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 S T R U C T U R E , A U D I T O R  I N D E P E N D E N C E AND A U D I T O R  TURNOVER  by ABIGAIL B.A. (First Simon F r a s e r  NIELSEN  Class Honours), U n i v e r s i t y , 1982  A T H E S I S S U B M I T T E D I N P A R T I A L F U L F I L M E N T OF THE R E Q U I R E M E N T S  FOR THE D E G R E E  OF  MASTER OF S C I E N C E (Business Administration) in THE F A C U L T Y OF GRADUATE Faculty  We  STUDIES  o f Commerce a n d B u s i n e s s  accept to  this  thesis as conforming  the required  standard  THE U N I V E R S I T Y - OF B R I T I S H October  ©  Abigail  Administration  COLUMBIA  1985  Nielsen,  1985  In  presenting  degree freely  at  this  the  available  copying  of  department publication  of  in  partial  fulfilment  University  of  British  Columbia,  for reference  this or  thesis  thesis by  this  for  his  or  thesis  and study. scholarly her  of I  the agree  I further  purposes  gain  shall  permission.  •Department  of  and  T h e U n i v e r s i t y o f British 1956 M a i n Mall Vancouver, Canada V6T 1Y3 Date  DE-6(3/81)  ftuSunevs Columbia  OC>oW lS t l^gtT  that  agree  may b e  representatives.  for financial  requirements  /VdyyvorusV/^UoKv,  It not  is  that  the  Library  an  by  understood allowed  advanced  shall  permission  granted  be  for  the that  without  for  make  it  extensive  head  of  my  copying  or  my  written  i i  Abstract This market the  and  structure  rate  this  t h e s i s examines  auditor  recent  changes  examines  researchers.  We  auditing, auditor over time.  with  a  concluded  that  competitive  possibility  of nonindependence. market  then a period  be  compromised  with  pricing  We  f o r audits  also  the  of  two  concluded  changes  lead to  competitive  rents  f o r the that  t o a more where  a  other  economic allows  of d i s e q u i l i b r i u m occurs until  extension  of  of  structure  pricing will  the existence  non-competitive  section  market  and  collaboration  from  may  summary  in  resulting  state,  first  written  independence, whereas  non-competitive  The  the  independence, and  t h e r e l a t i o n s h i p between  independence  paper  auditor  of p u b l i c  of auditor  thesis  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  i f  a  competitive independence  equilibrium  i s  achieved.  The  second  section  of t h i s  such a d i s e q u i l i b r i u m p e r i o d fees, the to  and  the competitive  client  fees  is  to  companies  identicalthat  higher However,  auditor  i n p a r t i c u l a r , the rate  disequilibrium, price  reduce  on  t h e s i s examines  equilibrium. match  will  audit  as  change  may  structures not  independence,  of auditor  should  drive  Incumbent  the lower  services  independence fee  rivalry  bids  be c o m p r o m i s e d i n exchange  a l l auditors  auditor  of t h e i r  price.  During fees  will  either  competitors,  auditors A third  down  or  offering possibility  incumbents  maintain  f o r nonindependent  actions--. •  will  i f  auditor  turnover.  auditors  t o nonincumbent  a t a lower  the e f f e c t s of  be  willing  to  risk  nonindependent price  rivalry  increases The  action, not  only  auditor  existing  on  literature  on  auditor  changes between  sample  of  prohibitions  firms. on  have  rivalry,  then  we  turnover  during and  Michigan  tests  failed  turnover  changes result the any  expected areas  for  1969  t h e s i s examines  changes, 1983  be  that  paribus,  to  also  f o r changes non-Big  r e s u l t s of  as  recent  an  the  study  of  for a  removal  for  random  of  AICPA  and  direct  increased  increase  in  year  Eight  Big  auditor to  The  auditor  no  change  Eight did  not  Eight  r e l a t i o n s h i p to why  this  auditor  study  alter  were using these  auditor  Further  over  market  and the  for basic  time.  Only  auditors  indicated  time.  number  did  turnover  discussed.  in  auditors  changes  Big  rates  r e s u l t s of  examined.  auditors  Eight  are  of  period  within  to  (MIDAS).  turnover  price  t e s t s were p e r f o r m e d  increased  research  performed  of  of  regression  significant  explanations  review  Annual  constant  from non-Big  effect  examined.  hypothesis  fifteen  a  advertising  observe  to  the  the  the  empirical  invitations  System  r e j e c t the  an  bidding,  as  After  was  that  Data A n a l y s i s  future  ceteris  turnover.  and  expect  s e r i e s of  statistically  potential  this  auditor  period  relatively  changes  but,  auditor  acted  the  within of  fees  Assuming  would  a  over  segmentation  of  competitive  solicitation  computed,  i m p l i c a t i o n would  turnover.  rivalry  OTC  empirical  lowers  empirical portion  increased  the  an  not are  A  of  produce  the  examined,  and  iv  T A B L E OF  CONTENTS Page  ABSTRACT  i i  T A B L E OF CONTENTS  iv  L I S T OF T A B L E S  v i  ACKNOWLEDGEMENT CHAPTER  v i i  1 INTRODUCTION Issues  1  in Public  Auditing 1  Auditor  Independence 3  The  Role  of the Independent  Auditor 4  Market  Structure  and A u d i t o r  Independence 5  Empirical  E f f e c t s of P r i c e R i v a l r y 7  Research Methods  and Hypotheses 9  Organization  of t h i s  Thesis 10  CHAPTER  2 R E V I E W OF THE S T E I N ,  NIELSEN  AND  SIMUNIC  ARTICLE 11  Definition  of Auditor  Independence 12  Market  Structure  E f f e c t s on A u d i t o r  Independence 14  Assumptions  Employed  by  SNS f  The  Costs  14  of Nonindependence 15  The  E f f e c t s of Increased  Rivalry 16  Page CHAPTER  3 L I T E R A T U R E R E V I E W OF R E S E A R C H ON A U D I T O R  CHANGES 22  CHAPTER  4 E M P I R I C A L R E S E A R C H METHODS AND R E S U L T S Summary  of Theoretical  35  Hypotheses 36  Assumptions  Employed  i n the Empirical  Study 37  Sources  of Data 40  Research Methods 42 Summary  of Descriptive  Statistics ..  Formal  Tests f o r Trends  i n Auditor  44  Turnover 47  Results  of Regression Tests 49  C H A P T E R 5 SUMMARY OF R E S U L T S AND I M P L I C A T I O N S FOR RESEARCH Summary  of Test  FURTHER 51  Results 51  Possible Explanations for Results Tests Areas  f o r Subsequent  of S t a t i s t i c a l 52  Research 54  CHAPTER  6 SUMMARY AND C O N C L U S I O N S  57  FOOTNOTES  64  BIBLIOGRAPHY  70  APPENDIX A "Market b y M. S t e i n ,  Structure  A. N i e l s e n  and Auditor  a n d D. S i m u n i c  APPENDIX B L i s t  o f S a m p l e OTC C o m p a n i e s  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  APPENDIX D R e s u l t s  Independence"  of Regression Tests  74 95 Auditors  99 104  vi  L I S T OF T A B L E S Page  Table I Total  Auditor  Changes and T u r n o v e r  Rates,  Table I I Summary o f OTC A u d i t o r C h a n g e R e s u l t s Table 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 Table  IV Segmented A u d i t o r  Changes,  1969-1983  1969-1983  ..  60  61 62 63  vi i  Acknowledgement  I  wish  Hughes, B i l l  to  thank  S t a n b u r y and  Chairman  and  project.  Additional  Mike  Stein  Kate  Fraser.  who  for their  gave  the  members  o f my  committee,  Patricia  e s p e c i a l l y Dan  Simunic,  who  acted  as  guidance  support  throughout  the  and  thanks are owing helpful  t o Gordon  comments, and  t o my  Richardson  and  family,  and  Jim  1  Chapter  One  INTRODUCTION Issues  in Public  Over  Auditing  the past  directed  toward  auditing  industry  twenty  i n the United  lack  auditor  independence  of  academic  has  been e x t e n s i v e ,  research  other  interest  i n both  the  industry.  For  example,  auditing  industry  Department charged  in  that  have  trends  of  market And  of  while  auditing  by no means h a s been the  early  either  behavior  the perceived  a  1970's,  concern or  of  was c h a l l e n g e d In  anti-competitive by t h e  U.S.  year,  the  that  the  public  nature  of the  competitive  A consent  bidding  judgment  Another  example  the  of  general  of p u b l i c  Senate's examination  of market  concentration  In  entitled  "The R e p o r t  Department  Ethics  auditors  Rule  antitrust  AICPA  and t h e b i d d i n g  structure  1977 r e p o r t  Justice  Justice  violated  between  settled the suit,  Federal  Professional  t h e market  their  the  erosion  scrutiny.  Since  and  as  of  organization  indicated  structure  1972.  Department  removed.  regarding  community.  such  an a l l e g e d  issues  t h e I n s t i t u t e ' s Code o f  legislation.  was  i n such  of the public  Issues  general  has been  1  prohibiting  Justice  of such  on t h e i n d u s t r i a l  parties  auditing  States.  continuing  interest  attention  and composition  competition,  and  t o t h e academic  numerous  3.03  auditor  a r e examples  the  limited  considerable  the organization  apparent  concentration  years,  and  the  prohibition  public  concern  was t h e  i n public  U.S.  auditing.  of t h e Subcommittee  on  2  Reports,  Accounting  and  Government O p e r a t i o n s " they  concluded  markets,  that  of  accounting  firms  no  price competition  Senate  insufficient that  Metcalf  prevalent  Eight  still  in  firms.  that  audit Their  after  the  firms)  on  Report),  competition  prohibition,  the  same t i m e ,  the  in auditing.  Commission  on  strongly disagreed  Subcommittee.  the  national represented  displayed  little  or  AICPA a l s o examined  the  The  the  price competition  1978  Auditor's with  Instead  price competition,  excessive  Committee  in auditing.  the  (Cohen C o m m i s s i o n )  the  still  so-called Big  competitiveness by  the  largest national  o l i g o p o l y which  approximately of  known as  attitude,  the  of  insufficient  bidding  cartel-like  investigation  the  an  (or  almost  was  among t h e  the  an  levels  there  reflected  elimination  At  (commonly  particularly  conclusion  Management  of  report  of  Responsibilities  the  conclusions  finding  evidence  AICPA c o m m i s s i o n e r s  in auditing  their  of of  asserted  jeopardized  audit  Metcalf  Cohen  quality.  The  federal  Commissions regarding interest the  are the  produced 1976),  notable U.S.  i n the  1970's.  antitrust  o r g a n i z a t i o n of In  fact,  reflects  industry.  and  the  and  examples  auditing  publication  composition  suit  the  Who  Additionally,  non-academic  concern  industry.  However,  general  the  the  p u b l i c a u d i t i n g d i d not  Audits  continuing  and  of  continuing  on-going  the  success  America interest  changes current  in  of  (first in the; uproar  the  end  privately  published  both  in  the  in  current  public  auditing  over  "opinion-  3  shopping"  now  under  review  Oversight  and  Investigations  Commerce, i l l u s t r a t e s behavior Auditor  of  been is  academic  auditors the  influenced  is  be by  expected  the  to  be  with  the  the  other  hand,  may  alter  his of  attest  public  on  Energy  and  .over  the  concern  willing  to  regarding an  of  a l l auditors  interest, of  not  only  to  consequence  statements."  client  any and  Given  the  be  are  academic  is  not  execution  "independent"  to  be  in  "collude"  based  users  on  the  societal  value  auditor, great  perfectly  auditor  breaches concern.  of  of But  independent.  nonindependence but  . On  "nonindependent"  recognized  with  of  auditor  discovered  opinion  researchers, the  auditor  he  i n the  of has  misrepresentation.  always to  An  u n w i l l i n g to  independent viewed  interest  if  breaches  chooses or  leading  to  client  T h u s an  actions  an  certainly  who  conduct  independence.  possible  generally  conditions  his  and  particular  given  report  auditor  client.  function  of  any  auditing his  a  reports,  are  the  of  structure  Of  3  auditor  function.  independence not  of  preferences  financial  client  preferences  are  Subcommittee  C o m m i t t e e on  the  been e x t e n s i v e .  attest  client's  Thus  the  into  "independent"  a u d i t i n g and  the  House  2  research  has  his  of  of  continuing  potential erosion  deemed t o  his  the  Independence  The public  auditors.  the  by  such  audited  are  of  conditions financial  4  The  Role  of  The modern of  the  role  of  business  the  Independent  firm,  the  Auditor  public  auditor  community. the  As  auditor  i s expected  procedures  of  a  written  statement  (opinion)  statements  accurately  Such  credibility  separation of  company  as  the  examine  to  financial outside  as  the  accuracy  the  the  particular  audited  o w n e r s of  companies,  interest  to  accounting and  creditors,  financial of  auditors  the  provide financial  statements  are  of  e s p e c i a l l y where t h e r e  e f f e c t i v e management,  third  submit  the  firm's  financial  o w n e r s h i p and  investors,  of  the  outside  position  "independent"  to  the  whether  in  from  (audit)  from  between  potential  client  reflect  Therefore  to  the  to  hired  reports  reporting. interest  established  a. p r o f e s s i o n a l  methods and  firm.  is well  p a r t i e s , such employees,  as  is a  and  are  current  and  and  governmental  agenc i e s .  However, confronting  there  the  public  behave  independently.  client  f i r m ; however,  the  impact  parties  that  might  m a n a g e r s ) may financial statements have  are  any  demand  l i m i t e d leverage  that  Auditors  5  the  upon  pressure  reporting.  number  auditor  over  of  potential  impede  his  their  financial  auditors  ability  and  f i r m are  concerned  paid  transmitted  auditors  third  conflicts  engaged  profitability.  Whereas the impartial  the  information  their on  may are  owners of  negative  have put  a  party  by  to  Thus owners  to  ensure  users  of  reporting,  to- e n s u r e ' t h i s  to the  about third (and  suitable financial  these  result.  users  5  Furthermore, conflicting Although  the outside  auditor  i n t e r e s t s of owners  the  correspond  owners'  and  regarding  shareholders  may  audited  management  may  performance  t o t h e owners of t h e f i r m .  The the And  compensation  threat while  of termination  auditors  The  "nonindependent" refusing  client  defection.  and/or  requests  would  with  environment  p o t e n t i a l "nonindependent"  Market  Structure  How  independence  has  literature.  To  foster  more  not put  Thus,  be b a s e d  i t  fees.  their  h i s own  may  through  of a u d i t  qualify  client  account and  audit  conflict  choose  to  rather risk  of a c t i o n .  be  client costs  Thus  auditor  of  than  on t h e e x p e c t e d  by t h e p u b l i c  action.  i s  their  the  provides  6  Independence  been  provides,  evidence  management.  s t r u c t u r e of p u b l i c a u d i t i n g a f f e c t s  or less auditor  literature  anecdotal  and A u d i t o r  t h e market  in their  auditors  either choice faced  directly  information  for misrepresentation  a choice  benefits associated  the  may  to misrepresent  or  auditor  maintain  management.  users,  also confronts  rationale  between t h e  outside  the reduction  resign  auditor  and  Such  institutional  the  on a u d i t o r s  can e i t h e r  the public  self-interest,.  for  hired  most o b v i o u s method o f p r e s s u r i n g  opinions,  and  of  pressure  to  financial  and  and  interests  reporting  evaluation  apply  get caught  (shareholders)  managers'  the  use  may  well  simply,  addressed  indicating  the  does c o m p e t i t i o n  independence? at  in  best, that  auditor existing  in auditing  At the present  only  spotty  increased  and  time, rather  levels  of  6  competition public  actual  difficult  to  gauge,  found  independence by  t o impede t h e  provides  [1985]  independence  a  diminished  auditor  competition  can  of  auditor quality.  The and  structure  auditors  examined  Whereas  Shockley  risk  to  auditor  competition,  a  recent  is  evidence that  undermined  in  the  highly  Thus t h e e x i s t i n g l i t e r a t u r e structure  be  is  generally  a  conclusive  on  auditor  Nonetheless,  independence  on  and  higher  in  various  on  independence  assertions  with  found  sole  the underlying  exception  Kihlstrom audit  on  auditor  [1982]  quality.  independence 8  no  response.  research  structure  Gonedes  of  activity  of  levels  of  accounting  7  Theoretical  existent.  found  still  have  assessing  levels  markets.  mixed  studies  independence.  e f f e c t of market  only  nonindependent  users  of  auditing  per i o d i c a l s .  of  increasing  independence  perceived  market  empirical  evidence with  competitive  versus  of a u d i t o r  Knapp  perceived  the  perceived  independence  perceptions  [1981]  study  often  auditors.  As  users'  are  is  a  independence is  that As  and  analysis  cannot  independence.  Kihlstrom be  is  directly  the  has  audit  largely applied  well  to  quality  the  of  market  demonstrated,  ingredient  undefined,  non-  paper  the e f f e c t of  been  significant  between  is virtually  unpublished  examined  However, the concept of  Gonedes  relationship  of  audit  presented and  issue  thus of  by  their  auditor  7  The of  how  research  the  auditor work,  market  author  researchers various  on  market  independence  that  extended that  paper  of in  by  this  arguments auditor  is  that We  act  when p r i c e  rivalry  drives  independence the p r i c e  auditor  The  (hereafter  is  of P r i c e  second  major  research  referred  how  entire text  of  discussed  and  conclusions  of  be  we  concluded i s the  the  to  the  we  fee  equilibrium.  At  between as  the  showed  auditing  until  those  diminished  competition, Thus,  a  This  9  refutes  distinction  and  into  lead  that  attainment  audits.  i t generally will  entitled  that  market,  competition that  time,  1 0  Rivalry  component work  t o as  The  for public  compromised  restored.  Effects  abovementioned  be  [1985]  main  equilibrium.  to the competitive  independence  Empirical  may  other  research  independence  introduced  two  r e s u l t of t h i s  two  made  thesis  auditor  but w i l l  competing,  of the c o m p e t i t i v e  of t h i s  demonstrating  Simunic  "competition"  affect  for either  First,  that  also  of  is  A,  here.  in  attainment  auditor  and  i n the market  significant  the  The  However,  for auditor  independence. as  incentives  issue  may  with  of a model  i n Appendix  price  segment  Independence."  thesis.  which claim  rivalry,  first  provide  be m e n t i o n e d  the competitive  auditing  collaborated  Auditor  condition  itself  the  Stein, Nielsen  and  should  sufficient  public  construction  i s included  within  thesis addresses this  nonindependence.  Structure  paper  For  conditions  i s a paper  "Market  of  recently  the  or  in this  structure  independence. the  effort  contained  of  SNS).  of  this  Stein, Using  t h e s i s extends  Nielsen  the analyses  and  the  Simunic  o f SNS  as  a  8  starting can  point,  there  be t e s t e d .  One  second c o n c l u s i o n rivalry have  into  the  those at  non-competitive  may  a lower  nonindependence expect  incumbent  auditor  to  will  another  fee  i f t h e incumbent  lower  bids,  amounts  lower  his  auditor  trigger  believes  stock  asymmetry  i s  substitutes,  Such  rather  an  rivalry  not  increases  auditor  lowering  than  Hence,  empirical  only  fees 1 2  but,  services  the  costs  of  the  would 1 1  Either the will  switching  would  competitors' the lower b i d  to maintain  clients'  of  market  would ceteris  higher  i s plausible i f  reductions level  also  client  his  behavior  i n an a u d i t  implication  lowers turnover.  some  lose  to  regarding  fee  to  willing  Auditor  chooses  attempt to  are  some c u r r e n t  for  (again,  or  auditor  audit  fees.  n o t match  auditor  demands  of c l i e n t s implied).  does  information  that  similar  remaining  price,  would  acquiescing  words,  rationally  forcertain clients.  may  other  d r i v i n g down a u d i t o r s '  or i f the auditor  incumbent  action,  by  offering identical  (in  due t o i m p e r f e c t  the  auditors  rates,  competing a u d i t o r .  occur  fees  i f incumbent  o u t w e i g h a n y e x p e c t e d b e n e f i t s ) , we  t o see r i v a l r y  switch  First,  However, as not a l l a u d i t o r s  nonindependence  price  consequences.  existing  that  of  presumably  to competitors  price.  introduction  a u d i t i n g markets  be compromised at  The  demands f o r n o n i n d e p e n d e n t  clients  risk  three  ramifications  i m p l i c a t i o n r e s u l t s from the  i n d i c a t e d above.  clients  clients'  such e m p i r i c a l  following  independence maintain  are certain empirical  be  fees  from  his  information with that  paribus,  perfect price also  9  R e s e a r c h Methods and This second audit  phase of  the  recent  auditor  be  price  reporting  in  period  changes  were  and  auditor event  The could the  causes.  as  intent  fifteen  of  an  recorded  Additionally, markets  in to  those (that  a  stable  which and  changes  any  and  fee not  auditor  other  change  the  f i r m was  considered  as  research  an  this  in  an by  because  an  structural an  "auditor  study.  i n the  period  from  auditor  r e s u l t i n g from or  this  fifteen  identifiable  financial  in this  the  motivated  significant not  companies  l e v e l s changed by  of  constant.  examined  from a OTC  rate  indicated  apparently  i s , where  invitation  of  further  of  bidding,  remained  over  extant  assuming  the  set  the  groups  an  whether not,  year,  structure)  increase  year  by  the  competitive  has  for  in  further  constituted  A l l firms  Thus  defined  observe  changes  audit  or  affecting  change,"  1983.  only  and  on  that into  I n d u s t r i a l Manuals  recorded  i n market  merger  OTC  then  considerations  or  procured  -  price  exogenous  subdivided  examine  time has,  was  to  we  addressed  Assuming  solicitation  1969  distill  research.  restrictions  rivalry,  effort  a change  of  Moody's  of  is  substitutable products,  over  information  turnover  successfully  removal  changes  Auditor  of  thesis  advertising  increased  year  auditor  this  providing  auditor for  of  markets can  auditors that  question  Hypotheses  was  to  rate  of  examined. sample  attempt  approximate  to  determine auditor Thus  were  the  regressed  whether  turnover total over  further, subdivide- the  markets with  highly  we  during auditor time.  existing  substitutable  10  products, sectors  we  also  performed  of a u d i t o r  [1]  regressions  on  the  following  sub-  changes:  . a l lauditor  changes  within  the  Big  Eight  auditing  f i rms; [2]  a l l auditor  changes  within  the non-Big  Eight  auditing  f i rms; [3]  Our should  sum  of a l l a u d i t o r  and  non-Big  hypothesis  confirm  examined, the  the  that  and  Eight  not  The  and  major  recent these  are noted.  literature earlier  describes tests  discusses  assumptions  implications  research  major  Big  Eight  auditor  during  chose  turnover  the  period  nonindependence  over  accounts.  this  t h e s i s i s as  the main are  Five  and  suggestions  Three  turnover,  procedures of  summarizes for  follows.  i m p l i c a t i o n s of  specified  Chapter  conclusions  Chapter  concludes.  occurred  a l lauditors  auditor  performed. provides  increased  and  and  the  further  t h e SNS  the  relevance  of  Chapter  the  research.  Four  statistical  series  results  paper.  of  herein.  time  Two  empirical  a review  the  followed, the  Chapter  the  provides  works t o the t e s t s performed  the  and  on  the  Thesis  o r g a n i z a t i o n of  summarizes The  this  within  firms.  that  price rivalry  that  of  auditing  predicts  p o s s i b l e l o s s of c l i e n t  Organization  changes  analyses  of Chapter  Four  Chapter  Six  11  Chapter R E V I E W OF  In  this  "Market  Nielsen  and 1 3  The  reviewed,  and  a brief  the  Auditor  [1985]  main  SNS  conclusions  auditor  A  major  of  the  is identified  only  the  but  is  independence.  some This  later from  effect  from  inherent  inherent  argument  the by  of  what  as  in this the  the  SNS)  is  saw  are  discussed. motivation  apparent  relationship  Stein,  thesis.  market  we  paper  assumptions  lack  of  structure as  a  between  recurring assertion in auditing literature  there  [1981,  on  independence,  factors.  of  Independence"  and  reported  r e s u l t e d not  research  misunderstanding  that  research  paper  theoretical  overview  relevant e m p i r i c a l i m p l i c a t i o n s are  additional  The  ARTICLE  ( h e r e a f t e r r e f e r r e d to as  such e m p i r i c a l r a m i f i c a t i o n the  SIMUNIC  summary a n d  S t r u c t u r e and  Simunic  presented.  for  S T E I N , N I E L S E N AND  chapter,  entitled  One  THE  Two  common these has  two been  t r a d e - o f f between c o m p e t i t i o n is  well  summarized  on  by  and  Shockley  p.787]:  As competition for audit clients increases, clients' opportunities and incentives to replace incumbent auditors also increase. Reasons f o r the change may range from m i n i m i z a t i o n of a u d i t f e e s t o a search for a more compliant auditor. Regardless, auditors' d e p e n d e n c e on their clients may increase if they believe that other a u d i t i n g f i r m s w o u l d be h a p p y t o accept the engagement should a client become displeased.  As  a  result  competition least  two  affects  of  such arguments,  auditor  the  question  i n d e p e n d e n c e has  e m p i r i c a l studies examining  users'  been  as  to  whether  included  perceptions  of  in  at the  12  independence the  of  there  the other  been  indicated  mixed  i n Chapter  (Shockley  One,  [1981],  and  stated  that  structure  and  view,  that  independence. even  public  has  very ."  issue  of  felt  this  t h e SNS  of  aditor  conclusion,  Kay  independence little  [p.37]  and  Lavin  [1979]  is critical,  t o . do  In f a c t ,  independence  with  "In our  professional  the authors  i s not a  of u n d e r s t a n d i n g auditor  a general  article  we  Definition  under  stated  client  preferences definition  only  major  continued  problem  in  s h o w e d how  of  the  consensus  market  was  on  the  structure,  i n order.  operational  Hence,  definition  independence  may  be  1 0  "an  auditor  i s independent  actions  are not  influenced  client."  sufficiently  independence,  [p.3]  "operationalized"  i t i s not  used  the  However,  while  by such  of the a  b r o a d t o encompass v i r t u a l l y a l l particularly  of a t h e o r e t i c a l model.  we  and  conditions.  article,  the a u d i t o r ' s  First,  an  even  Independence  i n t h e SNS  be  devised  market  i f  may  construction  independence  b u t we  various  of A u d i t o r  and  t h e o r e t i c a l model  not  independence,  compromised  of  lack  between  that  in  manner.  market  auditing.  relationship  issues  auditor  .  the  Given  As  In t h e i r  while  competition  a n o t h e r s e t of a u t h o r s have  r e l a t i o n s h i p between  independence.  asserted  we  hand,  i s b a s i c a l l y no  auditor  that  As  [1985]). On  his  auditors.  r e s u l t s of s u c h t e s t s have  Knapp  we  public  above  Hence,  definition  useful  i n t h e SNS in  t h e common a s s u m p t i o n t h a t  the  in  the  article, following  auditors  are  1 3  utility when of  maximizers  over  wealth.  i s i t i n the auditor's his  client?  independent"  First,  simple  economic  of  the  action  action  The  of nonindependence  account  rents.  include  possible  action  i s  clients'  The  the  auditor  The  of independence  bargaining  power  action.  independence."  In  estimates)  the client's  auditors.  Thus  judges  example,  the  definitions  client  with  changing  can then by  SNS.  1 6  the  of the wealth.  the client  may  nonindependent loss  client  of  other  and/or  the  pressure  termed  but  benefits  auditors.  and c o s t s  of  into  not  only (or  changing  independent"  transactions These  for  considers  t o be n o t c r e d i b l e  significant  has  "bargaining  auditor  also  be " b a r g a i n i n g  be t r a n s l a t e d  a  client-specific  reputation  resist  of termination faces  over  on  1 5  benefits,  will  based  and b e n e f i t s  t h e incumbent  expected  the auditor  the threat  associated  used  and  auditor  potential  i s  case,  him worse o f f .  o c c u r s when t h e a u d i t o r  This  this  e x a m i n e s h i s own c o s t s  to  i f  to  status.  "incentive  of nonindependence  costs  also  question,  independent  maintaining  costs  of p r o f e s s i o n a l  form  costs  make  and f u t u r e  by a n y damage  nonindependent  model  current  and  caused  second  will  include  legal  t o be  to h i s utility  auditor's  fines or  detected,  rents  sufficient  he  respect  and any accompanying  economic  loss  with  expected  nonindependent  the  i s deemed t o be  i s made b y t h e i n d i v i d u a l  examination  benefits  interest  an a u d i t o r  when n o n i n d e p e n d e n t  Such an a s s e s s m e n t  T h e n we a s k e d  two  the simple  i f  i f ,  for  costs  operational mathematical  14  Market  Structure  With  an  constructed,  operational the  independence the  E f f e c t s on A u d i t o r  issue  can  review  determine  pricing  of  how  which  market  (with  competitive  the  costs  costs  independence client's result  of  the audit  sufficient necessary  to  The  auditor  not  as  of termination SNS  Employed  assumptions,  action  i s that  independence  by  of  assumption used  i n that  we  incentive non-  possibility  of  will  i f  result and  client  case,  bargaining  knows  that a  the major  of t h e monopoly, pricing  [economic]  i s  rents are  [p.10]  are  which  predicated must  i n t h e SNS p a p e r  be  on  could  then  limit  a  number  highlighted  stated  that  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 . useful  and/or  SNS  conclusions  several  to  from  competitive  and  was  I n summary,  "outside  a  competitive  to  "small"  auditor  c a s e we c o n c l u d e [ d ] t h a t ensure  above  the  In this  the  also  intent  resulting  i s credible.  research  with  leads  are considered "large."  examined  incentive  rents)  Nonindependent  affect  we  concluded that  for  hold  The  of rents  a r e deemed  may  article,  monopoly,  allows  f o r nonindependence."  Assumptions  central  will  threat  mandatory  of economic  of nonindependence  of d e f e c t i o n  We  independence  structure  conditions  the existence  pricing  nonindependence.  and  exist.  the absence  auditor  oligopoly.  market  independence  of  I n t h e SNS  collusive  independence, whereas  was  of  be a n a l y z e d .  under  bargaining  were  definition  paradigm cases of competition  brief  Independence  the  This  here.  a l l  of A  audits  assumption  discussion  to  a  15  single  auditing  market  differentiation  and  must  before  be  relaxed  empirically. the  An  auditing  are  and  scale  sufficiently  any  vague  auditor  may  perceive  whereas another use  of  a  independent actual  action.  auditing  national  and  on  a  especially auditor period The  period  when e x a m i n i n g  s e l e c t i o n may  Costs  of  (and  indicated  the  Thus  (such an  amount  services  i n the  of  SNS  as  the  acceptable,  of  in  the  product  offered  by  a r t i c l e was i s too  auditor  at  one  the  firms.  assumption  issue  of  "nonindependent,"  as  auditing  of  standards  differences  same a c t i o n  motivated,  costs  of  the i n the  nonindependent  therefore  hand,  earlier,  is crucial  exceed  independence w i l l other  nature  methods.  as  applied  least  based  restrictive,  turnover, in part,  by  where multi-  Nonindependence  nonindependence the  be  is  considerations.  As  If  the  assumption  accounting  some  modelling This  product  i t i s commonly a c c e p t e d  that  only.  this  heterogenous  method)  non-national  the  of  research  reporting  the  between  issues  legitimate  reporting  exists  a l l of  single  view  Furthermore,  smaller,  Finally,  allow  markets,  differentiation  the  potential action  may  particular  this  i n some a r e a s ,  regarding  a  auditor  of  example of  to  between a u d i t o r s  the  Obviously,  extension  i s that  opinions  avoid  economies.  important  product  thereby  i f the  ensure  size  auditor's  action  are  the  expected  the  auditor's  auditor  assesses  of  the choice  deemed t o  costs of be  b e n e f i t s ) , then  these  independence. costs  as  of  action.  1 7  "large" incentive On  the  "small,"  then  16  there (to  a r e two  the  client),  However,  i f  so  This by  then  then the  we  bargaining  auditor  issue  auditor  other  clients.  rents  act as a c o l l a t e r a l  nonindependence  will  problems  rents  with  the c o l l a t e r a l  of  article,  argument  that  that  of  not  i f  the  primary  rents these  to  the  of  a  SNS  from lost  collecting  nonindependent  lead  create  faced  the  auditors with  would  loss  l o s s of  sum  them  E f f e c t s of  the  result  possibility  rents  will  i s left  a s an  empirical  question  of  ensure  limits  of  possible  Nevertheless,  nonindependent issue  action that  the remain  should  be  research.  section of  a number  argument.  of  Increased  distinction  bond  indicated  costs  final  or  we  these  in future  the  are  the costs In  the  ensuring  aggregate  of  resulting  argument  SNS  addressed  promotes  occur.  the c l i e n t  interest.  [1981b]  jeopardize  the  This  central  not  the  unclear.  The  will  independence.  magnitude  The  is costly  nonindependent  some  the  bond  individual  nonindependence,  In  by  magnitude  to DeAngelo,  Thus DeAngelo's  while  incentive  i s of  is  According  rents  that  faced be  and  r e f e r r e d to DeAngelo's  of  activity.  independence  may  of the nature  cost  large  defection  requires.  a nonindependent  paper,  If client  the t r a n s a c t i o n s costs  significant, client  p o s s i b l e outcomes.  Rivalry  of  whether auditor  between  the  SNS  increased  article levels  independence.  competition  and  To  returned of do  rivalry.  to  the  competition this,  we  Rivalry  made is  17  competing; that  that  is,  takes place  between  profit  levels  include  both p r i c e  at  of  things,  the  In  the  competition based  on  a  that  there  cheating  Given of  is have takes  serves us  auditors,  then  defection  then  costs  where  among  the other  argument  a  is  i n d e p e n d e n c e may  be  been  achieved.  disequilibrium  theoretical  Secondly,  the  that  independence  this  mechanisms  market  l e t us  auditors,  the be for  would  would a l s o groundless.  such h y p o t h e t i c a l  and  recalling fees  and  to  for  assume that  ensure  client  consider  the that  assumption collusively  I f we  also  assume  companies  changing  hold.  cheating  With  non-independence,  their  Therefore  SNS  such  identical.  know t h a t  conditions  the  of  independence w i l l  oligopolist  are  the  illustrate  policing  would  bargaining  auditors  product  refers to  by,  e q u i l i b r i u m has  among  assumptions,  transactions  no  through  can  place.  positive  under  that  assume t h a t  sufficient  oligopolists  disallowed,  Such a c t i o n s  impedes a u d i t o r  to  their  profits. showed  rivalry  homogeneous t e c h n o l o g y ,  incumbent  rivals.  oligopolistically.  no  these  organized  of  we  actions  increase  competition  competitive  let  i s organized  to  hand, c o m p e t i t i o n  economic  rivalry)  the  First,  competitive  try  disequilibrium situation  oligopolists no  of  f o l l o w i n g example  audits  other  study,  until  scenario.  of  of  equilibrium characterized  (actually  compromised The  SNS  the  set  they  non-price  On  absence  as  expense  and  competitive  i s the  firms  the  differentiation. state  rivalry  an  provides  clients' oligopoly  for  the  and  threats operating  opportunity  18  where  the  lack  (Additionally, changing  of p r i c e  i f we h o l d  auditors,  such a c o l l u s i v e Let  us  relax  so that  market"  oligopolistic  market  (and or  Big  with  Our the  was  into  approached  AICPA  rule  Certainly through  with  the  used  bidding,  rivalry.  And  assume following  that  such  the removal  of  an  unreasonable, evidence  concentration  cited  existed  of the n a t i o n a l ,  furthermore,  of p r i c e  above  indicated  Such  a  price i n 1972,  competitiveness  other  rivalry  scenario  may  and d i r e c t methods  to auditors  we may  to  no r i v a l r y  codes p r o h i b i t e d  advertising  Thus w h i l e  safely  i s not  the  1 8  ethics  prior  assumption  the a n t i t r u s t suit  lack  However,  was n o n - e x i s t e n t  assumptions  approximate  t h e dominance  must have been a v a i l a b l e changes.  The  market  until  auditors.  restrictive  closely  firms.  assumption  rivalry  period  turnover  of the anecdotal  of the c o n t i n u e d  such as c o m p e t i t i v e  competition  limited auditor  more  much  when p r o f e s s i o n a l  promote  for  i n auditing  the mid-1970's.  second  reasons  audits.  prohibited  oligopolistic  that  with  auditing  allegations  extending  exogenous  of  can  for  to exist)  Eight,  competition  some we  t h e 1970's.  continues  expect  structure  conform  throughout  other  independence.  oligopoly.)  "real-world  would  ensures auditor  constant  we w o u l d  now  employed above,  and  rivalry  the  be u n a b l e rule  have  of the professional  been  activities solicitation of non-price  preceding  the  to state  that  changes,  was m i n i m a l  among  compared  we  can  to the  p r o h i b i t i o n s i,  19  The and  next  common  to  and  allowing  assumptions  technology  restrictive exist,  two  different some  i n d e p e n d e n c e may oligopoly.  not  we under  an  therefore  enhanced  the  face in  necessarily  hold  with  expect  a  fees.  are  obviously  does  costs,  thus  bargaining  "real-world"  some  independence  auditing  collusion stable  l i m i t e d fee and  too  Cheating  Hence,  in a  even  with  oligopolists  differing  reasonably  oligopoly, l e v e l s of  among  "real-world."  dispersion  would  auditors  cheating  a l l . audits  auditors  Nevertheless,  auditors,  no  across  approximate  for  of  between  market  for  dispersion  minimal  and  auditor  turnover.  Now, market  assume (to  either  restrictive firms  have  longer  oligopoly  prevent  auditor  competitor's stated  (and  i n the  bid, SNS  price  rivalry  theoretical situation)  to  client  independence  clients  incumbent  our  incentives  compromise of  that  the  lower  and  to  reduce can  be  his  to  a  Auditors  t h e y may  rents).  into  be  audit  can  However,  maintained.  to  no  willing  existing  fee  the less  nonincumbent  retain their  accompanying  independence  that  or  p o t e n t i a l fees.  in order  to  introduced  market,  such  defection,  is willing  is  to  stock i f  meet  Therefore,  study:  Thus the introduction of r i v a l r y could produce the appearance of nonindependence as those auditors attempting to maintain rents cannot also maintain independence. . . . However, once rivalry forces fees to the competitive price, there will be no f u r t h e r p r i c e c u t t i n g and a u d i t o r i n d e p e n d e n c e w i l l be guaranteed. [p.14]  the the as  20  To  summarize,  assertion auditor During  that  in  the period events  in  incumbent  occurring.  the possible  auditors costs then  will  expect  loss  turnover,  as  client  price.  Such  information auditors their  other  However, once the  would  constant  the be  rivalry  competitive  leads  abovementioned  the  choose  will  an  would  (where t h e  in  services  r e s u l t when of  would  a r e eroded; and, auditor auditors  at  a  either  because  lower  incumbents  they  do  imperfect  b i d amounts, or t h a t fees  actions  " l a r g e " ) , we  increase  because  risk  as a l l  t o nonincumbent  audit  incumbent fear  that  demand s i m i l a r f e e r e d u c t i o n s .  has completely price  be a t  nonindependence  move  some  then  to find the  However,  as the rents  bids  situation.  expect  rents.  expect  inhibits  nonindependent  are considered  the lower  i s  and a u d i t o r  t h e SNS c o n c l u s i o n s  thesis  be r i v a l r y )  the  eroded  achieved,  turnover  a l l  economic  auditor  should  remain  rents  independence relatively  time.  then  observable.  lower  that  i n d e p e n d e n c e may  to risk  turnover  not t o reduce  clients  over  This If  rivals'  be a s s u r e d ,  may  (independent)  regarding  choose  disequilibrium  a  companies  increased  their  on  fees  we w o u l d a l s o  identical  match  action  argued  should  economic  t o see decreasing  offering  and  of  n o t be w i l l i n g  paribus,  we  (which  Auditor  auditors  of nonindependent  ceteris  not  i s based  article  o f d i s e q u i l i b r i u m , we w o u l d  following  over  SNS  competition  independence  that  the  to the empirical regarding  price  r e s u l t s t o fees  As f e e d a t a empirical  i s very  portion rivalry  and a u d i t o r difficult  of t h i s  thesis.  are correct,  then  turnover  should  to obtain,  in this  i n v e s t i g a t i o n i s l i m i t e d to the secondary  21  set  of  observable  auditor  appointment  considerations, into  and  find  then  with  increasing  In  this  were  we  and  can  of  are  that,  that later  price.  motivates chapters.  endeavor, turnover  a  This  the  ceteris  then  empirical However,  review  i s presented  of  the  brief  entitled  empirical  is  equilibrium  would  to  of  the  "Market  from  paribus,  before  the  drives  provides portion  of  the of  Three.  article  have  been  increased rate  fees  of  down  fee  auditor to  the  t h e o r e t i c a l framework  this  turning  existing  Structure  the  implications  results  rivalry  in Chapter  expect  review  main c o n c l u s i o n s  competition,  while  a  article  implication that  increase  we  substitutable  changes.  One  should  offering  present,  have p r o v i d e d  The  motivated  If  1 9  markets  auditor  the  change.  s u c c e s s f u l l y segment a u d i t  highlighted.  changes  auditor  price  rivalry  Simunic  and  of  by  auditors  Independence."  presented,  rate  primarily  price  rate  chapter,  Nielsen  Auditor  is  where  an  Stein,  the  i f we  subdivisions  products,  and  events,  thesis detailed to  that  literature  on  in  research auditor  22  Chapter L I T E R A T U R E R E V I E W OF The Nichols  R E S E A R C H ON  theoretical studies and  Price  that  the  serve  to compromise a u d i t o r  ability the  power  relationship has  been a c k n o w l e d g e d  of  empirical  aspects  of  auditor  studies  The  the  have  in the  and  Roberts  [1967],  Fortune  500  list  the  to  year  accomplish  examine  and  were  -  and  the  t h i r t e e n year  t o CPA  found in  span.  f i r m mergers,  auditor  increases  the  and  auditor  examining  was  wanted  to  the Of with  sought exploit  auditor  auditor Moody's these the  number  different of  these  produced  companies  they  137  a  base c o n s i s t i n g of  and  to  changes  137  in  chapter.  changes  also  apparent  presented,  Burton  they  may  client's  are  a data  concluded  Thus,  this  both  the  1965,  attempting  listed  of  by  client  important  industrial  First,  Roberts  companies  were due  1952  tasks.  most  auditor  relationships to threaten  Burton 620  of  that  produced  remainder  and  Furthermore,  changes  largest  changes,  companies  economic  during  two  auditor  client  the  period  in  incumbent  The  Using  [1974]  auditor  independence  auditor  Burton  thirteen  an  been  r e s e a r c h on  of  the  auditor.  turnover.  order,  earliest  replace  Barlev  in p r i o r research.  regarding  chronological  between  auditor  studies  CHANGES  auditor-client conflict  independence  over  between  AUDITOR  Goldman and  i n power  t o t e r m i n a t e and  client's  on  [1983] and  asymmetry  Three  over  Roberts  set  by the the out  systematically evidence the  whether existing  independence.  changes  occurring  in  I n d u s t r i a l Manuals changes,  remaining  83  54  changes  (non-merger)  23  changes  broken  auditors  with  down a s f o l l o w s :  13  companies  70 c o m p a n i e s m o v e d t o B i g E i g h t  changing  to  non-Big  Eight  audit  firms. Burton principal  aspects:  this, they  involved  cited  were,  consisted annual  to the firms  the  examined.  that  the  auditor  changes.  To  of the f o l l o w i n g  and succeeding companies and  and  fee competition i n their  the change,  asking  lastly,  From  reasons  three  of the companies  f o r the they  this  and  Roberts  existed  made  research,  f o rauditor  i n management,  Burton  As s t a t e d  determine  involved.  t h e m o s t common  services.  to  reports  change,  r e s p e c t i v e l y , changes  evidence  attempted  both preceding  for  that  additional  period  the  to the auditing  concluded  empirical  research  analyzed  reasons  they  for  their  questionnaires  principal  then  f o r t h e 83 i d e n t i f i e d  f o rthe years  sent  inquiries  Roberts  reason(s)  accomplish  they  and  changes  the  found  during  need little  the  time  paper:  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 major factor i n the switches. I t i s p o s s i b l e thatauditor changes i n small corporations are more a f f e c t e d by t h i s f a c t o r . [ p . 34] Such  a  result  prohibitions  i s  not  on c o m p e t i t i v e  unexpected, bidding  given  that  the  were n o t o f f i c i a l l y  AICPA  removed  u n t i l 1972. The  next  Strawser  [1971],  auditing  firms  registration  study  on  examined by  under  auditor  changes,  the extent  national  firms  the Securities  by  Carpenter  of displacement as  Act  a result of  1933  of  smaller  of f i r s t (a  and  time  phenomenon  24  which  i s  Strawser all  commonly  sent  as  which  made  o f 1969 o r d u r i n g  received  165  usable  initial the  CPA f i r m s a s a u d i t o r s .  Strawser  concluded  replaced  when a c l i e n t third  Bedingfield changes study, 1,  for their  The contrasted  of  the  and  clients  between the  Roberts  non-nationals)  both  actually  whereas Burton  Carpenter  f i r m s were  the  was  mandated  SEC  Forms 8-K.  t o determine national  auditing  Additionally,  8-K,  they  sent  study  c a n be  and  Roberts.  the national  before incurred  and Roberts  and a f t e r  concluded  found  (relative  the reported  a net loss  Whereas  f i r m s had gained  and Loeb  a u d i t o r s h a d more c l i e n t s  searched  also  Loeb  that  firms  beyond  and  of Burton  November  Hence,  the  Bedingfield  Their  2 0  f i r m s ) were  they  disagreements.  by  auditor  i fnational  companies.  found  t o be  performed  r e p o r t e d between  Forms  work  and  likely  newly  1952 a n d 1 9 6 5 , B e d i n g f i e l d  national  data,  They  indicating  o f t h e 250 l i s t e d  to the earlier  Burton  nationals  of  t o each  results  clients.  auditor-client  examination  questionnaires  while  1973, sought  gaining or losing of  the  250 d i s c l o s u r e s  B i g Eight plus other  evidence  this  the final  1970.  137 r e s p o n s e s  changes  on  of  of  public."  auditor  reported  1971 a n d , F e b r u a r y  either  on  "goes  [1974] u s i n g  examined  as  company  study  information  (defined  From  officers  i n either  quarter  with  Carpenter and  financial  filings  that smaller auditing  and Loeb  which  public").  first  responses  national  The  "going  questionnaires to the chief  companies  quarter  known  of c l i e n t s .  that to the  changes,  the  Furthermore,  that fee competition  seldom  25  motivated that as  auditor  47 p e r c e n t  having  Again,  of t h e i r  and Roberts  AICPA  competitive  Loeb examined  bidding  the  major  until  mid-1970's  was f o c u s e d  change.  pertaining  This  in itself  a period  on t h e o r g a n i z a t i o n the Metcalf  the  issue  auditors  and  t h e 1972 r u l e  represents  of  study to  auditor  when  considerable  public  auditing.  competitively  addressed given  levels of concentration  a t t r i b u t e d to the B i g Eight  The  on a u d i t o r  next  Palmon  auditor data  study  produced  .[1979],  changes.  bases  presented  In their  f o r evidence  base c o n s i s t e d  of large  Standard  Poor's  and  twenty-four  year  sample  included  as  December  of  criteria  was  AMEX a n d o n l y  period  paper,  Coe a n d  of auditor  industrial Compustat ending  Palmon  turnover.  examined  two  The f i r s t  data  (selected  tape) which 1976.  were  The  from  listed  initial  applied,  1976.  However,  after  their  t h e s a m p l e was r e d u c e d  1 1 5 OTC c o m p a n i e s .  These  firms  over  a  listed  selection  t o 461 N Y S E ,  were then  the  random  5 0 0 N Y S E , 2 0 0 AMEX a n d 3 0 0 OTC c o m p a n i e s 31,  by Coe  o f e m p i r i c a l d a t a on  companies  in  the  firms.  changes, prepared  an overview  were  i s remarkable  a n d Cohen C o m m i s s i o n s  behaved  of  whereas B e d i n g f i e l d and  papers  1979.  p a r t i c u l a r , both of whether  change.  removal  t h e r e s u l t s of t h e B e d i n g f i e l d and Loeb  In  high  competition  auditor  prior to the  sanctions,  changes a f t e r  changes were p r e s e n t e d  attention  fee  the reported  was c o n d u c t e d  i n 1 9 7 4 , no o t h e r  that  indicated  reported  r e s u l t s a r e not s u r p r i s i n g , i n that the  study  auditor  Although  in  to causing  contrasting  Burton  B e d i n g f i e l d and Loeb  respondents  to contributed  such  published  displacement,  150  examined  26  in  order  to assess  a l l auditor  f r o m CPA  f i r m merger  resulting  Coe  and  Palmon's  dominance g e n e r a l l y and  that  auditor  statistically prime  related  or i n f l a t i o n  statistically rates  and  was  except  significantly  during  analysis  The s e c o n d all  SEC  years two  that  auditing  firms  Palmon paper  auditor  that  was  during  the  the firms  two-year to  more and,  Palmon  were as f o l l o w s : probable  after or  not  for  the  exhibited  year  a  company period.  to  A second  evidence  2 1  the  large  clients  period.  claim.  during  that  the  period,  contained  auditors  twenty-four  obtain  whether  this  firms  Coe  increased  of t h e sample  o f SEC  lost  no  turnover  although  changes  independence and a u d i t o r  they addressed  opinion;  And  the case with  over  found  auditor  indicated  than  period,  f o r the B i g Eight  by Coe a n d  cross-section  i s  between  substantiate  results  Eight  such as the  authors  t o time.  this  Eight  dismissal  unfavorable  Their  auditor  the  s i x years  Big  year  variables  companies changing  [1980] sought  between  issues  last  Big  not  n o t b e s h o w n t o be  of B i g Eight  examined  examined  the  could  of change  data cannot  base  rate  was  Additionally,  two  of t h e i r  examined,  turnover  linkage  related  publicly-listed  years  time  the rate  the  data  over  the rate  o f 1974 a n d 1 9 7 5 .  higher data  that  the twenty-four  relationship  statistically  changes  that  over  Furthermore,  that  those  indicated  macroeconomic  rates.  Palmon a s s e r t e d  careful  to  significant  and time,  auditors  rates  plus  activity.  findings  increased  change  changes,  smaller Coe a n d  regarding  the  turnover.  The  whether  an  the issuance management  an  o f an is  27  successful  in  termination  The  of  hiring a  study  a  more  predecessor  was  conducted  financial  statements  industrial  companies between  found  that  in  for  the  Eight  auditors  issuing  an  that  the  Big  Eight  was  by  not  unfavorable  small  unfavorable  issued  by  analyzing  1973  smaller  Results  research  question  pertaining  compliant  successor  auditor  attempts  by  In  the  empirical  Coe  and  auditees  are  not  following  evidence  on  not  be  F r i e d and  existence  and  i n the  SEC  determine  i f the  disclosure  requirement  preceding  auditor  s i g n a l to  Schiff  analyzed  listed  companies  and  for  the  that  a matched  market.  prices  switched  set  of  the  Big  result  they  both  issuance  second,  of  found  dismiss  the  of  subjective  search  for a  more  statistically.  concluded  Schiff  that  [1981]  of  requirements concerning Forms 8-K).  stock  hand,  degree  reported  information  a  as  the  such  successful.  (as  conflicts  likely  analyzed  the  client  disclosure  of  clients'  Palmon  a l l of  dismissal  the  small  and  to  on  and  where  following  to  opinions  Coe  likely  the  opinion.  large  other  tentatively  year,  the  the  of  to  SEC  Palmon  more  for  could  audit  sample,  were more  auditors  opinions.  Nevertheless,  On  the  firms,  after  unfavorable  1977.  significantly opinion.  auditor  both  and  Eight  firms  an  of  company  Big  industrial  and  who  samples  large  companies were a u d i t e d  compliant  for  In  For both  auditors  market  impact  auditor  changes  particular of  they  reporting  changes  their a  study,  between  auditor-  Fried  an and  48 p u b l i c l y -  1972  that  sought  provided  sample of  c o n t r o l companies  examined  did  and  1975,  not  change  28  auditors. firms  stated  auditor with  O f t h e 48 c o m p a n i e s no  previous  Using  a  did  reported  conflicts  found  Thus,  they  result  was d i f f i c u l t  reaction  no  returned  to  sought  They  also  their  propensity  more  fiscal  tests  auditor  of  the  time  that  for  and  size  F r i e d and  significance.  i n t e r p r e t a t i o n of t h e i r f o r the  of  companies  change,  statistical  found  general  negative  market  changes,  b y Chow a n d R i c e  [1982],  r e l a t i o n s h i p between a u d i t o r auditor  opinions.  evidence  on w h e t h e r  companies  the issuance  t o determine issue  receive  of  whether  qualified  an  a  reports.  unqualified  tend  qualified  auditing  change,  The  turnover authors t o change opinion.  firms  differ in  Finally,  a client  company  opinion  from  they was the  auditor.  their  companies  f o r those  in specific  whether, a f t e r an a u d i t o r  succeeding  1974  on a u d i t o r  to  to  disagreements  around  of q u a l i f i e d  hoped  likely  For  change  as the motivation  r e s u l t i n g from  examined  that  the possible  empirical  auditors  reported  unclear.  study  the issuance  25  existed prior to the  reaction  the  relationships  remained  next  and  However,  acknowledged  The  market  preceding  Schiff  conflict  auditors,  2 2  of the auditor  auditors.  change  multivariate t e s t s , the authors  of a negative  announcement switch  of  did  13 c o m p a n i e s  auditors.  series  some e v i d e n c e the  auditor-client  d i s m i s s a l , whereas  their  that  research,  listed  Chow a n d R i c e  i n the Disclosure  year-ends.  c o l l e c t e d data  Journal  between  The r e s u l t i n g 9,460 company  on a l l SEC  t h e 1973 a n d reports  were  29  then  categorized  and  by  their  by  auditor  changes  chi-square  changing  test  auditors  audit  opinion.  that  audit  audit  qualified and  for  is  not  qualification when  dispute,  or  reason  for changing  reason  used  a  was  item  as  being  the  successor  auditors  Chow a n d receive  an  The published McConnell by  occurring sets  included  more l i k e l y  authors  Rice  used  tend  found  the  no  to  evidence  by  extensive  McConnell  sought closely between examined a l l  to  whether  to  January by  NYSE and  as  a  a  a  potential  more  that  three  Rice  test  to  auditor  study  Based  a  large  1,  1974  on  on  determine  the  and over  of  likely  changes  doctoral  to  work  31,  five  c h a n g e s , and  a  was  thesis, discussed  auditor  December the  i f  change.  research  set  2 3  opinions.  auditor  his  were  reports.  unqualified  an  in  again  auditors  a. company- i s m o r e  after  AMEX a u d i t o r  differed  qualified  chi-square  McConnell  as  accounting  Chow a n d  that  issue  e x t e n d much o f  examining  in  management as  auditors  reports,  research  [1983].  found  examined.  results  issue  unqualified opinion  most  disputes,  that  variable  f i n a n c i n g , an by  of  qualified  variables  identified  to  a  concluded  significant such  new  qualified  analysis, with  logit only  activity,  as  of  with  question  logit  a  the  address  Finally,  data  they  not  identified  above,  analysis  using  other  issue  results  a  c h a n g e s , was  to  the  receiving  for auditor  propensity  From  opinions,  independent  Fee  the  audit  they  auditor's.  To their  any  non-changes.  compared  management c h a n g e , merger policy  unqualified  independence,  Furthermore,  switching,  and  changes  1978.  The  year  period  large  sample  30  of  OTC  changes. "  The  2  actual  subsequently  analyzed  8-K  were as  follows:  406  changes  and  10-K  c h a n g e s , and total  OTC  he  prepared  sets  OTC  changes  McConnell  in  of  statistical set  significant  these for  for  and  for  each  and  were  SEC  Forms  277  percent  AMEX  of  the  were an  the  the  client's  population  i n order  to  three  unqualified  and  by  of  examining  the  was of  of  changes,  and  the  opinion  either  Directors;  comparing  existence  auditor by  performed  and  the  footnote  change Board  successor  preceded  the  recommended  or  and,  whether  c h a n g e were- v o l u n t a r i l y - g i v e n . were t e s t e d  total  of  significant  differences  terms of  issues  existed  indicated  for  and  statistical also  twenty-five  determine  data  occurrences  Secondly, McConnell  examined,  Thus a  the  the  other-than-qualified  auditor  of  First,  preceding  preceding  disclosed  phases.  disagreements  following areas:  issues  the  the  for  the  research  performed  20  into four  regarding  auditor  populations.  research  opinions.  the  each  that  changes,  approximately  i n t e n t i o n of  change; whether  reasons  his  disagreements  by  NYSE a u d i t o r  the  whether  approved  (or  changes  statements  tests with  these  auditor;  205  significant  other-than-unqualified  whether  financial  descriptive tabulations  changes,  each data  the  auditor  population.)  separated  terms  reported  via  number o f  whether among  above.  the  Each  of'  significance  between  the  chi-square  three  tests  were  or  not  statistically  the  three  data  sets  in  31  In  the third  evidence data  of  section  increasing  set f o rauditor  Eight  auditors.  extent  of  of Big  changes  And l a s t l y ,  auditor-client  h i s research,  McConnell  Eight  by e x a m i n i n g  dominance  t o and from McConnell conflict  B i g Eight  examined in  each  sought  and  each  non-Big  and compared t h e of the three  data  sets. McConnell's by  OTC f i r m s  for  reveal  either  the  Additionally, experienced  significantly  NYSE  from  r e s u l t s indicate that  or  than  the auditors'  that  the  other-than-unqualified  audit  with  OTC  firms  unqualified Eight  opinions.  and  non-Big  incidence auditor  experiencing  of  No  Eight  to  rates  perspective,  Big  disagreements auditing  NYSE  firms  opinions  Eight  firms.  firms  to auditor  Furthermore,  h a d t h e l e a s t number o f  the greatest  auditor  number  significant  of  changes,  other-than-  d i f f e r e n c e between B i g  was  other-than-unqualified  than  auditors.  prior  preceding  auditors  changes  found  regarding  opinions  the  preceding  an  of research,  he  change.  that  there  B i gEight  Eight  firm  firm  i f the  third  w a s n o t a. s i g n i f i c a n t  auditors,  populations,  the  disagreement changing  From t h e r e s u l t s o f M c C o n n e l l ' s found  the auditor  companies  more  d i dthe smaller  found  lower  AMEX  significantly  termination McConnell  major  both  or  t h e NYSE  vice  phase  exodus  versa.  a n d OTC f i r m s  Within tended  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 , p r e d e c e s s o r was a n o n - B i g  AMEX p o p u l a t i o n  was t h e c h o i c e  from  non-Big the  of successor  different  t o engage a B i g  or hire  Eight  Eight  a  smaller  auditor.  Only i n  not  conditional  32  on  the  the  McConnell to  position  found  maintain  that  of  the preceding  t h e OTC c o m p a n i e s  t h e s t a t u s quo.  auditor.  Furthermore,  seemed t h e most  inclined  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 observed among OTC registrants. F u r t h e r m o r e , w h e r e a s NYSE a n d AMEX auditor changes resulted i n net gains f o rB i g Eight a u d i t o r s , the B i g E i g h t l o s t a n e t o f t w o OTC e n g a g e m e n t s . [ p . 131]  McConnell's ambitious data  did  and  investigation  he  carefully  represents  to date.  applied  He u s e d  i s . not McConnell  has presented  information interest. the  limiting  The Menon  declared  and organized  Additionally, lack  of  the time  most  data  study  examined  by  bankruptcy from  statements,  Schwartz  a very  time  data  over  of certain  f r a m e was  errors prior to a five  and  the years  reports, Menon  This  Rather  issues of  constrained t o 1974, t h u s  year  period.  by S c h w a r t z firms.  companies  1974 t o 1 9 8 2 .  Forms used  time.  he  amount o f e m p i r i c a l  a u d i t o r c h a n g e s by f a i l i n g  annual  methods t o  theories.  on a u d i t o r t u r n o v e r ,  during  large  t o Coe and Palmon  a s a m p l e o f 132 N Y S E a n d AMEX  information  compare  analyses  range of h i s study  recent  collected  a significant  McConnell's or  similar  any g e n e r a l  statistical  most  However, one i s s u e t h a t  i n that,  was n o t t e s t i n g  including  [1985],  authors  surprising  the  statistical  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  [1979],  by  on a u d i t o r c h a n g e s  a number o f r e s e a r c h a r e a s .  omission  he  empirical  base  analyze  study  10-K's,  and The that  Utilizing  and  proxy  a matched-padrs- t e s t t o  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 between  failing  and  33  healthy  firms.  Their  significantly  greater  healthier  firms.  choose  new  Eight)  a  They a l s o  in replacing  Eight  tendency  auditor-type  significantly Big  results indicated that  to  a  more Big  to  found (that  that  auditors  failing  auditor.  pronounced  firms than  firms  i s , either Big  terminated  Eight  switch  failing  Eight  This  Thus the  the  tended  to  or  non-Big  tendency  authors  a  did  for companies changing  auditors.  had  was  from  non-  concluded:  [T]he i n c e n t i v e s b e h i n d auditor switching can vary depending upon the f i n a n c i a l c o n d i t i o n of the f i r m . T h i s s u g g e s t s a need to c o n t r o l f o r the presence of corporate financial 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 the effect of other possible variables that may be •associated w i t h t h e phenomenon of a u d i t o r switching. Focusing attention on situational or contextual variables t h a t may influence auditor switching should contribute to developing a theory of auditor switching. [p.260]  Finally,  Schwartz  qualifications  nor  and  management  associated  with  auditor  service  fee  competition  in  and  auditor The  selection for  preceding  auditor  changes  interest  in this  virtually  a l l  attention  of  firms of  toward  models.  work  has  the  on  either  the  firms,  the  p r o b a b i l i t y of  two  much o f  dominance an  has  been  of  auditor  more  research been  distress. studies  on  considerable  decades.  of  that  important  However,  empirical, with  development  Furthermore,  focussed or  past  statistically  financial  major there  the  audit  They c o n j e c t u r e d  experiencing the  neither  were  become r e l a t i v e l y  that  over  the  that  changes  may  indicates topic  found  displacement.  review  directed  theoretical  Menon  any  little  underlying  the  attention  has  the  Big  auditing  change  Eight  following  been  the  34  issuance and  of  Palmon  found  for  presented  investigated auditor  limited Big  regarding  to  only  Nevertheless, seen  efforts  evidence  Eight  inconclusive.  refers  be  other-than-unqualified  [1979]  only  time  been  an  as cited  the  Thus the  in this  of  chapter.  an  the  Only where  turnover the  auditor  portion  work d e s c r i b e d and  auditor  motivating  portion  r e s u l t of,  rates  Additionally,  empirical  limited  empirical  both a  fees  opinion.  turnover  increased  auditors. audit  a  of  auditor  of  evidence  this  work c i t e d  extension  to,  they over  changes  i n Chapter  Coe  thesis above.  Four  the  has  must  research  35  Chapter  Four  E M P I R I C A L R E S E A R C H METHODS AND In rates  this i s  analysis listed  c h a p t e r , an e m p i r i c a l  presented.  of a u d i t o r  firms,  over  The  change a time  any  i n auditor  changes  study  i s  Thus,  reviewed,  procedures  tests  literature  provided  an o v e r v i e w  past  two  considered Three. result Coe  from  hypotheses;  the  presented  work  presented  simply  generate the  auditor  differs  article  here  and  a n d Menon  should in  testing  descriptive  Chapter  in  from  of  any  studies, The  i s not t o turnover.  the  Chapter  here  [1967],  behavior.  on a u d i t o r  be  However,  the intention  extend  reviewed  [1985].  changing  material  tested  Roberts  the  largely  i n that  more d e s c r i p t i v e  i n t h e SNS  chapter  changes ' over  discussed  of Burton  have been  hypotheses  hypotheses,  i n the preceding  detailed  aspects of auditor  here  year  and r e s e a r c h  empirical  research has not pursued  on c e r t a i n  study  efforts  they  fifteen  number o f t h e m e t h o d s e m p l o y e d  [1979], and Schwartz  rather,  the  are presented.  The  a  price  t o determine i f  assumptions  of t h e r e s e a r c h i n t o  the earlier  much o f t h e p a s t  developed  major  Finally,  decades.  publicly-  increased  performed over  of  and  chapter, the motivation f o r this  the  review  particular,  and Palmon  Instead,  then  turnover  the collection  assumed  as an e x t e n s i o n of t h e s t u d i e s  In  reporting  and  of  existed  and r e s u l t s  The  the  were  in this  are described.  statistical  auditor  involved  period  tests  examined.  of  i n f o r m a t i o n f o r a sample  Statistical  period  study  study  rivalry. trends  RESULTS  theories  Two.  The  36  theoretical briefly  framework  summarized  is  where a u d i t o r s economic this  existing  and independence  auditors  on  As effect  the  client  remaining  accounts  stock  of  rather  through diminished  fees.  unavailable,  an  such of  risk  fees, and,  Client firms rivals'  regarding  rationally risking  will lower  the lower decide  fee  nonindependence,  be t h e e r o s i o n  However,  examination  this  auditor  to  reductions  clients.  should  rivalry  than  of  decreasing  turnover.  auditors  Therefore,  erosion  information  incumbent  of p r i c e  examines  through  imperfect  will  study  clients.  possible  auditor  not a l l a u d i t o r s  the scope  their  their  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  of either  beyond  from  rents  increased  amounts, o r because  their  rivalry  maintain  simultaneously  diminished  some  b e c o m p r o m i s e d when p r i c e  cannot  switch  forego  i s  results,  paribus,  because  study  A disequilibrium  ceteris  bid  may  disequilibrium implies  bids  empirical  into a u d i t i n g markets.  rents  independence,  this  Hypotheses  independence  introduced  motivates  below.  Summary o f T h e o r e t i c a l Auditor  that  as  project.  primary  of economic data  i s  warrants a research  research  the secondary  fee  the  largely endeavor  Therefore,  e f f e c t of price r i v a l r y  on  rents  this auditor  turnover.  Once  rivalry  equilibrium,  drives  auditor  and  auditor  if  the primary  turnover  prices  down  independence w i l l should  motivation  remain  for auditor  to  the  be r e s t o r e d  relatively  competitive and both  constant.  fees Thus,  s e l e c t i o n i s p r i c e , and i f  37  audit  markets can  auditors  offering  introduction increased  the  of  rate  The of  be  substitutable  price of  above  auditor  work  assumptions  a s s u m p t i o n s must  be  that  first  price  selection the  is  of  an  As  [1967] in  confirmed  auditor  that  selection  subsequent  studies  and  [1985]  Menon  important evidence the  at  regarding  role  auditor  in  of  what c o n s t i t u t e s Therefore, the  was  i n the  to  that  other  causes  date,  primary  absence, of  common m i c r o - e c o n o m i c  an  direction  contains  the  E a c h of  this by  the  these  price  audit  cannot  motivation concrete  assumption  of  results  rule  factor change,  Schwartz  switching, opinions  price  as  preceding  an  from  with  the  certainty  selection.  to. t h e as  the  such  Thus,  auditor  evidence  were  Furthermore,  conclude in  auditor  considerations  inconclusive. we  for  [1974] and  the  Three,  unimportant  changes.  for auditor  in  Roberts'  AICPA  Loeb  states  auditees  reasons  an  1972  study  i n Chapter  and  was  B e d i n g f i e l d and  some a u d i t o r  the  in  used  the  least  to  observe  general  demonstrated  to  been  the  project.  employed factor  concluded  published  the  Study  competition  prior  have a l s o  then with  to  i t also  Whereas B u r t o n  fee  by  of  turn.  other-than-unqualified  change,  studies  research  pertaining  changes have been mixed.  but  Empirical  primary  results  expect  suggests  here,  in  assumption  auditor.  empirical  services,  would  only  in this  i n the  the  i n t o sub-markets  changes.  discussed  major  audit  we  performed  used  Assumptions Employed  The  rivalry  summary n o t  empirical  major  s u c c e s s f u l l y segmented  the  contrary, primary  38  factor The  i n product  validity  untested  of  at this  The  second  auditing  market  market,  where  Certified  auditing  firms,  size  to the  domination  are  the  by  into  remain  exists the  the  total  U.S.  auditing by  the  national  Big  firms  Eight  local  and  a major  clients. firms  client  regional,  audit  On  of any  the  are generally  other unable  clients.  i s most p r o n o u n c e d  Thus, i n the  accounts.  i t may n o t  Therefore, subdivide  sub-markets of a u d i t o r s  or  made  a r e of s u f f i c i e n t scope  of the largest  we c a n s u c c e s s f u l l y  the  exclusively  be  an  the national  appropriate  (un-segmented) a u d i t o r  turnover.  within  i s  auditors  firms,  research  a common d i v i s i o n  auditing  corporate  that  these sub-  recent  performed  smaller,  auditing  within  by  In  2 5  (CPAs),  offered  auditing  of auditor that  must  implies  t h e s i z e and scope d i f f e r e n t i a l s between  analysis  audits  supported  services.  of B i g Eight  non-national  study.  s u b - m a r k e t s where t h e  differentiation  or regional  forthe largest  i s  study  substitutes  international corporate  only  for  i s  services  national  examine  here  into  a n y s i g n i f i c a n t number  Given and  segmented  near-perfect  and between  the local  market  this  e a c h may s i n g u l a r l y u n d e r t a k e  the largest  audit  assumption  in  Accountants  services  The that  be  product  audit  the  auditors.  used  assumption  Public  i n this research  simplifying  f o r audit  between  hand,  can  that  general  a  assumption  This  indicating  i s employed  time.  are offering  markets.  of  such  markets  auditors  and  selection  changes  assumption the overall  offering  to  i nour used market  substitutable  39  audit the  services.  B i g Eight  The  i s  such d i v i s i o n  and non-Big  third  project  One  major  that  Eight  an o b s e r v a b l e  that  searching  we  are  changing  exist  theory until  during  predicts  that  that  competitive acted  as  the  price  bidding,  were  would expect 1970's.  rate  of a u d i t o r  turnover  The  assumption  the  some  period  of  price  relatively  constant  economic  rents  competitive  equilibrium  independently,  and r i s k  actions.  auditor  protect, have  any c o s t s  However, t h i s  study,  we  solicitation  on have  As  these  respectively, turnover  changes  this  we  during  examines the  Whereas  we  turnover  turnover  should  With  identical  with  to  would  during  a  remain  pricing  operating  incentives  associated  study  changes once t h e  auditor  auditors no  empirical  of auditor  attained.  at equilibrium. to  turnover  price rivalry.  in  of increased  rivalry,  Our  prohibitions  i n auditor  employed  of the rate  indication  Recall  1969 t o 1983.  e q u i l i b r i u m has been  expect  no  behavior  time  in auditor  this  AICPA  direct  increase  from  of  auditor  In  Thus, our a n a l y s i s o f a u d i t o r  final  competitive  of  increased  some  the  concerns  achieved.  i n 1 9 7 2 , 1978 a n d 1979  t o observe  research  price rivalry.  increase  a d v e r t i s i n g and  removed  this  i f any t r e n d s  will  removal  for  within  of increased  i s  recent  i s between  i n fee competition.  discover  rivalry  invitations  sanctions  to  here  and examine a p e r i o d  change  a period  the competitive  assume  implicit  can i d e n t i f y  which contains  i s made  auditors.  assumption  we  that  at  behave  and the non  nonindependent  does not n e c e s s a r i l y imply  zero  auditor  40  turnover  at equilibrium.  uniformly  agree  nonindependent  as  I f we a s s u m e  to  behavior,  what then  nonindependence a r e s p e c i f i c the  client  may e n g a g e auditors  with  Such b e h a v i o r  phenomenon  of  equilibrium  we w o u l d  of  auditor  Sources  this  them  might  "opinion  search  resemble  versus costs  of  Therefore  2 6  fee structures, for  independent  contentious reporting  the  currently  Thus,  disputed  at the competitive  some c o n s t a n t ,  positive  rate  turnover.  of Data  In  order  possible  t o examine a u d i t o r changes  data  One p o t e n t i a l  sources data  publicly-listed  were c o n s i d e r e d  s e t would  include  firms as recorded  a data  s e t was u s e d  ending  i n 1978, where he f o u n d  auditor  changes.  by M c C o n n e l l  In order  would have  period  that trend analysis  such  News D i g e s t  examination extensive  forthis  data  [1983]  such  an e x t e n s i o n  of  McConnell's  to the existing  body o f  study.  changes  for  approximately  3,300  a data a  auditor be  set, the daily  sufficient  required.  would 2  further Such  p r o j e c t as a  locally.  literature.  time  However, as  details,  forthis  work  Such period  c o u l d be p e r f o r m e d .  provide  of  year  over  S E C F o r m s 8-K a r e n o t a v a i l a b l e of  research  forthe five  a total  s e t was n o t c o n s i d e r e d  of  a number  i n t h e SEC News D i g e s t .  o f t h e S E C F o r m s 8-K w o u l d  set  addition  not  time,  a l l auditor  t o be r e v i e w e d  does  over  t o o b t a i n such  News D i g e s t  the  auditors.  on t h e s e  to find  the  identical  shopping."  expect  that  to individual facing  a l l auditors  independent  implies  i n a u d i t o r s w i t c h i n g as they agree  not  constitutes  companies, although  who  issues.  that  7  an full  Nevertheless, be  a  welcomed  41  Another information in  possible  I n d u s t r i a l Manuals.  [1967]  and  Manuals as t h e i r general large  number  there  are  and  First,  most  from  contain  smaller  auditor  manuals  from  a single  locally  In  large  part,  a v a i l a b l e source  f o r the  this of data  Thus even  that  OTC  not  year.  not  not  This firms  i s have  just  those  reporting  "gaps"  companies  will  sample  (where h i s sample  sizes,  And f i n a l l y ,  a  will  auditors.  Furthermore,  selected  u s e o f t h e Moody's m a t e r i a l  time-series  information  changes  fail  to  auditor  provide  information  indicate  multiple  2 8  the disadvantages  I n d u s t r i a l Manuals were  study.  the  year.  t h e Moody's M a n u a l s  changes w i t h i n  using the  change  listed  f o ra  However,  I n d u s t r i a l Manuals  of a l l  provide  with  [1983] showed  firms  basis.  firms.  of auditor  and  t h e Moody's  listings,  associated  record  that  when  i n any given  Notwithstanding OTC  OTC  McConnell  included  only  listed  Burton  These manuals  on an a n n u a l  traded  Moody's  overall rate  the  information procured  they  change  firms  used  including auditor  i n t h e Moody's M a n u a l s ) .  in  auditor  by  [1979]  of data.  firms  companies  i n that  OTC c o m p a n i e s  occur  sources  actively  the  greatest  included  for  The s t u d i e s  number o f d i s a d v a n t a g e s  selected  of  data  Palmon  information,  Moody's Manuals.  the  and  of i n d u s t r i a l a  significant  Coe  primary  financial  largest  of  i s a v a i l a b l e f o r t h e N Y S E , AMEX a n d OTC  t h e Moody's  Roberts  source  listed  above,  t h e Moody's  as source material  choice  w a s made b e c a u s e  was d i s c o v e r e d . allowed  2 9  no  other  Additionally,  f o rcomparison  r e s u l t s i n d i c a t e d by Coe a n d Palmon  for this  [1979].  with  the  42  The that  data  the  set  was  market  restricted  of  OTC  audits  competitive  (compared w i t h  period  changing  market  in  the  of  reasonable  that  researchers  has  pronounced  i n the  on  average,  in  auditor  OTC  the  between  1974  were  NYSE o r and  made  tier  the  likely  another.  Thus,  switches  on  two  the  major  auditing  examination auditor  firms  assumed  firms  one  than Given  find  reported  changes  we  Eight were  companies of  to  more " i n listed  segregating  believed  the  with  auditors  relatively  assumption  on that  companies of  t h o s e made by  sub-markets,  costs  non-Big  OTC  sub-market  our  that,  in accordance  average,  to  less  listed  auditor  versus  companies would y i e l d  that  r i c h e s t source  an of  information.  change data  reporting  1983.  This  the  OTC  on  of  finally,  Eight  expect  exchanges.  of  firms  of  from  into  Big  previous  d o m i n a n c e was  larger  a  seems  transactions  number  And  that,  would  OTC  the  most  during  by  T h u s we  3 0  fewer  with  the  Methods  Auditor  trends  assumed  market  change  Research  by  Eight  assumed  assumption  presented Big  largest  regarding  we  This  A d d i t i o n a l l y , McConnell  firms.  change  been  AMEX m a r k e t s )  audits.  compared  OTC  we  to  group" the  the  b e c a u s e we  have  structure.  f o r OTC  the  findings  switches,  less  NYSE and  evidence  AMEX.  1978,  by  McConnell's  as  firms  would  companies encountered  switching  either  the  indicated that market  t o OTC  in  time  during period  auditor  AICPA  were c o l l e c t e d the  fifteen  seemed  turnover  prohibitions  for year  sufficiently  preceding on  and  a  sample  period long  to  following  bidding,  from  of 1969  capture the  OTC to any  removal  advertising  and  43  solicitation companies  in  was  41  financial  of  auditor in  changes  motivated of  by o t h e r  The  the  where  i s  Thus,  1983.  to  isolate  where  change  criterion  control  for  d i s t r e s s and/or controls  experiencing and  3 1  apparently  this  to  constraint  exchange,  general  c a u s e d by a  financial  a  and  o f 1969 a n d  order  OTC  approximately  those changes  in  were  Moody's  had a u d i t o r  from company m e r g e r s  for  listings  for  sufficient  also  for  those  a name c h a n g e  f o r e a c h o f t h e 200 s a m p l e  the fifteen  Manuals,  the companies  information  were  years listed  under in  a number o f f i r m s failed  to Moody's f o r s e v e r a l listing  that  1984  prices  companies  larger  firms  intention  by s e v e r e  client  2 0 0 OTC c o m p a n i e s  Moody's  our  such  o f 2 0 0 OTC  was  2  auditor  collected  that  used  Additionally,  resulting 3  was  sample  represented  determinants.  motivated  t o move o n t o a  involved.  and  f o r the years  non-price  by  A OTC  1970  size  study  listings  caused  changes  the  s t r u c t u r e , and t o e l i m i n a t e  bankruptcies.  growth  listed  in this  changes  changes  from  r e s u l t i n g from f a l l i n g  simultaneous  auditor  1979.  a l l OTC c o m p a n i e s  that  market  in  The s a m p l e  information  Recall  and  selected  listed  Manuals.  percent  1978  randomly  simultaneously Industrial  1972,  t o report  years.  from other  companies  where  the  surrounding  t h e "gap,"  both  their  sources,  no  Although  the  had large  An e f f o r t  auditor that  review.  firms  1970  were a l l of  and  1984  r e p o r t i n g - "gaps,"  financial  information  w a s made t o g e t a u d i t o r a n d we a s s u m e d  listing auditor  remained change  took  that  for  unchanged place.  44  Nevertheless, their  nine  reporting  listing  of  The  the  companies  "gaps" were c o n s i d e r e d 191  sample  auditor  firms  change  was  then  further  purposes  of  this  study,  only  by  from  a  change  price CPA  auditor  changes.  in auditors  merger  that  was  t o d e t e r m i n e i f t h e change  auditor  merger. "  companies if  Similarly,  any  indicating other  switch.  Such  mergers, disputes  auditor  pertinent exogenous  major  changes-  from  the t o t a l  prompted  auditor 159.  changes  The  presented could  applying  not  were c a u s e d by  the above  criteria,  occurred  of these  positively auditor  Events  were  to  of  closely from  an  of a l l  ascertain the  client  auditor company  proceedings,  listed  an  or  surrounding  individual  collected.  changes  3 5  Statistics  i n A p p e n d i x C. be  as  resulting  histories  C h a p t e r XI  changes  the  motivated  resulted  include  the removal of these  that  listing  changes  have m o t i v a t e d  voluntary  OTC  from the c o l l e c t i o n  were, e x a m i n e d  could  methods.  defined  switch  financial  changes  number o f a u d i t o r  Summary o f D e s c r i p t i v e  After  the  factors  lawsuits,  auditor  191 For  apparently  in auditor  e v e n t s may  over accounting  five  was  a l lp o s s i b l e  examined  B.  analyzed. was  as  complete  the remaining  change"  excluded  A  3 3  i n Appendix  and  Thus any  Accordingly,  3  on  "auditor  considerations. firm  i s provided  examined an  from the sample  too l a r g e .  information  companies  identifiable  were e l i m i n a t e d  over the f i f t e e n  c h a n g e s , by However,  3 6  year  and  twenty-three  identified  mergers.  the r e s u l t i n g  The  of  years by  number  of  totalled firm,  these  as t o whether total  number  changes  or not of  is  they  annual  45  auditor rates,  changes,  are presented  inclusion The  auditor  rates  twenty-three  resulted  percent.  Both than  I.  The d a t a  changes  turnover  situation  of t h e above  found  included  excluded, percent  rates  Table  AMEX  changes.  are  percent,  a l l CPA f i r m m e r g e r s .  fortotal  by  Coe  and  annual  Even  changes  changes  (as  increased firms  year  remarkably  shown  in  t o 168 c h a n g e s  over  absolute  period.  fifteen  number small.  of  sample In  Table  of  f o r AMEX  firms,  mergers rate  were  w a s 3.21  contrast, I I , the  i ssignificantly  our total  t h e OTC  in  data-  a l l changes  found a t o t a l of  findings  over of  a  159  i s increased i s  included)  higher.  discovered  with  115 OTC c o m p a n i e s  i fa l l mergers a r e  changes  was f o r  including  only  twenty-four  [1979]  3 7  Palmon.  a  significantly  which  turnover  f r o m CPA f i r m m e r g e r s , C o e a n d P a l m o n from  was 5.09  turnover  When a u d i t o r  resulting 66  rate  highest  auditors  I I summarizes our f i n d i n g s compared  collected  by  percent.  by Coe a n d Palmon  to B i g Eight  Coe a n d Palmon's h i g h e s t  a l l of  caused  5.95  The a b s o l u t e  b y C o e a n d P a l m o n w a s 3.42 Eight  was  annual  that  not  for  mergers.  average  the average  calculated  rate  from non-Big  segregated  Assuming were  turnover  where a l l o f t h e t w e n t y - t h r e e  turnover  any of t h e r a t e s  the  rate  mergers,  N Y S E , AMEX o r OTC c o m p a n i e s .  and  and  presented.  unidentified  from a u d i t o r  are  unidentified possible  for  changes  calculated auditor  changes  are also  a "worst case"  changes  the  of these  the average annual  Assuming  higher  i n Table  number o f y e a r l y  turnover  mergers,  with  or exclusion  average  the  along  f o r 191  Nevertheless, both  studies  the i s  46  The  frequency  presented of  of a u d i t o r  i n Table  the t o t a l  191  III.  firms)  the  fifteen  year  once  or twice  during  companies years.  to  auditor have the  evidence  firms  during  the years be  proper  in  under  review.  only  sample  auditors  the  OTC  fifteen  were  not  t h e a v e r a g e number  per  company. within  "audit"  However,  during  twelve  in this  to support  as c o n j e c t u r a l  differentiation,  auditor  change*  auditor  changes  within  non-Big  Eight  changes  firms,  within  Eight  firms  companies firms).  firms Eight  either  changed  over  changes  not appear  average  Eight  (.83)  While  any  the  such a  of we  given  year,  notion  that  or "opinion"  without  our assumption regarding  product  OTC  one  a l l  auditors  with  percent  shopping  conclusion  can  further  evidence  and  market  segmentation  testing.  Given  Big  often,  on m u l t i p l e  engaged  considered  firms  at  firms with  companies i s  ( o r 44.5  auditors  o f 94  three  o f OTC  than  does  individual  examined,  than  auditors  at less  these  for  more  information  above  A total  the period  change  changes  no  only  d i d not change  Thus t h e m a j o r i t y  inclined  by  E i g h t y - f i v e companies  period.  listing  changes  ( o r 63.4 firms  fifteen  the  Big Eight audited (with In  for  percent)  IV the  113  and  non-Big  ( o r 59.2  following  Eight  of  within  switches  auditors.  auditors  eight  Additionally,  In  191  audited  serviced  companies.  the of  1969, sample  by  non-  121  OTC  Hence t h e B i g  clients only  and  categories:-  in-group  78 c o m p a n i e s  of the sample  examined.  annual  percent) of the  the B i g Eight  a net gain  presents  f i r m s , changes  combined  the remaining  1983,  period  Table  the B i g Eight  and  experienced  year  data  audit  over  four  the  auditor  47  changes  from  resulting  non-Big  from  unidentified non-Big the  The are  CPA  to  Eight  average  also  to  firm  changes),  Eight  non-Big  Eight  to  a  annual  following  of  26  auditors.  Eight  firms did  turnover  i n d i c a t e d in Table  f i r m s were  (with  total  Eight  Big  Eight  mergers  with  Big  Big  rates  IV,  and  an  additional  confirmed  from  T h u s some m o v e m e n t  from  occur.  for  the  segmented  where a u d i t o r - t y p e auditors.  This  used  and  Coe  studies.  number of  changes  turnover than  Formal  Tests  set  of  Palmon and  those  performed  of  for  of  ,  by  representing and  the the  Palmon.  using  the  Interactive  in auditor  number of  independent from  1969  regression Data  Eight  between that  are  that  the  two  a l l of  the  significantly  Turnover  were performed  annual  reporting periods  reveals  and  in Auditor  analyses  IV  study  Coe  non-Big  rates conforms with  this  increasing trends  regression  or  for comparison  I I and  indicated in reported  14  annual  allows  Tables  f o r Trends  auditor-type, fourteen  the  1  either Big Eight  calculation  rates  test  variable  Michigan  represents  Inspection  higher  a  data  have been c a l c u l a t e d i n  number of c o m p a n i e s a u d i t e d by a u d i t o r - t y p e i n 1969  To  six  changes  x  OTC  as  manner:  total  by  identified  with  the  auditor  variable to  1983.  routines  Analysis  changes over  System  time,  dependent  changes  per  indicating  the  These  tests  available (MIDAS)  were  on using  thea  48  significance  level  of 5 percent  h y p o t h e s e s were s t y l e d as 1.  H  0  :  H,  2.  H  0  H  0  H  0  performed.  follows:  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 another Big Eight auditor, statistically significant relati t h e number o f a u d i t o r c h a n g e s a n d  a B i g Eight to there was no onship between time.  : 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 another Big Eight auditor, there was a statistically significant positive relationship 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 . :  For those OTC auditor changes from a Non-Big 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 a n d t i m e . : F o r t h o s e OTC auditor changes from a Non-Big 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 statistically significant positive relationship 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 .  :  H,  Two  and a l t e r n a t i v e  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 w a s 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 a n d t i m e .  :  H,  4.  The n u l l  : 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 statistically significant'positive relationship between 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 .  H,  3.  (.05).  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 Eight and Non-Big E i g h t a u d i t o r s , t h e r e was n o statistically significant relationship between 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 . : F o r t h e sum Eight and statisticall between t h e  additional  tests  As our data  Eight  to  Big  tested  (again  Eight  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 Non-Big Eight a u d i t o r s , t h e r e was a y significant positive relationship number o f a u d i t o r c h a n g e s a n d t i m e . for  indicated auditors,  at the 5 percent  trends some the  level  in auditor movement  changes were from  non-Big  f o l l o w i n g h y p o t h e s e s were  of s i g n i f i c a n c e ) :  49  5.  H  :  0  H,  6.  H  0  H,  It test  For a stat the  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 Non-Big Eight auditor, there was no istically significant r e l a t i o n s h i p between number o f a u d i t o r c h a n g e s a n d t i m e .  : For a stat the  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 Non-Big Eight auditor, there was a istically significant r e l a t i o n s h i p between number o f a u d i t o r c h a n g e s a n d t i m e .  :  F o r t h o s e OTC auditor changes from a Eight to a Big Eight auditor, there statistically significant relationship 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 .  Non-Big was no between  : For those OTC auditor changes from a Eight to a Big Eight auditor, there statistically significant relationship 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 .  Non-Big was a between  should  be n o t e d  for either  theory  does  interest  tests are  summarized  expect fifteen  to  changes,  should  turnover.  are fully  turnover.  As. our  i n changes  for  documented  between  completeness  h a v e no b e a r i n g The  results  to  and  on o u r  of the  six  i n A p p e n d i x D,  and  Tests  t o our hypothesis  find  with  might  included  were s t y l e d  below.  years  associated increase  above  decreasing  results  auditor  of Regression  According  are  the  regarding  or  two h y p o t h e s e s  to predict trends  tests  and  described  Results  attempt  the  only,  conclusions  these  increasing  not  auditor-types,  that  some  increase  examined  (and  our  n o t be  our theory  time  discussed  earlier,  in auditor  turnover  thus  a  variable).  apparent  in  predicts that  an  the  positive Although total  we  would  during  the  coefficient a perceptible  annual  increasing trend  auditor should  be  50  apparent in  tests  trend our  within 2  to 4).  in auditor results  significant  from  non-Big  the  positive  were  significant  found,  Eight  a t 0.25 of  some  auditing  firms,  Eight  f o r an  auditors. with  the other  regression  r e l a t i o n s h i p between auditors  client  supports  companies  this result  discussed  result,  failed  was  value to  of  indicate  t h e number  i s only  this  increasing price  and  result  tangential  of  recommendations  i n the following  chapter.  non-  evidence  our  not  during  implications for further  an  of  national general  interesting,  here does  turnover The  from  to the to  i s somewhat  auditor  rivalry.  changes  from smaller  the evidence presented  overall  changes,  variable  our e a r l i e r  that  of i n c r e a s e d  i n changes  time.  must c o n c l u d e  period  no  changes  r-squared  tests  firms, fact,  these  the time  an  while  of  In  trend  For  Thus  theory  increasing  auditing  increasing  hypothesis.  our  f o u n d an  t h e number o f a u d i t o r  (.0025) w i t h  to Big Eight of  perceptible  findings.  percent  the p o s i t i v e  exodus  their  between  except  Palmon  s i g n i f i c a n t r e l a t i o n s h i p between  changes and  Eight  and  the B i g  confirm  to Big Eight  statistically  While  Coe  coefficient associated  A l l  auditor  Big  not  relationships  time  .54737.  Whereas  sub-markets (and thus  changes w i t h i n  did  and  any  t h e segmented  we  support assumed of  research  this are  51  Chapter SUMMARY OF R E S U L T S AND Summary  of Test  In  the  results  an  described. SNS  during  implied  this  hypothesis.  studies auditor  turnover in  in  examined. turnover  within of  no  this  Coe  failed  from  relatively  segmentation  over  of  constant  auditor  Eight  be  fifteen  significant  examined  years  were both  the  that  data  into  d i d not a l t e r changes  over  a s t o why  of these  to  period.  subdivisions and  time.  changes result  Only the  indicated  time.  this  auditor  the basic  auditors  o f no period  that  time  auditors  relationship  Each  tests  year  the notion  r e s u l t s of increased  examined.  i n turn.  rates  to  r e l a t i o n s h i p between  during  to Big Eight  number o f p o t e n t i a l e x p l a n a t i o n s  the  failed  [1979],  fifteen  the Big- Eight auditors  the expected  the  constant  Eight  non-Big  Palmon  the  increase  t o r e j e c t the hypotheses  collected supported  the non-Big  by  should study  were  The r e s u l t s o f t h e r e g r e s s i o n  study  changes w i t h i n  rates  turnover  significant  The d a t a  statistically  produce  and  turnover  relatively  changes  found  by  general  provided  rates  our  and  turnover  our empirical  Although  and time.  remained  containing  rivalry,  change  auditor  Additionally,  RESEARCH  motivation  on a u d i t o r  auditor  recorded  generally  performed change  those  the  study  that  of p r i c e  than  FURTHER  the t h e o r e t i c a l framework  a period  support higher  chapter,  empirical  Whereas  article  I M P L I C A T I O N S FOR  Results  preceding  of  Five  There a r e a  study  auditor possible  any  d i d not  turnover reasons  over must  52  Possible  Explanations  The that  a  result  increased price  years not  general  examined.  provided  Either  the three  by  our t e s t s .  may  be  that  period  removal  i t  no  that 3  8  ,  3  attained  formal  in  1972  p o s s i b l e reason rates  for  e q u i l i b r i u m f o r OTC the time  that  detected  rule  over  the  changes  this  time was  prohibitions  selection,  sanctions  longer  firms  i t  is  quite  was- m o r e m i n o r  that  p e r i o d does  relatively t o t h e SNS  may  have  than  the  total  changes  from  1969  to  by  the been  although  were  removed  t h e U.S.  Federal  issued a public  statement  Thus  f a r enough  rates.  model,  already  bidding  prohibiting  enforced.  not extend  to auditor turnover  filed  Council  rule  strictly  effects  suit  constant  For example,  forbidding competitive  to the a n t i t r u s t  be  finding  p e r i o d examined.  indicating  time  t o be  stimuli  to auditor turnover  i s that, according  in  our  fees  negating  9  (due  no  imply  fifteen  or the  of t h e AICPA  t o a u d i t o r changes  D e p a r t m e n t ) , the AICPA  would  the  thus  study,  t o o weak  effect  auditor  Justice 1967  were  unlikely  on  the e f f e c t  before  the  seems  effect  turnover  competitive  rivalry,  this  effect  residual  during  could  removal of p r o h i b i t i o n s d i d  in  changes  the major  Although  Another auditor  Thus,  any  had  expected.  rule  that  plausible  the AICPA's  incumbent a u d i t o r s decreased  such  minimal.  d i d not occur  employed  Tests  auditor turnover  for increased price  assumption  by  of constant  rivalry  a c t as c a t a l y s t s primary  f o r R e s u l t s of S t a t i s t i c a l  bid  i t i s possible that to  capture  (The a b s o l u t e 1970  competition  might  high  earlier number  support  of  this  53  conclusion)."  0  Furthermore, competitiveness market  in  structures,  competitiveness price we  average  attainment possible  expected  the  versus  specialization auditor  be  study.  overall  too  be finer  However,  could  for  to  model  products  or  (which  the  the  small  is  fee  information  Therefore,  to discover  We  our  assumed  that  of  Big  where  the  Such  are  Therefore,  a  trends  actually at  include  could  the  involves  underlying  services  absolute  one  presented.  substitutes.  tests  the  as  sub-markets  might  that  competitive  turnover  identical.  of  the  failing  into  changing  remains  r e v e a l any  p r o j e c t , such  t o p r o d u c e any  to  of  increased  approximate markets  perfect  i n d i c a t e d by  research  this  equilibrium  regional expertise)  given  levels  differentiation.  segregation  and/or  of  access  auditor  coarse  nearly  such  for a l l firms).  near  the  of  whether  a u d i t i n g market Eight  period  empirical findings  product  changes not  in this  unlikely  data  were o f f e r i n g  to  without  a  levels  i n t r o d u c t i o n of  shortcoming  increased  be  the  explanation  non-Big  theoretically,  found  of  may  to  higher  i f  distinguish  f o r the  markets where  perceived  prior  know  competitive  possible  partitioning  this  not  regarding  participants  in  the  results  segregating  within  do  cost  explanation  assumptions  Eight  we  been a c h i e v e d  of  Another  markets during  to  total  of  OTC  way  has  assumption  the  Thus a major  no  equilibrium  our  existed  rivalry. have  (or  given  least  industry  uncover  trends  performed  within  number of  changes  further segmentation  additional information.  would  54  Another  likely  from  the fact  set  used  in  immediately set  of  that  explanation there  this  were  f o r our e m p i r i c a l  significant  study.  By  l i m i t e d our analyses  larger  OTC  are not  OTC  firms  that  in  that  McConnell  firms,  thus  listed  [1983]  auditor  changes  reported  to  the  controls  providing  for a stable  distorted NYSE  our  and  have  throughout results.  AMEX  Areas  a  f o r Subsequent  Further  the  collection the  three  neglecting  t h e numerous  smaller  This a  changes  is  when  he  Furthermore,  without  change  period  may  information  1967  firms  work  period  be  be  the  further  looking  f o r that  required  public  change  within  to  at  the  period,  we  data.  this  resolve  study.  announcement  information  t o 1969,  Moody's  identify  increased  announcement.  could  in  have  s e t of p o t e n t i a l l y i n f o r m a t i v e  (although  could of  a l l  additional  listed  also  larger  examined our  s e t of companies  lastly,  significant  significantly  And  1967  The  available  additional short  from  1967.  publicly  the  narrow  year  AICPA  auditor  years  preceding  a  to a  problems contained  of  we  changes  SEC.  would  1967  data  Moody's Manuals  a l lof the e f f e c t s r e s u l t i n g , from i n c r e a s e d - b i d  following  the  Research  work  abovementioned that  large  stems  of a u d i t o r  the f i f t e e n  auditor  eliminated  the  discovered  n u m b e r o f OTC  Manuals  problems with  i n Moody's.  absolute  OTC  using  results  and  Manuals not  for  available  i f , for this  auditor  to include  captured,  required  number these  of years  o f OTC  occurred  sample  a l l companies  for  years  locally).  sample  turnover  A d d i t i o n a l l y , the  expanded  a  ensure  competition  were  w o u l d be  for  To  the  size  are This  firms,  following of  reporting  OTC in  55  t h e Moody's M a n u a l s o v e r (recall percent and  that of  our  those  final  in  this  sample  firms  years).  n u m b e r o f OTC  not  data  set  firms  in this  such  we  used.  of  found  by  change  we  produced  alter  the  41  first  expanding  the  results  for  the  workload  potential  Examination  i t  data  auditor  reporting of  collection  such a  the Moody's  is  OTC  the found  a very  rich  would  require  and  the years  1971  errors,  thus  the to  to  a data  SEC  set would  smaller subset Manuals.  of  listed  in of  similar  SEC  of in  number  information  contained  substantially  be  by  for trend analyses.  1973  from  that  large  1971  strongly  companies,  numerous  period.  procured  to the  for  present.  preferred as  on  increasing  in that  i n f o r m a t i o n c o u l d be  the  auditor  source  a project  f o r a n a l y s e s of changes  change  of  the  examination  where a v e r y  analyzed  project to  firms  Thus a more c o m p l e t e  time  due  apparent  to only those  according to McConnell,  changes  research  a b s o l u t e number  [1983],  collected  and  through  that  encountered  large  by M c C o n n e l l ,  classification  the  examination  i n both  to this  have e l i m i n a t e d  over  c h a n g e s c o u l d be  firms  the  examination  turnover  Nevertheless,  limitations  information.  Unfortunately,  all  embellishments  McConnell  our  to that  auditor  of  approximately  i t is unlikely  manner would  Given  t h e Moody's M a n u a l s ,  scope  represented  simultaneously listed  solve the basic  restricting  auditor  size  period  study.  would  auditor  extended  However,  Unfortunately,  changes  the  over  i s available  56  Finally, determining The set  further  obvious  method  t o do t h i s  of a u d i t o r change effect  earlier  in this  rivalry  fees)  be  rivalry,  price  thesis,  into  we w o u l d  over  over  expect  publicly,  the task  This  chapter  given  empirical  tests,  and  research  work.  While  might  generate  results either  some  are l i k e l y  concentrate increased  their  rivalry  effect  of the  period  period  additional  larger data  research on a u d i t  fees.  discussed  introduction audit  audit  contained  would  basic  of t h i s  set of on  fees  increased the  of fee  prove  very  unavailable  one."  1  results  suggestions  i f future  efforts  As  i s largely  information,  t o be a c h i e v e d  expected  The c o l l e c t i o n  the  extension  the  i f  be an o n e r o u s  some  secondary  fee decline until  of time  summarized  an  Thus  of  achieved..  ( i nour case,  that  fee data  would  provided  a significantly  fees.  achieved.  that  admittedly  has  on a u d i t  equilibrium.  a time  long  issue  this  examine  t o see a general  a sufficiently although  and  rivalry  was  the  be t o a v o i d  i s to drive prices  equilibrium  interesting,  would  the standard  a market  observed  competitive data  of  address  e q u i l i b r i u m has been  information,  down t o t h e c o m p e t i t i v e  could  should  when t h e c o m p e t i t i v e  primary  of  research  of our  for  further  research  project  more  interesting  researchers  auditor  examine  changes,  the primary  effect  or of  57  Chapter SUMMARY AND In  this  between  the  and  the  thesis, market  rate  motivation allegations of  competition  of  public  that an  this  underlying  could  studies  had  to provide  (both  academic  answer  to  the  other of  and  inhibit  the  the  Independence," summarized In  competitive  the  settled  auditor  paper  posed  entitled  article, equilibrium  surfaced  the  i t appeared  evidence  such  and  construction  auditor  the  of and  independence  that  researchers regarding in  part  of  the  auditing  this  In c o l l a b o r a t i o n the  independence. "Market and  is fully  concluded in  first  e x a m i n e d how  Nielsen and  we  have  Does c o m p e t i t i o n  above.  auditor  Two,  independence  were unanimous  in  author  Stein,  levels  the  Anecdotal  evidence  persistent  increased  decades,  of  general  independence?  described  the  two  perceptions  sufficient  the  that  without  model.  users'  affect  by  past  independence, The  from  allegations  legislative)  i n Chapter  this  be  relationships  time.  literature  such over  not  question  a u d i t i n g may was  over  stemmed  following question:  researchers,  effort  A.  on  research  addresses  As  theoretical  empirical  The  the  i n a u d i t i n g somehow c o m p r o m i s e  issue  promote or  changes  in accounting  numerous times  failed  some o f  auditing, auditor  research  auditors.  resurfaced  examined  auditor this  found  have  CONCLUSIONS  s t r u c t u r e of  of  for  we  Six  The  Simunic  and  of  this  Auditor  in  was  Appendix  attainment  provides  two  structure  (SNS), which  reproduced the  with  result  Structure  that  auditing  market  thesis  of  the-  sufficient  58  conditions the  for  auditor  e f f e c t s of  between that  increased  competing  being  with  price.  And  expect  to  as  new  further  period  of  second  portion  of  existing OTC  auditor listed  information  Assuming increased would  Regression identifiable  auditor  those  that  during  the  was  rivalry  predict  although  rivalry this  on  found  competitive  rivalry  will  risk  to  decrease  incumbent  auditing  services  auditor  we  at  a  lower  would  also  turnover  during  in  the  time  in  1972,, 1978  review  empirical  this 191  and  study,  companies  1969  to  19.79  markets,  auditor  on  the  auditor  auditor  turnover  computed, and  an  For  from  a  1983.  prompted  our  turnover  was  theory  should  be  period.  number of  Coe  After  sample of  auditing  turnover  changes,  I n d u s t r i a l Manuals  t e s t s performed  by  auditor  performed.  increased  that  on  thesis.  collected for a  increase  reported  rivalry  a l l auditors  auditor  AICPA- r u l e changes- i n  price  observable  of  (or  the  hypotheses,  rate  c h a n g e s was  M o o d y ' s OTC  that  not  replace  SNS  of  literature  auditor  i n the  increasing  increased  i n the  of  until  offering identical the  analyzed  i n d e p e n d e n c e and  expect  companies  of  examined  study  would  extending an  auditor  we  rivalrous disequilibrium.  effect  the  on  competition  compromised  we  auditors  Furthermore,  of  However, as  client  discover  The  of  be  i s achieved.  fees  firms  this  may  nonindependent,  auditors'  levels  auditors)  independence  equilibrium  independence.  changes  Palmon  were  sample d a t a  indicated  changing  behavior.  recorded,  and  significantly  [1979],  the  absolute  the  no And  rates  higher number  than of  59  changes trend  recorded  discovered  from non-Big  fees  remarkably  i n d i c a t e d an  Eight  Finally, results  was  to  Big  reasons  were e x p l o r e d .  and  increased  assumptions inadequate. continuing  Given interest  modelling  and  recommended. results  by  changes,  or  failing  auditor  the  nature  i n these  examining through  the  significant OTC  model  of  discover  predicting is  data the  our  testing  future either  firms  expected diminished  incorrect, set  research  of  problem,  these  researchers a  collection  larger of  audit  or  our  examined  issues, further refinements  additional However,  to  turnover  and/or the  only  auditing firms.  E i t h e r our  employed  The  i n c r e a s i n g movement o f  Eight  for  small.  may  data fee  were and  the  to  the  hypotheses find set data.  of  is  richer auditor  60  TABLE T O T A L A U D I T O R CHANGES  I AND TURNOVER  RATES  1969-1983 Excluding Identified Auditor Mergers No. o f Changes 1 9 6 9 - 70 1 9 7 0 - 71 1 9 7 1 - 72 1 972-73 1973-74 1 974-75 1 9 7 5 - 76 1 9 7 6 - 77 1 9 7 7 - 78 1 978-79 1 9 7 9 - 80 1 9 8 0 - 81 1 9 8 1 - 82 1 9 8 2 - 83  18 13 13 12 7 8 13 10 13 10 12 8 1 1 1 1  TOTALS  159  Averages  1 1 .36  Source:  Moody's I n v e s t o r 1970-1984.  Excluding A l l Identified and P o s s i b l e A u d i t o r Mergers No. o f Changes  9, 42 6, 81 6, 81 6, 28 3, 66 4, 19 6, 81 5, 24 6, 28 5.24 6.28 4.19 5.76 5.76  13 9 1 1 10 6 8 13 10 1 3 9 1 1 6 10 7  % 6, 81 4, 71 5, 76 5, 24 3, 1 4 4, 19 6, 28 5, 24 6, 28 4.71 5.76 3.14 5.24 3.66  1 36  5.95  Services,  9.71  I n c . OTC  Industrial  5.09  Manuals.  61  TABLE I I SUMMARY OF  OTC  A U D I T O R CHANGE R E S U L T S  Nielsen 1. T o t a l N u m b e r o f OTC 2.  Time P e r i o d s  Examined  :Number o f C h a n g e Examined 3.  T o t a l Number o f Changes :Annual  4.  Firms  Turnover  Turnover  and  191  115  1969-1983  1952-1975  14  24  Auditor  1 68*  66  Rate  6.28%  2.39%  37  1 36  Rate  5.09%  1 .34%  * F o r c o m p a r i s o n w i t h Coe and Palmon's r e s u l t , t h i s amount i n c l u d e s a l l changes i d e n t i f i e d i n the rough data, except changes such as " H a s k i n s and S e l l s " t o " D e l o i t t e , H a s k i n s Sells."  Source:  Palmon  Periods  T o t a l Number o f A u d i t o r Changes E x c l u d i n g A l l P o s s i b l e Mergers rAnnual  Coe  Moody's I n v e s t o r 1970-1984.  Services,  I n c . OTC  Industrial  for and  Manuals.  62  TABLE I I I F R E Q U E N C Y OF A U D I T O R  Number o f A u d i t o r Changes  Number o f Companies  Percentages (%)  0  85  44.5  1  59  30.9  2  35  18.3  3  9  4.7  4  2  1. 1  5  1  .5  TOTALS  Source:  CHANGES BY COMPANY  Moody's I n v e s t o r 1970-1984.  191  Services,  100.0%  I n c . OTC  Industrial  Manuals.  63  TABLE I V SEGMENTED A U D I T O R CHANGES 1969-1983 Changes w i t h i n Big Eight Auditors 1 9 6 9 - 70 1 9 7 0 - 71 1 971-72 1 972-73 1 9 7 3 - 74 1974- 75 1 975-76 1 976-77 1 977-78 1 978-79 1979- 80 1 9 8 0 - 81 1 9 8 1 - 82 1 982-83  Changes w i t h i n Non-Big Eight Auditors*  3 4 3 4 1 2 1 2 3 2 5 2 3 2  37  TOTALS Average Annual Turnover Rate Average Annual Turnover Rate (Coe & Palmon)  2.34?  .92  1 1 5 4 5 4 4 4 4 4 5 3 4 3 3  63  Total In-group A u d i t o r Changes  14 9 7 9 5 6 5 6 7 7 8 6 6 •5 100  5.77%  3.74%  .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 r e m o v e d , 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%.  Source:  Moody's I n v e s t o r S e r v i c e s , 1970-1984.  I n c . OTC  I n d u s t r i a l Manuals,  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 pertaining to the public auditing industry in the United States. 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 public audits, the - l e v e l s of competitiveness and the l e g i s l a t i v e or 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 in Canada than that found i n t h e U.S. However, l i t t l e attention has been directed toward the structure and conduct of Canadian public auditors, with v i r t u a l l y no academic or p r o f e s s i o n a l r e s e a r c h devoted to these i s s u e s . C e r t a i n l y the l a c k of a v a i l a b l e C a n a d i a n d a t a hampers any such research effort.  2.  "Opinion-shopping," or when a c l i e n t c o m p a n y e i t h e r m a k e s m u l t i p l e a u d i t o r c h a n g e s or p r o p o s a l s w i t h the i n t e n t i o n of 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 the issues under review by t h e H o u s e S u b c o m m i t t e e . The Subcommittee has c a l l e d f o r h e a r i n g s t o examine b o t h the o v e r a l l q u a l i t y and e f f e c t i v e n e s s of f i n a n c i a l disclosures in the U.S. According to C h a i r m a n J o h n D. D i n g a l l , the hearings 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 o w n e d c o r p o r a t i o n s " a n d t h e performance of the Securities and Exchange 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 and a c c o u n t i n g responsibilities." ["Congressional Subcommittee Convenes. . . ," p. 12] The hearings commenced February 20,1985 a n d a r e e x p e c t e d t o continue throughout 1985.  3.  F o r an e x c e l l e n t overview B u c k l e y and Weston [ 1 9 8 0 ] .  4.  A review of the complete body of 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 . However, 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 p a g e o f A p p e n d i x A.  5.  For a Barlev  6.  T h e a b o v e d i s c u s s i o n on t h e role of the public auditor assumes t h a t p e r f e c t i n f o r m a t i o n does not e x i s t . In f a c t , a n 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 information asymmetries do exist (for example, between owners 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 firm and third party users), the usefulness of the public auditor is maintained. T h i s a s s u m p t i o n of imperfect information is used throughout the analyses c o n t a i n e d i n t h i s t h e s i s .  7.  Such arguments could be perceived written by practicing auditors who  of  the  issues  involved,  f u l l d i s c u s s i o n of t h e s e c o n f l i c t s , see [ 1 9 7 4 ] and N i c h o l s and P r i c e [ 1 9 8 3 ] .  Goldman  see  and  a s s e l f - s e r v i n g when are interested in  65  maintaining elevated levels of market concentration. However, the f o l l o w i n g example i s by Sterling [1973], a notable accounting academic who c l e a r l y h a s no personal self-interest involved. Sterling stated: 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 today is i t s lack of power. . .[which] i s lessened f u r t h e r by t h e existence of competition among accounting firms. Resignation f r o m an e n g a g e m e n t might be a n e f f e c t i v e m e a n s o f e n f o r c e m e n t i f i t were not f o r the f a c t t h a t o t h e r f i r m s may take t h e e n g a g e m e n t and i s s u e an o p i n i o n . [p.66] 8.  For example, see W a t t s and Zimmerman [ 1 9 8 1 ] and D e A n g e l o [1981a]. These a u t h o r s have d e f i n e d a u d i t quality to be the 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 will both discover and report a breach in the client's accounting system. Thus one measure of auditor independence i s the assessed p r o b a b i l i t y of an auditor reporting a discovered breach.  9.  Consistent competitive  with price  10.  See  Two  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, rivalrous actions can include other forms of non-price competition. In 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 competition (or p r i c e r i v a l r y ) .  12.  Even if the increased rivalry was based on n o n - p r i c e determinants such as product differentiation, we would expect to observe increased turnover i f incumbents refuse to i n c r e a s e or a l t e r t h e i r package of s e r v i c e s r e n d e r e d at a constant p r i c e . S i m i l a r arguments regarding information 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 ' proposals for increased services.  13.  The i n t e r e s t e d e n t i r e t e x t of  14.  The work in 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 the analyses p r e s e n t e d i n the September, 1985 version of 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 n u m e r o u s c o m m e n t s on that version, and Mr. S t e i n has d e c i d e d t o p u r s u e t h i s topic- area in his doctoral dissertation. The authors acknowledge that 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 areas, including the lack of a precise definition of auditor independence. Nevertheless, f o r the p u r p o s e s of t h i s t h e s i s e n d e a v o r , the a n a l y s e s and c o n c l u s i o n s of the existing SNS paper form the framework for the work presented here.  Chapter  standard includes a  for a  full  micro-economic normal return to  discussion  reader i s d i r e c t e d t h e SNS article.  to  of  this  Appendix  theory, capital.  the  mechanism.  A  for  the  66  15.  I n t h i s p a p e r we a s s u m e t h a t t h e m a r k e t f o r a u d i t s prefers auditor independence (or at least the appearance of independence) over nonindependence. Although we acknowledge that a sub-market f o r a u d i t o r nonindependence e x i s t s , we a s s u m e 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 is 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.  For the s a k e of c o n v e n i e n c e , none of by SNS will be reproduced here. 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 the e x i s t e n c e of d i f f e r e n c e s in auditors' opinions regarding whether or not 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 as " 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 of auditors' assessments as to the costs of nonindependence. This issue is discussed further in Chapter Four.  18.  The a s s u m p t i o n conform with throughout the restricted un a l l e g a t i o n s of extended into motivated the investigation.  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 . For his doctoral d i s s e r t a t i o n , Simunic [1980] c o l l e c t e d fee data for a sample of 397 U.S. firms by distributing questionnaires to a total of 1,207 companies. Francis [ 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 study using publicly a v a i l a b l e A u s t r a l i a n data which i n c l u d e d a u d i t fee data.  20.  In 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 F o r m s 8-K to require the reporting of a change in the principal auditor of a registrant. The requirement stated that firms were to disclose any significant accounting or auditing disagreements with former a u d i t o r s o c c u r r i n g i n the e i g h t e e n months preceding the auditor change. Subsequent amendments to this requirement included an extension of the disagreement period to t w e n t y - f o u r months, the mandatory d i s c l o s u r e as 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 r e c o m m e n d e d or approved 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 firms voluntarily disclose the reasons f o r the a u d i t o r change.  21.  This section of Coe and Palmon's paper is extremely confusing. 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 between the r a t e of a u d i t o r changes and time[p.5], they then referred ( i n c o r r e c t l y ) to their t o t a l annual turnover data, i n d i c a t i n g that turnover rates did increase over time, e s p e c i a l l y d u r i n g the f i n a l s i x y e a r s  the equations employed A g a i n , the i n t e r e s t e d  of  an o l i g o p o l i s t i c m a r k e t structure would much of the anecdotal evidence cited 1970's. Certainly price competition was til the antitrust suit in 1972, and the continued l a c k of p r i c e competitiveness the mid-1970's. Such a l l e g a t i o n s l a r g e l y Senate Subcommittee (Metcalf Commission)  67  of t h e s a m p l e period. I t i s only with very careful 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 found only Eight auditor turnover r a t e s i n c r e a s i n g over time, and that this result was not documented i n the material presented. 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 stated that they did find increasing auditor turnover rates. Given Coe and Palmon's problems of e x p o s i t i o n , McConnell's oversight i s understandable. 22.  I t s h o u l d be n o t e d that the c r e d i b i l i t y of such selfreporting i s q u e s t i o n a b l e . T h e 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 written statements from their former a u d i t o r s i n d i c a t i n g whether they agreed or 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 previous auditor-client disagreements.  23.  The a u d i t o r s i d e n t i f i e d opinions were Arthur T o 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 , 3 0 0 auditor changes identified (through examination of the d a i l y S E C News D i g e s t p u b l i c a t i o n ) w e r e made b y OTC companies, McConnell 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 example, see [1982], and Simunic  26.  F o r example, i f t h e r e i s s u f f i c i e n t disagreement i n the appropriate reporting m e t h o d t o be u s e d f o r a n i n d i v i d u a l client, one auditor may perceive an action as nonindependent, 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 method compared to another auditor who views 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 zero costs of nonindependence.  27.  T h i s author approached McConnell with the idea of extending h i s d a t e base such that some trend analyses could be performed. However, M c C o n n e l l d e c l i n e d .  28.  Examination of McConnell's data for multiple auditor changes r e v e a l s that t h i s i s not a s i g n i f i c a n t problem.  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 listings and auditor c h a n g e i n f o r m a t i o n f o r m o s t o f . t h e same c o m p a n i e s l i s t e d i n the Moody's Manuals. However, i t s first edition was p u b l i s h e d i n 1 9 7 6 , 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 data. Furthermore, McConnell [1983] found 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 to conclude that i t was a n 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 above problems, c o u p l e d w i t h t h e f a c t that Who Audits America i s not 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 .  as having a tendency to qualify Young & Co., Coopers & L y b r a n d , and  DeAngelo and S t e i n  [1981b], [1984].  Dopuch  and  Simunic  68  30.  For example, [1983.]  see  Coe  and  Palmon  [1979]  and  McConnell  31.  The sample size of 200 firms was b a s e d on a n i n f o r m a l assessment of the marginal b e n e f i t s / c o s t s of sampling, and that this amount a t l e a s t e q u a l l e d Coe a n d 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 the sample s e t then c o n s i s t s of "stagnant" companies; that is, these are firms e x p e r i e n c i n g i n s u f f i c i e n t growth t o "move o n " t o t h e l a r g e r exchanges. The i m p l i c a t i o n s of t h i s c o n s t r a i n t are discussed i n Chapter Five.  33.  The f o l l o w i n g OTC companies were removed from because of l a r g e r e p o r t i n g "gaps": D i g i t a l Products Corporation El Chico Corporation 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 Metallurgical Industries, Incorporated Motor C o i l s Manufacturing Corporation P r o f e s s i o n a l Care S e r v i c e s , Incorporated Rectisel Corporation S t e r l i n g Computer Systems, 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 , a n e f f o r t w a s made to get information on the continued existence of the predecessor auditor. I f the " o l d " auditor was l i s t e d subsequent t o t h e i n d i c a t e d change i n our sample of OTC changes, i n Who A u d i t s A m e r i c a , o r i n a n 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 a s s u m e d t h a t no m e r g e r took place. As i n d i c a t e d below, twenty-three changes c o u l d not 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 auditor merger occurred.  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 total collection of changes because of t h e reasons l i s t e d below: 1983 a u d i t o r change by Paul Harris Stores, Incorporated. The company organized a major r e f i n a n c i n g package that year and simultaneously changed from a non- B i g E i g h t a u d i t o r t o a B i g Eight auditor. 1981 a u d i t o r change by South State 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 auditor indicates a material accounting change where t h e o i l f i e l d pumping 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 change by United States Surgical Corporation. Changes i n accounting policies 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 b y  t h e sample  69  1977  t h e SEC a g a i n s t t h e c l i e n t c o m p a n y . a n d 1981 a u d i t o r changes by Van Dyk Research Corporation. The c o m p a n y s w i t c h e d b a c k a n d f o r t h between two a u d i t o r s d u r i n g a p e r i o d of C h a p t e r XI proceedings. An earlier change was not removed from the t o t a l changes 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 the s t a t u s of t h e s e possible changes/mergers. However, the AICPA librarians were unable to provide the necessary information i n time for t h i s t h e s i s submission.  37.  The difference between our computed rates and those presented by Coe and Palmon i s p u z z l i n g . Unfortunately, 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 annual turnover rates for OTC f i r m s , a n d h e n c e we c a n n o t c o m p a r e t h e two data sets. Given that there i s a seven year o v e r l a p (1969 t o 1975), such a c o m p a r i s o n would have 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 services for small c l i e n t s , O'Keefe and Barefield [ 1 9 8 5 ] f o u n d t h a t an a v e r a g e of 35 p e r c e n t of the very small manufacturing firms in their sample 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 from nonincumbent auditing firms. Assuming that these firms r e c e i v e d no u n s o l i c i t e d proposals prior to 1979, this evidence supports the n o t i o n t h a t the AICPA r u l e changes 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 a n i n c r e a s i n g m a r k e t for audits might sufficiently dampen the e x p e c t e d r e s u l t s of p r i c e rivalry. However, most observers of auditing markets concur that the overall market f o r a u d i t s has remained g e n e r a l l y s t a b l e over the past two decades. Legislation introduced in the past decade pertaining to the 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 and municipalities has not significantly altered the s i z e of the a u d i t i n g market.  40.  I t i s a l s o p o s s i b l e that other (exogenous) c r i t e r i a used i n a u d i t o r s e l e c t i o n have d e l a y e d the effects of increased 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 the time period e x a m i n e d may n o t e x t e n d l o n g e n o u g h 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 to auditor changes. However, anecdotal evidence that this a u t h o r has r e c e i v e d from professional auditors indicates that changes in the rate of auditor turnover 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 .  41.  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 to determine i f the competitive equilibrium has been r e a c h e d . F o r e x a m p l e , c o s t and c a p i t a l i n v e s t m e n t data may also be required to determine levels of profitability.  70  BIBLIOGRAPHY  American I n s t i t u t e of C e r t i f i e d Public Accountants. Report, C o n c l u s i o n s and Recommendations of t h e Commission of Auditors' Responsibilities. AICPA, 1978. Antle, R. Research,  "Auditor Independence." Vol. 22, S p r i n g , 1984.  A r n e t t , H. a n d P. Danos. M i c h i g a n , 1979.  Journal of Accounting  CPA F i r m V i a b i l i t y .  University  of  Beams, F.A. a n d L.N. Killough. "Audit Independence—An Extension of the Concept." National Public Accountant, Vol. 15, Dec. 1970. Bedingfield, J . Examination." 1 974.  a n d S.E. Loeb. "Auditor Changes Journal of Accountancy, Vol. 137,  Bolten, S.E. and J.H. C r o c k e t t J r . Independent A u d i t o r s ? " Financial 35, Nov./Dec. 1979.  An March,  "How I n d e p e n d e n t a r e t h e Analysts Journal, V o l .  Buckley, J. a n d F. Weston. R e g u l a t i o n and t h e Accounting Profession. 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. Roberts. "A Study of Audit Journal of Accountancy, V o l . 123, A p r i l , 1967.  Changes."  Carpenter, C.G. a n d R.H. Strawser. "Displacement of A u d i t o r s When C l i e n t s Go Public." J o u r n a l of Accountancy, V o l . 131, J u n e , 1 9 7 1 . Coe,  T. a n d D. Palmon. "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 Auditor Turnover." Unpublished Manuscript, New York U n i v e r s i t y , 1979.  Coe,  T. a n d D. Palmon. " A u d i t o r Independence: Type o f A u d i t Opinions and Auditor D i s m i s s a l . " Unpublished Manuscript, New Y o r k U n i v e r s i t y , 1 9 8 0 .  "Congressional Subcommittee Convenes Hearings Accounting Profession." J o u r n a l of Accountancy, A p r i l , . 1985. C h o w , C. a n d S. Switching."  into Vol.  SEC, 159,  Rice. "Qualified Audit Opinions and Auditor Accounting Review, V o l . 57, A p r i l , 1982.  Danos, P. a n d J.W. Eichenseher. "Audit I n d u s t r y Dynamics: Factors Affecting Changes in Client-Industry Market Shares." J o u r n a l of Accounting Research, V o l . 20, Autumn, 1982.  71  DeAngelo, L.E. "Auditor Independence, 'Low Disclosure Regulation." J o u r n a l of Economics, V o l . 3, A u g u s t , 1981[aTi DeAngelo, L.E. Accounting  "Auditor S i z e and and E c o n o m i c s , V o l .  Balling,' Accounting  Audit Quality." Journal 3, D e c e m b e r , 1981 [ b ] .  and and of  D o p u c h , N. and D. Simunic. "Competition in Auditing: An Assessment." Fourth Symposium on Auditing Research, U n i v e r s i t y of 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 o n A u d i t P r i c e s . " J o u r n a l of A c c o u n t i n g and 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. Reactions."  Schiff. "CPA S w i t c h e s and A s s o c i a t e d Market Accounting Review, V o l . 56, A p r i l , 1981.  Goldman, A. and B. Barlev. "The A u d i t o r - F i r m 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 Independence." Review, V o l . 49, O c t o b e r , 1974.  C o n f l i c t of Accounting  G o n e d e s , N. a n d R. Kihlstrom. "On t h e Q u a l i t y a n d Q u a n t i t y o f Auditing Services Under A l t e r n a t i v e Market S t r u c t u r e s . " Unpublished M a n u s c r i p t , U n i v e r s i t y of 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 F i r s t Ed., 1976. Harris, 8th Kay,  S.P. Ed.,  Audits  [ e d . ] Who May, 1982.  America.  Audits  America.  Data  Financial  Press,  Data F i n a n c i a l P r e s s ,  R.S. a n d N.A. Lavin. "Enhancing Auditors' Independence 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 . " Account ing Forum, V o l . 4 9 , May, 1979.  Knapp, M.C. Perceived Pressure."  "Audit Conflict: An Empirical Study of the Ability of Auditors to Resist Management Accounting Review, V o l . 60, A p r i l , 1985.  Lavin, D. "Perceptions of Accounting Review, V o l . McConnell, Eight  D.K. Firms.  the 51,  Independence of January, 1976.  Jr. P u b l i c Company A u d i t o r UMI R e s e a r c h P r e s s , 1983.  McConnell, D.K. Disagreements,"  Jr. "Auditor Auditing, Vol. 3,  Moody's I n v e s t o r s S e r v i c e s , 1970 1984.  Inc.  OTC  Nichols, D.R. and D.B. Smith. Auditor Changes." J o u r n a l of 21, Autumn, 1983.  Changes Spring,  Industrial "Auditor Accounting  the  Auditor."  Changes and and 1984.  Big  Related-  Manuals. Credibility and Research, Vol.  72  O'Keefe, T. and R. Barefield. "Purchases of Accounting Services by Small Clients: Description 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 of Oregon, 1985. Olson, W. "What is Auditor Accountancy, V o l . 149, A p r i l , Pany,  K. "Effects of Gifts, Discounts and P e r c e i v e d A u d i t o r Independence." Accounting 55, J a n . , 1980.  P e n n e y , L.H. Journal Pound  Independence?" 1980.  "The S i g n i f i c a n c e o f M e r g e r s o f of Accountancy, V o l . 112, Nov.  J o u r n a l of C l i e n t S i z e on Review, Vo'l.  Accounting 1961.  Firms."  G.D. and J.R. Francis, "Accounting S e r v i c e s Market: Theory and Evidence." J o u r n a l of 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, A u t u m n , 1981.  S a v o i e , L.M. Needed?"  "Client-Auditor The CPA, V o l .  R e l a t i o n s h i p : I s More 2, M a y , 1972.  Independence  Schwartz, K.B. and K. Menon. " A u d i t o r S w i t c h e s by Firms." Accounting Review, V o l . 60, A p r i l , 1985.  Failing  Shockley, R.A._ "Perceptions of Auditor's Independence: An Empirical Analysis." Accounting Review, 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 of A u d i t Independence: A C o n c e p t u a l Model." J o u r n a l of A c c o u n t i n g , A u d i t i n g and F i n a n c e , V o l . 5, W i n t e r , 1982. Shockley, R.A. a n d R.N. Holt. "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 the Market f o r A u d i t S e r v i c e s . " J o u r n a l of Accounting Research, V o l . 21, Autumn, 1983. S i m u n i c , D.A. "The Pricing of Audit Services: Evidence." J o u r n a l of A c c o u n t i n g R e s e a r c h , Spring, 1980.  Theory Vol.  and 18,  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 of Accounting Research, V o l . 22, Autumn, 1984. S i m u n i c , D.A. Auditing: Issues." Columbia,  and M. Stein. "Product Differentiation in 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 Unpublished Manuscript, University of British 1984.  Stein, M. , A. N i e l s e n , a n d D. Simunic. A u d i t o r Independence." Unpublished at the Universities of British Washington J o i n t Accounting Research 1985.  "Market S t r u c t u r e and Manuscript', presented Columbia, Oregon and Workshop, September,  73  Sterling, Vol.  Robert. " A c c o u n t i n g Power." 135, J a n u a r y , 1973.  Journal  of  Accountancy,  United States Senate. Report of the Subcommittee on 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 Operations. 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 and Independent Auditors." Unpublished U n i v e r s i t y of R o c h e s t e r , 1981.  Independence Manuscript,  W a t t s , R.L. a n d J . L . Zimmerman. "Agency Problems, Auditing, 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 and E c o n o m i c s , V o l . 26, O c t . , 1983. Zeff,  S.A. and R.L. Fossum. Clients." Accounting Review,  "An A n a l y s i s of Large V o l . 42, A p r i l , 1967.  Audit  APPENDIX A  MARKET STRUCTURE AND AUDITOR INDEPENDENCE  M. Stein, A. Nielsen, and D. Simunic  The U n i v e r s i t y of B r i t i s h Columbia June 1985  75  1.  DJTRODUCTION It i s commonly agreed that an auditor should  client.  Further,  the  auditor  should  also  be independent of h i s  have  the  appearance  independence to third parties, above actually being independent. all  auditors  may  not  always  be  independent,  and  in  the  of  However,  past  decade  considerable attention has been focussed on issues pertaining to auditor independence.  Some of the research  underlying auditor-client c o n f l i c t Price  (1976)],  the  to date includes examination of the  [Goldman and Barlev (1974), Nichols and  possible relationship between auditor  turnover  and  independence [Burton and Roberts (1967), Chew and Rice (1982), Nichols and Smith (1983)], and the e f f e c t of p r i c i n g p o l i c i e s or auditor size on audit quality [DeAngelo (1981a), (1981b)]. A d d i t i o n a l l y , the current debate over the provision of management advisory services by auditors stems from the alleged imply  negative  impact on auditor independence that  such services  may  [eg. Simunic (1984)]. Similarly, i n recent years there has been extensive debate regarding  the  market  structure  concentration  have  of  often  public  accounting.  maintained  that  Allegations  1  the  markets  of  market  for audits  are  structured o l i g o p o l i s t i c a l l y , especially i n the market for large c l i e n t s . For example, the Report of the U.S. concluded  that  there  is  Senate Subcommittee (Metcalf Report)  insufficient  competition  in  audit  markets,  2 p a r t i c u l a r l y among the largest national firms.  On  the other hand, the  AICEA Commission on Auditor's Responsibilities (Cohen Commission) asserted that excessive price competition i n extant markets for audits jeopardizes the q u a l i t y 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  their  concept of  " q u a l i t y " i s l a r g e l y undefined, and cannot be d i r e c t l y applied to auditor independence. perception  The a n p i r i c a l evidence regarding market structure and the  of auditor independence has been mixed.  785) studied the perceptions  Shockley (1981, p.  of CPA's and f i n a n c i a l statement users with  respect to the  independence of audit firms.  firms operating  i n highly competitive  He concluded that  "audit  environments ... are perceived  as  having a higher r i s k of l o s i n g independence." However i n a recent study, Knapp  (1985)  found  no  conclusive  independence i s undermined Knapp's r e s u l t s services  "does  that  a  the l e v e l  major  actual  or perceived  influence  independence remains unclear. offer  our model  effect  of  market  perceived  f o r audits.  of competitiveness on  user's  auditor's a b i l i t y to r e s i s t management pressure." The  auditors'  i n a highly competitive  indicate that not have  evidence  f o r audit  perceptions  of  (1985, p. 209)  market  structure  on  auditor  I t i s w i t h i n t h i s general context that we  demonstrating how  various  market  conditions  incentives f o r e i t h e r auditor independence or nonindependence.  provide We show  that a s u f f i c i e n t condition f o r 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 markets, nor whether auditors are independent.  i n extant  audit  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 a n a l y s i s , 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 p r i c e competition  leads to  impaired  independence. The remainder of the paper i s organized as follows. define auditor independence and introduce our model.  We  In Section 2 we then introduce  economic rents (Section 3) and demonstrate hew market structure a f f e c t s  77  independence  (Section 4).  The costs of nonindependence are detailed  in  Section 5, and Section 6 analyzes the alleged loss of independence due to rivalry.  2.  Cur conclusions and a b r i e f summary are provided i n Section 7.  A MODEL OF AUDITOR INDEPENDENCE We start  wealth.  by  Also,  assuming we  that  assume  auditors  that  all  accomplished by a common technology.  are  audits  utility are  maximizers  homogeneous  Further the audits are  over  and  are  statistically  independent i n the sense that the normal costs of each audit do not affect  3 one another.  We define the following notation:  -j_(aj) = auditor i ' s  F  fee for the audit of c l i e n t 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 c l i e n t j , Tj  = the net cost to the c l i e n t j of switching auditors. An auditor is independent of his c l i e n t i f the auditor's actions  not influenced by the preferences  of the c l i e n t .  are  However, since auditor  fees are channelled through the corporation there i s a potential c o n f l i c t between auditors fees  while  and managers.  auditors  must  Recognizing this c o n f l i c t , the auditor's  report we ask  economic interest  answer comes i n two v a r i e t i e s . by being nonindependent.  Managers may have de facto control over on  the  performance  the following question:  to be  independent of  his  of  managers.^  When i s  i t in  client?  Our  The f i r s t i s when the auditor i s worse off  We c a l l this incentive independence.  The second  i s when the auditor has s u f f i c i e n t bargaining power to r e s i s t the c l i e n t ' s requests for nonindependent action. More formally,  the auditor  following inequalities hold:  is  This we term bargaining independence. better  off  being independent  if  the  78  F ( a ) - C(a^) > 0 i  (1)  j  F ( a ) - C(aj) - D ( a ) < 0 i  j  i  In our  (2)  j  analysis, we  restrict  ourselves  to a discussion of  auditor  5 wealth.  We  assume that more wealth i s preferred to less, and  that  the  normal cost of an audit includes a normal return to the auditor's e f f o r t . This i s important as the wage paid to the auditor i s just s u f f i c i e n t at the margin for the auditor to be non-auditing  (1)  indicates  independent audit of c l i e n t that  not  First,  nonnegative, equation  i f we  that  the  j to not  having  nonindependent audit. seen.  other  activities.  Equation  indicates  indifferent between auditing and  the  auditor  prefers  having the  client  is  client.  preferred  (weakly) Equation  (weakly)  an (2)  to  a  Immediately, two key points of our analysis can  be  assume that the costs of nonindependence are always  then a necessary condition for nonindependence occurs when  (1) holds  strictly.  If equation  (1)  i s false  or holds with  equality, then equation (2) w i l l hold and the auditor would prefer to drop the c l i e n t 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(q )), u(w(q )), u(w(q ))] 1  2  3  qeQ where U(w) choices  i s the  (with  utility  respect  of  to a  wealth and particular  q-^, q , 2  client)  q  of,  3  are  MAX  auditor's  respectively, audit  independently, audit nonindependently, or do not audit. equation (1) and  the  For example, i f  (2) hold, then the auditor faces the following choice:  [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:  ^Oj)  - COj) > 0  (1)  F ( a ) < F ( a ) + T j , Vi=2 . . . M. 1  j  i  (3)  j  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 c l i e n t ' s  threat  to defect  i s not credible.  The incumbent auditor can r e s i s t the c l i e n t even i f : F  1  - C(a.) - D ( a ) > 0 1  (4)  j  p should hold, since a p r o f i t maximizing c l i e n t would not switch auditors. The The set  two preceeding sets of conditions are very d i f f e r e n t i n flavour.  f i r s t indicates the auditor prefers independence, whereas the second indicates  that  the auditor  can bargain  f o r independence.  equations (1) and (2) hold, the auditor i s incentive independent.  When 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) i s false. if  the market  structure  allows  Equation (1) i s l i k e l y to hold  the auditor  to earn  economic  rents.  Furthermore, the magnitude of D i s c l e a r l y important i n whether equation (2) w i l l hold. essentially  If i t i s believed that D i s very large, then auditors w i l l  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 i n audit markets. 3.  ECONOMIC RENTS Economic rents are defined as returns i n excess of the normal return  to an asset.  Typically, economic rents are earned on assets whose supply  80  i s limited, and the rent i s the difference i n the asset's value between its  best and best alternative use.  policy as their existence may market.  Rents are of interest i n economic  indicate imperfect  competition  i n a given  In particular, rents can often occur i n markets where s i g n i f i c a n t  barriers to entry exist thus l i m i t i n g supply. The market for audits, with for  the professional requirements necessary  supplier entry, i s a candidate  f o r economic rents.  In our model, an  economic rent exists with respect to a p a r t i c u l a r audit i f the inequality i n 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 affect  [1981b]  auditor  independence.  auditor-specific contended with  efficiency  that while  respect  also discussed  how  the existence  However,  gains,  her  not by  client-specific  to a p a r t i c u l a r c l i e n t ,  rents  rents  market  are  could  generated  structure.  reduce auditor  here.  by  DeAngelo  independence  the sum t o t a l of a l l other  rents act as a c o l l a t e r a l bond against nonindependence. consistent with those presented  of rents  client  Her results are  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. to a l l auditors.  These rents are endogenously determined and thus accrue Since  the loss of existing rents  component of nonindependence costs, these costs may directly  with  collateral  the size  bond  of the rents.  If this  i s also endogenously created  could  major  be expected to vary  i s correct,  by market  independence would exist regardless of market structure. this issue i n the next three sections.  be a  then  the  structure, and We investigate  81  4.  MARKET STRUCTURE AND  INDEPENDENCE  In this section we independence.  There are  issues involved. subdividing audits  in  are  optional.  CASE 1:  analyze  We each  how  market structure influences auditor  four paradigm cases which demonstrate the  look at what happens under monopoly and instance  compelled  (e.g.  for  the  institutional  legislatively  key  competition,  arrangement where  imposed) and  where  they  are  Later, we b r i e f l y introduce the intermediate case of oligopoly.  MONOPOLY, MANDATORY AUDIT  At f i r s t glance this case may auditor has  the maximum leverage  appear to be the arrangement where the to enforce  independence.  There are  no  substitutes for the auditor's service and the c l i e n t s are compelled to buy from a single supplier. F  1  where we  < F  2  This situation i s described by equation ( 3 ) :  (3)  + T  can think of T as being i n d e f i n i t e l y large.  ensure the auditor of bargaining independence. threat of defection and  This would seem to  The c l i e n t has no credible  the auditor shares this  information.  because the audit i s mandatory, the auditor must audit.  However,  In e f f e c t ,  this  changes the auditor's choices, as the option of withdrawing from the audit with outcome zero i s no longer available.  The choice faced by the auditor  is: 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 c l i e n t can impose upon the auditor through noncooperation. this  case are  The costs associated with D i n  the expected costs of loss of the monopoly charter.  For  instance, i f the auditor's actions are deemed to be nonindependent, t h i s  82  could invite governmental intervention which would reduce the monopolist's wealth.^ These two costs act i n opposing ways. the auditor w i l l maximize (5) by being  If E i s large (relative to D),  independent.  If D i s large then  the auditor w i l l s a c r i f i c e some independence. ^ 1  The key result for the mandated monopoly case i s that the c l i e n t auditor are bound to one set,  another.  Thus by l i m i t i n g the auditor's  nonindependence becomes, possible.  does not refer to equation (1). as the choice  and  choice  Note that the preceeding analysis  Here the existence of rents i s irrelevant  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 c l i e n t can choose the no audit option. and  Therefore  the auditor w i l l be independent i f either equations (1)  (2) hold; or a l t e r n a t i v e l y , i f equations (1) and  right hand side of  (3) i s now  interpreted as the cost of the alternative  to the monopoly-provided a u d i t .  1 1  If equation (1) f a i l s to hold, then the  auditor w i l l choose the no audit option. the  possibility  of  (3) hold, where the  nonindependence.  However, we have not eliminated  Using  the  formula, a monopolist sets price according to the  standard  microeconomic  equation:  1_ F[l - n ] = C  (6) 12  where TI i s the price e l a s t i c i t y  of demand and C  i s 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 p o s s i b i l i t y that equation (4) w i l l also hold; whether (4) w i l l hold depends upon'the size of D. enforce  independent action.  As  Large costs of nonindependence w i l l  DeAngelo  [1981b] pointed  out, one  major  83  component of D may  be the  aggregate rents are  large  loss of rents on other c l i e n t s . (in an  expected value  sense),  If the  then D may  lost be  13 s u f f i c i e n t l y large to bring the auditor bade to independence. Before  moving  to  the  next  case,  relationship between equations (6) and related charge  to  the  higher  expensive. right  a v a i l a b i l i t y of prices  This has  and  left  we  (3).  should  those  cases  the  effect  of  in  where  the  The  auditor  will  alternatives are  most  difference between  the  auditor w i l l be independent, i f the auditor has mispriced his service  due  holds, he may  not be  about the able  right  small.  While  the  (3) holds  to some uncertainty  (3)  (3).  the  keeping the  hand sides of equation  upon  The e l a s t i c i t y i n (6) w i l l be  substitutes  in  comment  hand side of  to r e s i s t  client  (3), and  pressure  i f (4) also  for nonindependent  action. CASE 3:  COMPETITION, MANDATORY AUDIT  Under competition, that  it  is  never  nonindependence, and the  case  of  a  nonreimbursable competition  equation  preferred  (1) holds with equality.  by  the  auditor  to  bear  This any  costs  the auditor w i l l be incentive independent.  mandated  monopoly,  noncooperation  we  costs.  the auditor has a counter.  still Unlike  The  have  the  monopoly  implies of  As with  problem  of  however,  in  auditor can force the c l i e n t  to change auditors and bear the transactions costs, T j . Thus i f the c l i e n t uses the  threat of noncooperation to induce auditor nonindependence, the 14  auditor can use the threat of forcing the c l i e n t to change auditors. In a competitive audits, Therefore  auditors  market where there are no rents and with mandatory  cannot afford  to  bear  the  costs  of  nonindependence.  we might expect to. see a mechanism for shedding these nuisance  c l i e n t s , such as an audit report q u a l i f i c a t i o n .  If we compare this to the  84  monopoly case, The  rents  imperfect  the difference i s the existence of rents under monopoly.  allow  soire  room  competition,  to go along  with  the c l i e n t .  the auditor would find  audits which cannot be shed.  Even  use for qualifying  with those  An empirical implication would be that audit  reports are more readily q u a l i f i e d the smaller the rents.  CASE 4: COMPETITION, NONMANDATORY AUDITS Again, equation  (1) holds with equality.  The auditor i s i n d i f f e r e n t  between auditing and not auditing a particular c l i e n t .  The auditor w i l l  tolerate no nonindependence, as i t i s costly and i n h i b i t s the making of a normal return.  Thus equation  (2) holds along with  (1) and the auditor i s  incentive independent.  CASE 5: OLIGOPOLY Oligopoly  i s an intermediate case between monopoly and competition.  For our purposes what i s important structure,  equation  oligopolistic product.  Equation  smaller than  return  to hold  strictly,  sloping demand  given  curve  that  for their  (1) implies the existence of rents and the p o s s i b i l i t y  of the monopoly case.  instances  i s likely  auditors face a downward  of nonindependence.  be  (1)  i s that with an o l i g o p o l i s t i c market  The remaining analysis would proceed along the l i n e s However, i n general, the rents to each auditor w i l l  i n the monopoly case, and hence there should  where equations  (1) and (4) hold  simultaneously.  to a further analysis of the oligopoly case  competition and r i v a l r y .  when  be fewer We  shall  we discuss  85  SUMMARY The  results  competitive  of  pricing  this  section  leads  to  non-competitive pricing allows  can  be  summarized  incentive  as  follows:  independence,  whereas  for the p o s s i b i l i t y  of nonindependence.  Whether auditor independence w i l l be maintained depends upon the magnitude of D. if  If D i s large, incentive independence results.  D i s small  then either bargaining  On the other hand,  independence occurs when  client  defection i s costly, or auditors w i l l be nonindependent i f c l i e n t s require it.  Outside of the monopoly,  competitive  mandatory  pricing i s sufficient  audit  case we  conclude that  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 t o 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 c l i e n t s . D (a.) =  J  That i s ,  F (a ) - C(a )  (7)  where N i s the set of c l i e n t s held by auditor one.  Presumably information  about the loss of auditor one's independence w i l l cause h i s other c l i e n t s to seek an independent auditor. auditor  i s collecting  c o l l a t e r a l bond.  many  rents.  Thus  D-^a..) w i l l  This  be large  i s the basis  when the  f o r DeAngelo's  86  The c o l l a t e r a l bond leads to the curious result that while individual rents create an opportunity  f o r nonindependence (our equation  (1)), the  aggregate loss of rents w i l l force equation (2) to hold and thus incentive independence i s achieved.  This  mechanism i s important  in that market  structure can determine the existence and magnitude of the rents. straight-forward  step to see how large rents increase  thus strengthen  the size of D and  the c o l l a t e r a l bond.  We have a number of c r i t i c i s m s of the c o l l a t e r a l bond. size  of the potential  independence. variations  loss may  not be s u f f i c i e n t l y  F i r s t , the  large  to ensure  Recall that nonindependence may be continuous, and small  from  auditor  independence  Auditors may take small deviations these  It i s a  deviations  are material,  may  serious  results.  from an independent action.  Even i f  frequently  not have  there  i s enough  judgment  required i n auditing decisions to obscure the impact of the nonindependent action.  Thus the p r o b a b i l i t y of actual detection of nonindependence may  be very small. Furthermore, equation nonindependence.  (7) defines  In r e a l i t y ,  firms  the maximum  f o r auditor  do not lose a l l of their  because of a single indiscrete act. And f i n a l l y , expressed  penalty  i n terms of an expectation.  clients  the cost D should be  If the probability of getting  caught i s small, then the accompanying penalties may not be s u f f i c i e n t l y large to deter nonindependent action. Therefore when the above factors are combined, the auditor may view D to be s u f f i c i e n t l y audit.  small such that equation  (4) holds f o r a p a r t i c u l a r  The size of D i s an empirical issue and we can see no reason to a  p r i o r i r e s t r i c t i t s range.  87  Another c r i t i c i s m of the c o l l a t e r a l bond i s that competitive provides a better mechanism to ensure auditor independence. (1) holds with equality then (2) must hold and guaranteed.  pricing  If equation  incentive independence i s  There i s no need to rely upon bargaining  independence when  rents exist and D i s small. We  believe the appeal of the c o l l a t e r a l bond argument for l i m i t i n g  competition  rests with a particular  market to which we now  6.  COMPETITION AND The  type of t r a n s i t i o n a l condition i n the  turn.  RI\ALRY  d i s t i n c t i o n between competition  in discussions of market structure and the  inter-firm  opportunism  and  characterized failure  by  the  to make this  we  r i v a l r y i s often overlooked  independence.  exploitation  ultimately lead to economic e f f i c i e n c y . other hand, by competition  and  of  By r i v a l r y we mean opportunities  Rivalry i s competing.  mean the state of competitive  absence of distinction  economic p r o f i t s . leads  We  that Cn  the  equilibrium  feel  that  to the kind of confusion  the  where  anti-competitive behavior i s seen as preserving independence. The argument that competition  (actually r i v a l r y ) impedes independence  i s 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 c l i e n t s may increase i f they believe that other auditing firms would be happy to accept the engagement should a c l i e n t become displeased. To understand the motivation  for the above argument, l e t us suppose  that the market for audits i s organized o l i g o p o l i s t i c a l l y , and there i s no r i v a l r y among the auditors."^  88  We  will  maintain  will  be  Auditors  our  previous  assumptions  used -in  independent i f either the conditions  2.  Section  for incentive  or  bargaining independence hold.  Incentive  independence rests upon  the  costs  of  nonindependence  being large, whereas bargaining independence depends upon equation (3): F  < F  x  (3)  + T.  2  With no r i v a l r y , F^^ equals F , 2  switching  auditors  and  i f the net transactions cost of  i s positive, then equation  (3) w i l l  hold.  What i s  important to note i s that we are describing a market situation where there are positive rents and yet no loss of independence. There are imperfect market  several  competition  troubling economic points. there  are  price  and  i s being  restricted  and  there  i s no  optimal  amount of  auditing  socially  As  quantity reason  in a l l cases of  distortions. to believe  i s occurring.  The  that  Additionally,  a  the  virtue of independence i s being maintained as a result of c o l l u s i v e , and therefore generally unstable, arrangements between suppliers. price  rivalry  The lack of  supports the mechanism necessary to ensure both incentive  and bargaining independence. Now,  l e t us suppose that price r i v a l r y  i s introduced  to the market  such that nonincumbent firms have incentives to charge lower fees incumbent auditors. F  l  (  a  j  )  ^ ^ j *  >  Auditors clients hold,  +  T  hold:  j*  ( 8 )  can no longer prevent c l i e n t defection.  desire then  The following relationship may  the  some type of auditor  than  nonindependence and  cannot  resist  the  If we assume that  equations  client's  (4) and  request.  i l l u s t r a t e s the claim that increased r i v a l r y can weaken independence. one  should  auditor  is  recognize  that the problem arises only because the  simultaneously  attempting  to  hold  on  to  (8) This But  incumbent  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 i s restored. Falling  fees also affect  incentive independence.  If we use a prime  to denote the lower fee structure under r i v a l r y , then: D  l  ( a  k  }  I  =  F  l  k kN k^j ( a  )  "  k  C ( a  >  )  I  F  'l  ( a  e  However,  )  C ( a  k  }  =  D  'l  ( a  k * )  ( 9 )  €  independence reduced  k " kN  may  not  be  the excess of  affected  structure  has  [F-C].  linearity  then the decrease i n D w i l l just offset  as  the  If there  lower  is  fee  sufficient  the decrease in [F-C]  and incentive independence w i l l hold. Thus  the introduction  nonindependence  as  of  rivalry  those auditors  could  produce  the appearance of  attempting to maintain rents  also  maintain independence.  Furthermore, with more  will  expect more cooperation  to support the previous  fees.  We  can see how  level  clients  of higher  the existence of rents and the desire to maintain  them provide pressure for auditor nonindependence disequilibrium.  rivalry,  cannot  However, once  rivalry  forces  during this  fees  period of  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  auditing  profession.  structure notions each  and of  is  auditor  incentive applicable  demonstrated  how  and how different  of In  auditors this  paper we  independence and  is critical  may  bargaining  under  various  the existence  of  have be  to society demonstrated  related.  independence market  rents  could  We and  and how  to the market  developed the illustrated  structures. compromise  We  how also  independence  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  o f a u d i t i n g markets i n r e c e n t would be p e r c e i v e d In  d u r i n g the e q u i l i b r a t i n g  conclusion,  competition instituted  y e a r s and showed how a u d i t o r  our a n a l y s i s  i n the a u d i t i n g rules to l i m i t  have added t o the p e r c e i v e d  argues  market.  entry  independence  process. strongly In  and r e s t r i c t  f o r the b e n e f i t s  the p a s t , rivalry.  the These  auditors  of to  independence competitively  such lose  rents their  i s more  i s necessary independence,  likely  organized.  profession rules  may  " p r o f e s s i o n a l i s m " o f a u d i t o r s , but a t t h e same  time c r e a t e d c o n d i t i o n s which can g i v e r i s e t o economic r e n t s . existence  of  t o be  (although  not  the s o c i e t a l  achieved  Since t h e  sufficient) for good  i f auditing  of  auditor  markets a r e  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 i n s u f f i c i e n t competition (Simunic, 1980).  3  See Simunic and Stein (1985) for the significance of this assumption. Also, note that we model action i n 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 t h i s problem, although to the extent the auditor must rely upon the goodwill and cooperation of management, the potential c o n f l i c t remains.  5  We have suppressed issues of uncertainty. To do this one can think of the D-'s as being expressed i n certainty equivalent units. As usual U'(w) > 0.  6  We exclude the p o s s i b i l i t y that unscrupulous auditors could save enough in production costs by supplying a low quality audit to make nonindependent costs negative. This assumption i s based upon a legal environment where such cheating i s heavily sanctioned. This i s i n contrast to the Klein and L e f f l e r (1981) model of product quality i n the absence of such legal sanctions. In that model quasi-rents are required i n 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 i s determined by p r e v a i l i n g market conditions. The fee offered i s not discriminatory i n the sense the auditor offers the same fee to a l l s i m i l a r c l i e n t s . We do not allow the fee to increase as compensation for auditor nonindependence. We are interested i n 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 i n 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, i n s t i t u t e third party l i a b i l i t y , etc.  10  The costs E and D may well be continuous i n the auditor's actions. Thus i t i s 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 i s sometimes useful to think of the continuous choice  92 analogue. In this case, as nonindependence i s not a l l or none, i t i s possible to have small D's thus allowing equation (2) to hold. 11  For instance, substitutes may be a surety bond to insure c r e d i t o r s , 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 i s 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 i s clear that even i f in a given period the auditor gets "stuck" with a noncooperative c l i e n t , the c l i e n t w i l l be passed on i n the next period. The c l i e n t w i l l have to bear a succession of transactions costs and f i n a n c i a l markets w i l l learn that i t i s the c l i e n t and not the auditor who i s unreliable.  15  This could accord with the situation where there are few providers of audit services and professional ethics codes prohibit a c t i v i t i e s such as advertising which promote r i v a l r y .  93 APPENDIX A  REFERENCES  American Institute of C e r t i f i e d conclusions and recommendations Responsibilities.  Public Accountants, of the Commission  1978, Report, on Auditors'  Buckley, J. and F. Weston, 1980, Regulation and the accounting profession (Lifetime Learning Publications, Belmont, CA). Burton, J. and W. Roberts, Accountancy, A p r i l , 31-36.  1967,  A study of auditor changes, Journal of  Chow, C. and S. Rice, 1982, Qualified audit switching, Accounting Review, A p r i l , 326-335.  opinions  and  auditor  DeAngelo, L., 1981a, Auditor independence, 'low b a l l i n g , ' and disclosure regulation, Journal of Accounting and Economics, Aug. 113-127. DeAngelo, L. 1981b, Auditor size and audit q u a l i t y , Journal of Accounting and Economics, Dec., 183-199. Goldman, A. and B. Barlev, 1974, The auditor-firm c o n f l i c t 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. L e f f l e r , 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 a b i l i t y of auditors to A p r i l , 202-211.  C o n f l i c t : An empirical study of the perceived r e s i s t management pressure, Accounting Review,  Nichols, D. and K. Price, 1976, The auditor-firm c o n f l i c t : An analysis using concepts of exchange theory, Accounting Review, A p r i l , 335-346. Nichols, D. and D. Smith, 1983, Auditor c r e d i b i l i t y 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 p r i c i n g of audit services: Theory and Journal of Accounting Research, Spring, 161-190.  evidence,  Simunic, D., 1984, Auditing, consulting, and auditor independence, Journal of Accounting Research, Autumn, 679-702. Simunic, D. and M. Stein, 1985, Audit r i s k i n a c l i e n t p o r t f o l i o context, Unpublished manuscript (University of B r i t i s h 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.).  Appendix  B  : L I S T OF  S A M P L E OTC  COMPANIES  Academy C o m p u t i n g C o r p o r a t i o n Aero Systems, I n c o r p o r a t e d A i r Cargo Equipment C o r p o r a t i o n Alabama By-Products C o r p o r a t i o n Algorex Corporation A l l i e d Security, Incorporated Alloy Metal Products, Incorporated Alpine Geophysical Associates, Incorporated American Medical S e r v i c e s , Incorporated American Nucleur Corporation American Recreation Centers, Incorporated Auric Corporation 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 Barringer Resources, Incorporated Bel Fuse, Incorporated B i g P i n e y O i l a n d G a s Company Biospherics, Incorporated B l a c k Angus Systems, I n c o r p o r a t e d B o s t o n S a n d a n d 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 Butler National Corporation Calumet 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 Carolina Mills, Incorporated Centrex Corporation Century Papers, Incorporated Cerveceria Corona, Incorporated Charvoz-Garsen Corporation C h a t h a m M a n u f a c t u r i n g Company Clayton Corporation 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 Communications I n d u s t r i e s , Incorporated Computer Usage Company, I n c o r p o r a t e d Comshare, I n c o r p o r a t e d Connohio, Incorporated Control Laser Corporation Cordis Corporation Cybermatics, Incorporated Cyclotron Corporation D.A.B. Industries, Incorporated Daylight Industries, Incorporated Dekalb AgResearch, Incorporated Dewey E l e c t r o n i c s C o r p o r a t i o n Discovery O i lLimited Dollar General Corporation DuArt 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 Corporation of America E.B.S. Data P r o c e s s i n g , Incorporated E d u c a t i o n a l Development C o r p o r a t i o n Educational Technology, Incorporation Elco Industries, Incorporated E l e c t r o n i c C o n t r o l Systems, Incorporated E l w e l l - P a r k e r Systems, Incorporated Evans (Bob) Farms, I n c o r p o r a t e d Fabric Wholesalers, Incorporated Fanning E n t e r p r i s e s , Incorporated 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 Fleet Leasing, Incorporated F l u o r o c a r b o n Company Funtime, Incorporated G & K Services, Incorporated Gam R a d , 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 General Kinetics, Incorporated G e r i a t r i c and Medical Centers, Incorporated Goddard I n d u s t r i e s , Incorporated Graco, Incorporated Guardian Packaging Corporation Gulf Energy and Development C o r p o r a t i o n Hallmark Data Systems, Incorporated Hamburger H a m l e t s , I n c o r p o r a t e d Haverty F u r n i t u r e Companies, I n c o r p o r a t e d Hermetite Corporation 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 Brothers, Incorporated Hydro Flame C o r p o r a t i o n Hytek 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 Infodata Systems, Incorporated Inter-Continental Services Corporation Inter-Polymer Industries, Incorporated International Packings Corporation Intertherm, Incorporated Isomet C o r p o r a t i o n Jaco E l e c t r o n i c s , Incorporated Jerrico, Incorporated Johnson E l e c t r o n i c s , Incorporated Jones and V i n i n g , Incorporated Kalvar Corporation Kettering Industries, Incorporated Keweenaw L a n d A s s o c i a t i o n , L i m i t e d Kratos, Incorporated Lady B a l t i m o r e Foods, I n c o r p o r a t e d Lake Shore, I n c o r p o r a t e d L e w i s ( P a l m e r G.) C o m p a n y , I n c o r p o r a t e d Life Sciences, Incorporated 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  Los A l a m i t o s Race Course 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 Twain M a r i n e , I n c o r p o r a t e d Mathematical A p p l i c a t i o n s Group, 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 Metallurgical Industries, Incorporated Metro-Tel Corporation Michaels ( J . ) , Incorporated Mile High Kennel Club Miles-Samuelson, Incorporated Miller Industries, Incorporated 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 National Beryllia Corporation Network Data 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 North American B i o l o g i c a l s , Incorporated Offshore Navigation, Incorporated Ohmart C o r p o r a t i o n Oneita K n i t t i n g M i l l s Oppenheimer I n d u s t r i e s , I n c o r p o r a t e d Oshkosh 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 Packaging Systems C o r p o r a t i o n Pasquale Foods, I n c o r p o r a t e d Paul Harris Stores, Incorporated P e e r l e s s M a n u f a c t u r i n g Company Photo-Control Corporation Photo-Marker Corporation Plasmine Corporation Polyplastex United, Incorporated Power D e s i g n s , I n c o r p o r a t e d Programming and Systems, I n c o r p o r a t e d Pulaski Furniture Corporation Puritan-Bennett Corporation 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 Systems, Incorporated 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 Refac Technology Development C o r p o r a t i o n Reuter, Incorporated Rex P l a s t i c s , Incorporated Rospatch Corporation Royalpar Industries, Incorporated San/Bar E l e c t r o n i c s C o r p o r a t i o n Saxton Products, Incorporated Scan-Optics, Incorporated Scope, I n c o r p o r a t e d S e n e c a O i l Company Sherburne Corporation Sirco International Corporation  Sloan Technology Corporation Solid Controls, Incorporated S o u t h S t a t e s O i l a n d 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 Staff Builders, Incorporated S t a u f f e r Communications, Incorporated 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 Technology, Incorporated Tad's E n t e r p r i s e s , I n c o r p o r a t e d Tapecon, Incorporated Technology, Incorporated Telemation, Incorporated 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 Tinsley Laboratories, Incorporated Trans-Industries, Incorporated Trion, Incorporated T r o x e l M a n u f a c t u r i n g Company Turner Broadcasting System, Incorporated 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 C o m p a n y United States Surgical Corporation U n i v e r s a l M a n u f a c t u r i n g Company Vail Associates, Incorporated Valmont 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 Walker C o l o r , Incorporated 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 Western Beef, Incorporated Weston (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 York Research C o r p o r a t i o n Zenith Laboratories (191 )  99  Appendix 1970  Auditor  C  : L I S T OF OTC  COMPANIES  CHANGING  Changes  Alpine Geophysical Associates, Incorporated American Nucleur Corporation 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 Clayton Corporation Comshare, I n c o r p o r a t e d E d u c a t i o n a l Development C o r p o r a t i o n Fanning Enterprises, Incorporated 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 , Incorporated Jaco E l e c t r o n i c s , Incorporated MSI E l e c t r o n i c s , Incorporated 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 Turner Broadcasting Systems, Incorporated Van Dyk R e s e a r c h C o r p o r a t i o n Walker Color, Incorporated Zenith Laboratories, Incorporated 1971  Auditor  Changes  Biospherics, Incorporated Daylight Industries, Incorporated E.B.S. Data P r o c e s s i n g , Incorporated Educational Technology, Incorporated E l e c t r o n i c C o n t r o l Systems, Incorporated 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 Hallmark Data Systems, I n c o r p o r a t e d Inter-Continental Services Corporation Jerrico, Incorporated Kratos, Incorporated Miles-Samuelson, Incorporated Programming and Systems, 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  Auditor  Changes  Alloy Metal Products, Incorporated Comshare, I n c o r p o r a t e d Discovery O i l Limited D y n a s i l Corporation of America 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 Miles-Samuelson, Incorporated 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 North American B i o l o g i c a l s , Incorporated  AUDITORS  Polyplastex United, Incorporated Sherburne Corporation Staff Builders, Incorporated Troxel Manufacturing Company 1973  Auditor  Changes  Barringer Resources, Incorporated Charvoz-Carsen Corporation E l e c t r o n i c C o n t r o l Systems, I n c o r p o r a t e d Goddard I n d u s t r i e s , Incorporated Hytek I n t e r n a t i o n a l C o r p o r a t i o n Intertherm, Incorporated Jaco E l e c t r o n i c s , Incorporated Life Sciences, Incorporated Miller Industries, Incorporated Refac Technology Development 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  Auditor  Changes  Alpine Geophysical Associates, Incorporated Calumet I n d u s t r i e s , Incorporated Dewey E l e c t r o n i c s C o r p o r a t i o n Goddard I n d u s t r i e s , Incorporated Isomet 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 Zenith Laboratories, Incorporated 1975  Auditor  Changes  A i r Cargo Equipment 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 Life Sciences, Incorporated 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 Polyplastex United, Incorporated Saxton Products, Incorporated 2B S y s t e m s , I n c o r p o r a t e d 1976  Auditor  Changes  Aztec Manufacturing Company Bel Fuse, Incorporated B l a c k Angus Systems, I n c o r p o r a t e d Cybermatics, Incorporated D y n a s i l Corporation of America E d u c a t i o n a l Development 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 Systems, 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 Services, Incorporated L o g a n C l a y P r o d u c t s Company Michaels ( J . ) , Incorporated Sirco International Corporation W a i l u k u S u g a r Company 1977  Auditor  Changes  Bisopherics, Incorporated 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 Systems, I n c o r p o r a t e d Michaels ( J . ) , Incorporated M i l l e r Industries, Incorporated National Beryllia Corporation NMC C o r p o r a t i o n Refac Technology Development C o r p o r a t i o n Tapecon, Incorporated Western Beef, Incorporated 1978  Auditor  Changes  Calumet I n d u s t r i e s , Incorporated Computer U s a g e Company, I n c o r p o r a t e d Inter-Continental Services Corporation Jaco Electronics., Incorporated Lady B a l t i m o r e Foods, 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 Pasquale Foods, Incorporated Royalpar Industries, Incorporated Sirco International Corporation Sloan Technology Corporation S o u t h S t a t e s O i l a n d Gas Company Staff Builders, Incorporated 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  Auditor  Changes  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 Discovery O i l Limited Evans (Bob) Farms, I n c o r p o r a t e d Life Sciences, Incorporated Metro-Tel Corporation 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 Packaging Systems C o r p o r a t i o n S e n e c a O i l Company Telemation, Incorporated 2B S y s t e m s , I n c o r p o r a t e d  102  1980  Auditor  Changes  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 , Incorporated G e r i a t r i c and M e d i c a l Centers, Incorporated Isomet C o r p o r a t i o n Kalvar Corporation Los A l a m i t o s Race C o u r s e Mathematical A p p l i c a t i o n s Group, Incorporated Photo-Marker Corporation R a d i a t i o n Systems, Incorporated Scan-Optics, Incorporated United States Surgical Corporation 1981  Auditor  Changes  Charvoz-Carsen Corporation Elco Industries, Incorporated Goddard I n d u s t r i e s , Incorporated Hermetite Corporation H i c k o r y F u r n i t u r e Company International Packagings Corporation 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  Auditor  Changes  Academy C o m p u t i n g C o r p o r a t i o n Alpine Geophysical Associates, Incorporated 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 Development 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 Hydro Flame C o r p o r a t i o n Hytek I n t e r n a t i o n a l C o r p o r a t i o n Kettering Industries, Incorporated North American B i o l o g i c a l s , Incorporated Photo-Marker Corporation Polyplastex United, Incorporated 1983  Auditor  Changes  Academy C o m p u t i n g C o r p o r a t i o n Alloy Metal Products, Incorporated 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 Hydro Flame C o r p o r a t i o n Life Sciences, Incorporated Maxon I n d u s t r i e s , Incorporated 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, York Research Corporation (159)  Incorporated  104 Appendix  D:  R E S U L T S OF  REGRESSION  TESTS  M I D A S S T A T I S T I C A L RESEARCH LABORATORY U N I V E R S I T Y OF M I C H I G A N 14:50:48 SEP 2 4 , 1985 1.  Total  Auditor  Changes  (159)  <READ F I L E = T . C H N G E S V A R = 1 - 2 L A B E L = C H A N G E S , Y E A R  CASES=1-14>  R E A D O B S E R V A T I O N S 1-14 V A R I A B L E S BY C A S E < R E G R E S S I O N VAR=1,2> LEAST  SQUARES  ANALYSIS  OF  REGRESSION  VARIANCE  OF  1.CHANGES  SOURCE  DF  SUM  REGRESSION ERROR TOTAL  1 12 13  18.858 82.356 101.21  MULT R=  .43165  R-SQR=  SQRS  . 1 8 6 3 2 SE=  VARIABLE  PARTIAL  COEFF  CONSTANT YEAR  -.43165  33.382 -.28791  N=  14 OUT  OF  14  MEAN SQR  F-STAT  18.858 6.8630  2.7478  SIGNIF . 1 233  2.6197 STD  ERROR  13.305 .17369  T-STAT 2.5089 -1 . 6 5 7 7  SIGNIF .0275 . 1 233  105 2.  Changes w i t h i n  Big Eight  Auditors  <READ F I L E = E . E VAR=1-2 L A B E L = C H A N G E S , Y E A R  CASES=1-14>  READ O B S E R V A T I O N S 1-14 V A R I A B L E S BY C A S E D E G R E S S I O N VAR=1,2> LEAST  SQUARES R E G R E S S I O N  ANALYSIS  OF V A R I A N C E  OF 1.CHANGES  SOURCE  DF  SUM  REGRESSION ERROR TOTAL  1 12 13  .31758 16.897 17.214  MULT R=  .13583  R-SQR=  SQRS  .01845  VARIABLE  PARTIAL  COEFF  CONSTANT YEAR  -.13583  5.5011 - .37363  3.  Changes w i t h i n  <READ F I L E = N . N  Non-B i g  N=  14  MEAN  OUT OF  SQR  .31758 1.4081 SE=  ERROR  6.0268 . 7 8 6 7 2 -1  SIGNIF  .22555  .6434  T-STAT  SIGNIF  .91278 -.47492  .3793 .6434  Eight Auditors  VAR=1-2 L A B E L = C H A N G E S , Y E A R  READ O B S E R V A T I O N S V A R I A B L E S BY C A S E  F-STAT  1 . 1866 STD  -1  14  CASES=1~14>  1-14  <REGRESS!ON VAR=1,2> LEAST  SQUARES R E G R E S S I O N  A N A L Y S I S OF  VARIANCE  SOURCE REGRESSION ERROR TOTAL MULT R=  OF  DF 1 12 13  .46547  R-SQR=  1.CHANGES SUM SQRS 6.6857 24.171 30.857 .21667  VARIABLE  PARTIAL  COEFF  CONSTANT YEAR  -.46547  16.400 -.17143  SE=  N=  14 OUT  MEAN SQR 6.6857 2.0143  OF  14  F-STAT 3.3191  SIGNIF .0935  1.4193 STD  ERROR  7.2083 .94096-1  T-STAT  SIGNIF  2.2752 -1.8219  .0420 .0935  106 4.  Changes w i t h i n  <READ F I L E = E N . E N  Big Eight  and Non-Big E i g h t  VAR=1~2 L A B E L = C H A N G E S , Y E A R  Auditors  CASES=1"14>  READ O B S E R V A T I O N S 1-14 V A R I A B L E S BY C A S E D E G R E S S I O N VAR=1,2> LEAST  SQUARES  ANALYSIS  OF  REGRESSION  VARIANCE  OF  1.CHANGES  SOURCE  DF  SUM  REGRESSION ERROR TOTAL  1 12 13  9.9176 35.011 44.929  MULT R=  .46983  R-SQR=  SQRS  . 2 2 0 7 4 SE=  VARIABLE  PARTIAL  COEFF  CONSTANT YEAR  -.46983  21.901 -.20879  5.  Changes  from  Big Eight  N=  14 OUT  OF  14  MEAN SQR  F-STAT  SIGNIF  9.9176 2.9176  3.3992  .0900  T-STAT  SIGNIF  2.5245 -1 . 8 4 3 7  .0267 .0900  1.7081 STD  ERROR  8.6753 .11325  t o Non-Big  Eight  <READ F I L E = 8 . N VAR=1-2 L A B E L = C H A N G E S , Y E A R  Auditors  CASES=1"14>  READ O B S E R V A T I O N S 1-14 V A R I A B L E S BY C A S E D E G R E S S I O N VAR=1,2> LEAST  SQUARES  ANALYSIS  OF  REGRESSION  VARIANCE  OF  1.CHANGES  SOURCE  DF  SUM  REGRESSION ERROR TOTAL  1 12 13  8.3176 32.611 40.929  MULT R=  .45080  R-SQR=  SQRS  . 2 0 3 2 2 SE=  VARIABLE  PARTIAL  COEFF  CONSTANT YEAR  -.45080  16.556 -.19121  N=  14 OUT  OF  14  MEAN SQR  F-STAT  SIGNIF  8.3176 2.7176  3.0607  .1057  T-STAT  SIGNIF  1.9774 -1.7495  .0714 . 1 057  1.6485 STD  ERROR  8.3727 .10930  107 6.  Changes  from Non-Big  <READ F I L E = N . 8  Eight  to Big Eight  VAR=1-2 LABEL=CHANGES,YEAR  Auditors  CASES=1-14>  R E A D O B S E R V A T I O N S 1-14 V A R I A B L E S BY C A S E D E G R E S S I O N VAR=1,2> LEAST  SQUARES  ANALYSIS  REGRESSION  OF V A R I A N C E OF  1.CHANGES  SOURCE  DF  SUM  REGRESSION ERROR TOTAL  1 12 13  11 .886 9.8286 21.714  MULT R=  .73984  R-SQR=  SQRS  .54737  VARIABLE  PARTIAL  COEFF  CONSTANT YEAR  .73984  15.629 .22857  <FINISH>  SE=  N=  14 OUT  OF  14  MEAN SQR  F-STAT  SIGNIF  11 .886 .81905  14.512  .0025  T-STAT  SIGNIF  -3.4001 3.8094  .0053 .0025  .90501 STD  ERROR  4.5965 .60002  -1  

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:
http://iiif.library.ubc.ca/presentation/dsp.831.1-0095895/manifest

Comment

Related Items