Bankrupcy, auditor Switching and Audit failure: Evidence from the UK. 1987-1994

Clive Lennox
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Clive Lennox: University of Bristol

No 98/2, Royal Holloway, University of London: Discussion Papers in Economics from Department of Economics, Royal Holloway University of London

Abstract: If a company's auditor believes that the company is likely to enter bankruptcy, the auditor is required to warn investors by giving a 'qualified' audit report. This paper investigates whether auditor switching can help explain why auditors frequently fail to warn about impending bankruptcy. The paper shows that managers use the switch decision to avoid receiving qualified reports and a switch exogenously reduces the accuracy of audit reports by replacing established incumbent auditors with less well informed new auditors. These results mean that the use of switching by managers is not necessarily contrary to investors' interests. Moreover, policies aimed at reducing managerial influence - for example, a recent EC policy proposal recommended the compulsory periodic switching of auditors - could reduce the accuracy of audit reports.

JEL-codes: M41 G33 (search for similar items in EconPapers)
Date: Written 1998-07
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