Auditor Switching - A Two-Stage Decision Process: An Empirical Study of Australian Companies
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This dissertation is concerned with a primary and two secondary research issues. The primary issue pertains to the existence of a two-stage auditor switching decision process; that is the auditor change and the auditor selection stages. The two secondary issues concern the relative influence of variables within their respective decision stages. External auditors are engaged not only to comply with the Corporations Law requirement and Australian Stock Exchange membership conditions but also to reduce the degree of information risk assigned by financial statement users to financial statements prepared by auditee management. The decision to switch auditors may cause financial statement users to assign a higher degree of information risk to financial statements, i.e., the indirect costs of switching auditors. A substantial increase in these indirect costs may have occurred as the average rate that Australian publicly listed companies switch auditor has increased in recent years. However, prior research has provided inconsistent and inconclusive evidence with regard to the variables that influence auditees to switch auditors. To avoid mis-perceptions by financial statement users about the newly appointed auditors' attestation of the financial information prepared by auditees, a greater understanding is needed of the auditor switching decision process to assist in mitigating these indirect costs of switching auditors. In prior research the underlying suggestion why auditees switch auditors is the development of a mis-match of audit services demanded to the services supplied by the incumbent auditor. To overcome this mis-match, auditees after deciding to change auditors then select a specific audit firm that offers suitable services and possesses suitable characteristics. A suggested reason for the inconsistent findings of prior research is that there are two decision stages (auditor change and auditor selection) in the auditor switching decision process and past studies have examined, intentionally or otherwise, different decision stages. From a two decision stage perspective, there are three additional explanations for the inconsistent findings of prior research. These explanations are 1) the inappropriate use of surrogate measures for the decision stage studied, 2) the misuse of the terms auditor change, auditor selection and auditor switching, and 3) the inappropriate research methodology and instrument design employed. This absence of a 'shared agreement' among researchers about the two-stage auditor switching decision concept and misuse of terms may have confused not only researchers but also survey participants and readers of auditor switching literature thus contributing to the inconsistencies in prior evidence as well as perpetuating the inconsistent results where the readers are the future researchers. A review of the literature identified five characteristic variables of the incumbent and replacement audit firms that influence the auditor switching decision. Four variables (disagreements between auditees and auditors that result in, or are caused by, the issuance of a qualified audit report and recommendations from three external sources) in addition to the five incumbent auditor characteristics were found to influence only the auditor change decision. In addition to the five replacement auditor characteristic variables, a further five variables, involving audit firm image creation or other promotional activities, have been found to influence the auditor selection decision stage. A primary and two secondary problems regarding the auditor switching decision process are addressed (1) How and to what extent does the impact of the five auditor characteristics on Australian auditees' decisions to change auditors (to terminate the incumbent auditor's appointment) differ from that on auditees' decisions to select the replacement auditor? (2) How and to what extent are the nine variables used by Australian auditee management in the decision to change auditors (to terminate the incumbent auditors appointment)? (3) How and to what extent are the ten variables used by Australian auditee management in the decision to select a replacement auditor? The provision of evidence to support the two-stage auditor switching decision process may be achieved by jointly examining and identifying significant differences in the perceived influence of auditor characteristics across the two decision stages and a comparison of their rank order of influence within each stage. Three empirical models are constructed to investigate these three research questions. Using the MANOVA (within-subjects) design, the first model is to analyse each respondent's perception of the level of influence of each of the five auditor characteristic variables across the two decision stages. The second and third empirical models are using an one-way ANOVA design to test the influence of each of the respective independent variables (i.e., nine variables for the change decision and ten variables for the selection decision) on the respective dependent variable (i.e., the change decision or the selection decision). Fifty-three usable responses were received from Australian companies identified as voluntarily switching auditors for the reporting year ended 1990 and/or 1991. The data collected for analysis were provided by company executives of these companies. The major findings of this study are: 1) Two of the five auditor characteristics, 'level of audit quality' and 'suitability of non-audit services', differed significantly in their level of relative influence across the two decision stages. Furthermore, there was some support in the results for a perceived difference in the influence of a third auditor characteristic, 'size of audit fees', across both stages. 2) Significant differences were perceived in the level of influence of variables on the auditor change decision stage. The six most influential variables were the higher audit fees, the auditor's offices were not located near the auditee's geographically dispersed offices, the incumbent auditor's lack of industry specialisation, a higher audit quality was not provided, the non-audit services offered were unsuitable, and director's recommendations. 3) In the auditor selection decision stage, significant differences were perceived in the level of influence of variables. The six most influential variables were the lower fees, the recommendations of business colleagues, a higher quality audit can be provided, the suitability of range of non-audit services, the closeness of the auditor's offices to the auditee's geographically dispersed operations, and the availability of industry specialisation. 4) A comparison of the rank order of influence of auditor characteristic variables within each decision stage found variances exist for two variables 'closeness of auditor's offices to the auditee's operations' and 'the level of industry specialisation' across the two stages. 5) The significant difference in the level of influence of characteristics of the incumbent and replacement auditors in the first finding suggests that auditors are not perceived as providing homogeneous services. Furthermore, from the significant difference in these auditor characteristic variables within each decision stage in the second and third findings imply that the auditor characteristics of an auditor are not perceived as homogeneous. The following major conclusions are drawn from this study. The evidence from these major findings support the existence of a two-stage auditor switching decision process. The results also show that auditor switching decision makers' perceptions of the variables that influence auditor switching vary across the two decision stages and with the auditor change and auditor selection decisions. Finally, because the characteristics of the auditors vary in their perceived influence across both stages and within each decision stage, these variances suggest the auditor characteristics supplied are perceived to be heterogeneous. This perceived heterogeneity permits audit firms to differentiate their services offered and requires auditees to employ a two-stage auditor switching decision process.
Master of Philosophy (MPhil)
Department of Accounting, Finance and Economics
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Selection of auditor