e d S o u t h S t a t e s O i l and Gas Company S p i r a l M e t a l Company, I n c o r p o r a t e d S t a f f B u i l d e r s , I n c o r p o r a t e d S t a u f f e r C o m m u n i c a t i o n s , I n c o r p o r a t e d S t u r m , Ruger a n d Company, I n c o r p o r a t e d S u r v i v a l T e c h n o l o g y , I n c o r p o r a t e d T a d ' s E n t e r p r i s e s , I n c o r p o r a t e d T a p e c o n , I n c o r p o r a t e d T e c h n o l o g y , I n c o r p o r a t e d T e l e m a t i o n , I n c o r p o r a t e d Time S h a r i n g R e s o u r c e s , I n c o r p o r a t e d T i n s l e y L a b o r a t o r i e s , I n c o r p o r a t e d T r a n s - I n d u s t r i e s , I n c o r p o r a t e d T r i o n , I n c o r p o r a t e d T r o x e l M a n u f a c t u r i n g Company T u r n e r B r o a d c a s t i n g S y s t e m , I n c o r p o r a t e d 2B S y s t e m s , I n c o r p o r a t e d UMC E l e c t r o n i c s Company U n i t e d S t a t e s S u r g i c a l C o r p o r a t i o n U n i v e r s a l M a n u f a c t u r i n g Company V a i l A s s o c i a t e s , I n c o r p o r a t e d V a l m o n t I n d u s t r i e s , I n c o r p o r a t e d Van Dyk R e s e a r c h C o r p o r a t i o n W a i l u k u S u g a r Company W a l k e r (B.B.) Company W a l k e r C o l o r , I n c o r p o r a t e d W e i n s c h e l E n g i n e e r i n g Company, I n c o r p o r a t e d W e s t e r n B e e f , I n c o r p o r a t e d W eston (Roy F . ) , I n c o r p o r a t e d Widmann ( L . F . ) , I n c o r p o r a t e d W r i g h t (Wm. E.) Company Wyman-Gordon Company Y o r k R e s e a r c h C o r p o r a t i o n Z e n i t h L a b o r a t o r i e s (191 ) 99 A p p e n d i x C : L I S T OF OTC COMPANIES CHANGING AUDITORS 1970 A u d i t o r Changes A l p i n e G e o p h y s i c a l A s s o c i a t e s , I n c o r p o r a t e d A m e r i c a n N u c l e u r C o r p o r a t i o n C a m p b e l l M a n u f a c t u r i n g Company, I n c o r p o r a t e d C l a y t o n C o r p o r a t i o n C o m s h a r e, I n c o r p o r a t e d E d u c a t i o n a l D e v e l o p m e n t C o r p o r a t i o n F a n n i n g E n t e r p r i s e s , I n c o r p o r a t e d F l u o r o c a r b o n Company G e r i a t r i c and M e d i c a l C e n t e r s , I n c o r p o r a t e d J a c o E l e c t r o n i c s , I n c o r p o r a t e d MSI E l e c t r o n i c s , I n c o r p o r a t e d Mogen D a v i d K o s h e r Meat P r o d u c t s C o r p o r a t i o n New Y o r k T e s t i n g L a b o r a t o r i e s , I n c o r p o r a t e d ' Ohmart C o r p o r a t i o n T u r n e r B r o a d c a s t i n g S y s t e m s , I n c o r p o r a t e d Van Dyk R e s e a r c h C o r p o r a t i o n W a l k e r C o l o r , I n c o r p o r a t e d Z e n i t h L a b o r a t o r i e s , I n c o r p o r a t e d 1971 A u d i t o r Changes B i o s p h e r i c s , I n c o r p o r a t e d D a y l i g h t I n d u s t r i e s , I n c o r p o r a t e d E.B.S. D a t a P r o c e s s i n g , I n c o r p o r a t e d E d u c a t i o n a l T e c h n o l o g y , I n c o r p o r a t e d E l e c t r o n i c C o n t r o l S y s t e m s , I n c o r p o r a t e d F i n e P r o d u c t s Company, I n c o r p o r a t e d H a l l m a r k D a t a S y s t e m s , I n c o r p o r a t e d I n t e r - C o n t i n e n t a l S e r v i c e s C o r p o r a t i o n J e r r i c o , I n c o r p o r a t e d K r a t o s , I n c o r p o r a t e d M i l e s - S a m u e l s o n , I n c o r p o r a t e d P r o g r a m m i n g a nd S y s t e m s , I n c o r p o r a t e d 2B S y s t e m s , I n c o r p o r a t e d 1972 A u d i t o r Changes A l l o y M e t a l P r o d u c t s , I n c o r p o r a t e d C o m s h a r e, I n c o r p o r a t e d D i s c o v e r y O i l L i m i t e d D y n a s i l C o r p o r a t i o n o f A m e r i c a F l u o r o c a r b o n Company Gap I n s t r u m e n t s C o r p o r a t i o n M i l e s - S a m u e l s o n , I n c o r p o r a t e d New Y o r k T e s t i n g L a b o r a t o r i e s , I n c o r p o r a t e d N o r t h A m e r i c a n B i o l o g i c a l s , I n c o r p o r a t e d P o l y p l a s t e x U n i t e d , I n c o r p o r a t e d S h e r b u r n e C o r p o r a t i o n S t a f f B u i l d e r s , I n c o r p o r a t e d T r o x e l M a n u f a c t u r i n g Company 1973 A u d i t o r C h a nges B a r r i n g e r R e s o u r c e s , I n c o r p o r a t e d C h a r v o z - C a r s e n C o r p o r a t i o n E l e c t r o n i c C o n t r o l S y s t e m s , I n c o r p o r a t e d G o d d a r d I n d u s t r i e s , I n c o r p o r a t e d H y t e k I n t e r n a t i o n a l C o r p o r a t i o n I n t e r t h e r m , I n c o r p o r a t e d J a c o E l e c t r o n i c s , I n c o r p o r a t e d L i f e S c i e n c e s , I n c o r p o r a t e d M i l l e r I n d u s t r i e s , I n c o r p o r a t e d R e f a c T e c h n o l o g y D e v e l o p m e n t C o r p o r a t i o n Time S h a r i n g R e s o u r c e s , I n c o r p o r a t e d W a l k e r (B.B.) Company 1974 A u d i t o r C h a n g e s A l p i n e G e o p h y s i c a l A s s o c i a t e s , I n c o r p o r a t e d C a l u m e t I n d u s t r i e s , I n c o r p o r a t e d Dewey E l e c t r o n i c s C o r p o r a t i o n G o d d a r d I n d u s t r i e s , I n c o r p o r a t e d I s o m e t C o r p o r a t i o n New D i m e n s i o n s i n E d u c a t i o n Z e n i t h L a b o r a t o r i e s , I n c o r p o r a t e d 1975 A u d i t o r C h a n g e s A i r C a r g o E q u i p m e n t C o r p o r a t i o n E l w e l l - P a r k e r E l e c t r i c Company L i f e S c i e n c e s , I n c o r p o r a t e d L o g a n C l a y P r o d u c t s Company New Y o r k T e s t i n g L a b o r a t o r i e s , I n c o r p o r a t e d P o l y p l a s t e x U n i t e d , I n c o r p o r a t e d S a x t o n P r o d u c t s , I n c o r p o r a t e d 2B S y s t e m s , I n c o r p o r a t e d 1976 A u d i t o r C h a n g e s A z t e c M a n u f a c t u r i n g Company B e l F u s e , I n c o r p o r a t e d B l a c k Angus S y s t e m s , I n c o r p o r a t e d C y b e r m a t i c s , I n c o r p o r a t e d D y n a s i l C o r p o r a t i o n o f A m e r i c a E d u c a t i o n a l D e v e l o p m e n t C o r p o r a t i o n E l e c t r o n i c C o n t r o l S y s t e m s , I n c o r p o r a t e d F i n e P r o d u c t s Company, I n c o r p o r a t e d G & K S e r v i c e s , I n c o r p o r a t e d L o g a n C l a y P r o d u c t s Company M i c h a e l s ( J . ) , I n c o r p o r a t e d S i r c o I n t e r n a t i o n a l C o r p o r a t i o n W a i l u k u S u g a r Company 1977 A u d i t o r C h a n g e s B i s o p h e r i c s , I n c o r p o r a t e d C a m p b e l l M a n u f a c t u r i n g Company, I n c o r p o r a t e d E l e c t r o n i c C o n t r o l S y s t e m s , I n c o r p o r a t e d M i c h a e l s ( J . ) , I n c o r p o r a t e d M i l l e r I n d u s t r i e s , I n c o r p o r a t e d N a t i o n a l B e r y l l i a C o r p o r a t i o n NMC C o r p o r a t i o n R e f a c T e c h n o l o g y D e v e l o p m e n t C o r p o r a t i o n T a p e c o n , I n c o r p o r a t e d W e s t e r n B e e f , I n c o r p o r a t e d 1978 A u d i t o r C h a n g e s C a l u m e t I n d u s t r i e s , I n c o r p o r a t e d C o m p u ter Usage Company, I n c o r p o r a t e d I n t e r - C o n t i n e n t a l S e r v i c e s C o r p o r a t i o n J a c o E l e c t r o n i c s . , I n c o r p o r a t e d L a d y B a l t i m o r e F o o d s , I n c o r p o r a t e d Maxon I n d u s t r i e s , I n c o r p o r a t e d P a s q u a l e F o o d s , I n c o r p o r a t e d R o y a l p a r I n d u s t r i e s , I n c o r p o r a t e d S i r c o I n t e r n a t i o n a l C o r p o r a t i o n S l o a n T e c h n o l o g y C o r p o r a t i o n S o u t h S t a t e s O i l and Gas Company S t a f f B u i l d e r s , I n c o r p o r a t e d Time S h a r i n g R e s o u r c e s , I n c o r p o r a t e d 1979 A u d i t o r C h a n g e s C a m p b e l l M a n u f a c t u r i n g Company, I n c o r p o r a t e d D i s c o v e r y O i l L i m i t e d E v a n s (Bob) F a r m s , I n c o r p o r a t e d L i f e S c i e n c e s , I n c o r p o r a t e d M e t r o - T e l C o r p o r a t i o n Mogen D a v i d K o s h e r Meat P r o d u c t s C o r p o r a t i o n P a c k a g i n g S y s t e m s C o r p o r a t i o n S e n e c a O i l Company T e l e m a t i o n , I n c o r p o r a t e d 2B S y s t e m s , I n c o r p o r a t e d 102 1980 A u d i t o r C h a nges C a m p b e l l M a n u f a c t u r i n g Company, I n c o r p o r a t e d C o c h r a n e F u r n i t u r e Company, I n c o r p o r a t e d EBS D a t a P r o c e s s i n g , I n c o r p o r a t e d G e r i a t r i c a n d M e d i c a l C e n t e r s , I n c o r p o r a t e d I s o m e t C o r p o r a t i o n K a l v a r C o r p o r a t i o n L o s A l a m i t o s Race C o u r s e M a t h e m a t i c a l A p p l i c a t i o n s G r o u p , I n c o r p o r a t e d P h o t o - M a r k e r C o r p o r a t i o n R a d i a t i o n S y s t e m s , I n c o r p o r a t e d S c a n - O p t i c s , I n c o r p o r a t e d U n i t e d S t a t e s S u r g i c a l C o r p o r a t i o n 1981 A u d i t o r C h a nges C h a r v o z - C a r s e n C o r p o r a t i o n E l c o I n d u s t r i e s , I n c o r p o r a t e d G o d d a r d I n d u s t r i e s , I n c o r p o r a t e d H e r m e t i t e C o r p o r a t i o n H i c k o r y F u r n i t u r e Company I n t e r n a t i o n a l P a c k a g i n g s C o r p o r a t i o n R a d i o F r e q u e n c y Company, I n c o r p o r a t e d Van Dyk R e s e a r c h C o r p o r a t i o n 1982 A u d i t o r Changes Academy C o m p u t i n g C o r p o r a t i o n A l p i n e G e o p h y s i c a l A s s o c i a t e s , I n c o r p o r a t e d C a m p b e l l M a n u f a c t u r i n g Company, I n c o r p o r a t e d E d u c a t i o n a l D e v e l o p m e n t C o r p o r a t i o n H e r s h e y C r e a m e r y Company H y d r o F l a m e C o r p o r a t i o n H y t e k I n t e r n a t i o n a l C o r p o r a t i o n K e t t e r i n g I n d u s t r i e s , I n c o r p o r a t e d N o r t h A m e r i c a n B i o l o g i c a l s , I n c o r p o r a t e d P h o t o - M a r k e r C o r p o r a t i o n P o l y p l a s t e x U n i t e d , I n c o r p o r a t e d 1983 A u d i t o r C h a n g e s Academy C o m p u t i n g C o r p o r a t i o n A l l o y M e t a l P r o d u c t s , I n c o r p o r a t e d F i n e P r o d u c t s Company, I n c o r p o r a t e d H e r s h e y C r e a m e r y Company H y d r o F l a m e C o r p o r a t i o n L i f e S c i e n c e s , I n c o r p o r a t e d Maxon I n d u s t r i e s , I n c o r p o r a t e d Osrow P r o d u c t s Company, I n c o r p o r a t e d T r o x e l M a n u f a c t u r i n g Company W e i n s c h e l E n g i n e e r i n g Company, I n c o r p o r a t e d Y o r k R e s e a r c h C o r p o r a t i o n ( 1 5 9 ) 104 A p p e n d i x D: RESULTS OF REGRESSION TESTS M I D A S ST A T I S T I C A L RESEARCH LABORATORY UNIVERSITY OF MICHIGAN 14:50:48 SEP 24, 1985 1. T o t a l A u d i t o r C h a nges (159) <READ FILE=T.CHNGES VAR=1-2 LABEL=CHANGES,YEAR CASES=1-14> READ OBSERVATIONS 1-14 VARIABLES BY CASE <REGRESSION VAR=1,2> LEAST SQUARES REGRESSION ANALYSIS OF VARIANCE OF 1.CHANGES N= 14 OUT OF 14 SOURCE DF SUM SQRS MEAN SQR F-STAT REGRESSION ERROR TOTAL 1 18.858 12 82.356 13 101.21 18.858 6.8630 MULT R= .43165 R-SQR= .18632 SE= 2.6197 VARIABLE PARTIAL COEFF STD ERROR CONSTANT 33.382 13.305 YEAR -.43165 -.28791 .17369 2.7478 T-STAT 2.5089 -1 .6577 S I G N I F . 1 233 S I G N I F .0275 . 1 233 2. Changes w i t h i n B i g E i g h t A u d i t o r s 105 <READ F I L E = E . E VAR=1-2 LABEL=CHANGES,YEAR CASES=1-14> READ OBSERVATIONS 1-14 VARIABLES BY CASE D E G R E S S I O N VAR=1,2> LEAST SQUARES REGRESSION ANALYSIS OF VARIANCE OF 1.CHANGES N= 14 OUT OF 14 SOURCE DF SUM SQRS MEAN SQR F-STAT REGRESSION 1 .31758 .31758 .22555 ERROR 1 2 16.897 1.4081 TOTAL 1 3 17.214 MULT R= .13583 R-SQR= .01845 SE= 1 . 1866 VARIABLE PARTIAL COEFF STD ERROR T-STAT CONSTANT 5.5011 6.0268 .91278 YEAR -.13583 - .37363 -1 .78672 -1 -.47492 3. Changes w i t h i n Non-B i g E i g h t A u d i t o r s S I G N I F .6434 SIG N I F .3793 .6434 <READ FILE=N.N VAR=1-2 LABEL=CHANGES,YEAR CASES=1~14> READ OBSERVATIONS 1-14 VARIABLES BY CASE <REGRESS!ON VAR=1,2> LEAST SQUARES REGRESSION ANALYSIS OF VARIANCE OF 1.CHANGES N= 14 OUT OF 14 SOURCE DF SUM SQRS MEAN SQR F-STAT REGRESSION ERROR TOTAL 1 6.6857 12 24.171 13 30.857 6.6857 2.0143 3.3191 MULT R= .46547 R-SQR= .21667 SE= 1.4193 PARTIAL COEFF STD ERROR T-STAT 16.400 7.2083 2.2752 -.46547 -.17143 . 9 4 0 9 6 - 1 -1.8219 VARIABLE CONSTANT YEAR SI G N I F .0935 S I G N I F .0420 .0935 4. C h a n g e s w i t h i n B i g E i g h t a n d N o n - B i g E i g h t A u d i t o r s <READ FILE=EN.EN VAR=1~2 LABEL=CHANGES,YEAR CASES=1"14> 106 READ OBSERVATIONS 1-14 VARIABLES BY CASE D E G R E S S I O N VAR=1,2> LEAST SQUARES REGRESSION ANALYSIS OF VARIANCE OF 1.CHANGES N= 14 OUT OF 14 SOURCE DF SUM SQRS MEAN SQR F-STAT REGRESSION ERROR TOTAL 1 9.9176 12 35.011 13 44.929 9.9176 2.9176 MULT R= .46983 R-SQR= .22074 SE= 1.7081 VARIABLE PARTIAL COEFF STD ERROR CONSTANT 21.901 8.6753 YEAR -.46983 -.20879 .11325 3.3992 T-STAT 2.5245 -1 .8437 S I G N I F .0900 S I G N I F .0267 .0900 5. C h a n g e s f r o m B i g E i g h t t o N o n - B i g E i g h t A u d i t o r s <READ F I L E = 8 . N VAR=1-2 LABEL=CHANGES,YEAR CASES=1"14> READ OBSERVATIONS 1-14 VARIABLES BY CASE D E G R E S S I O N VAR=1,2> LEAST SQUARES REGRESSION ANALYSIS OF VARIANCE OF 1.CHANGES N= 14 OUT OF 14 SOURCE DF SUM SQRS MEAN SQR F-STAT S I G N I F REGRESSION 1 8.3176 8.3176 3.0607 .1057 ERROR 12 32.611 2.7176 TOTAL 13 40.929 MULT R= .45080 R-SQR= .20322 SE= 1.6485 VARIABLE PARTIAL COEFF STD ERROR T-STAT S I G N I F CONSTANT 16.556 8.3727 1.9774 YEAR -.45080 -.19121 .10930 -1.7495 .0714 . 1 057 6. Changes f r o m N o n - B i g E i g h t t o B i g E i g h t A u d i t o r s 107 <READ FILE=N.8 VAR=1-2 LABEL=CHANGES,YEAR CASES=1-14> READ OBSERVATIONS 1-14 VARIABLES BY CASE D E G R E S S I O N VAR=1,2> LEAST SQUARES REGRESSION ANALYSIS OF VARIANCE OF 1.CHANGES N= 14 OUT OF 14 SOURCE DF SUM SQRS MEAN SQR F-STAT REGRESSION ERROR TOTAL 1 11 .886 12 9.8286 13 21.714 11 .886 .81905 14.512 MULT R= .73984 R-SQR= .54737 SE= .90501 VARIABLE PARTIAL COEFF STD ERROR CONSTANT YEAR .73984 15.629 .22857 4.5965 .60002 -1 T-STAT -3.4001 3.8094 S I G N I F .0025 S I G N I F .0053 .0025 <FINISH> 

Cite

Citation Scheme:

        

Citations by CSL (citeproc-js)

Usage Statistics

Share

Embed

Customize your widget with the following options, then copy and paste the code below into the HTML of your page to embed this item in your website.
                        
                            <div id="ubcOpenCollectionsWidgetDisplay">
                            <script id="ubcOpenCollectionsWidget"
                            src="{[{embed.src}]}"
                            data-item="{[{embed.item}]}"
                            data-collection="{[{embed.collection}]}"
                            data-metadata="{[{embed.showMetadata}]}"
                            data-width="{[{embed.width}]}"
                            async >
                            </script>
                            </div>
                        
                    
IIIF logo Our image viewer uses the IIIF 2.0 standard. To load this item in other compatible viewers, use this url:
https://iiif.library.ubc.ca/presentation/dsp.831.1-0095895/manifest

Comment

Related Items