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A Theory of Auditor Resignation

1998; Wiley; Volume: 36; Issue: 2 Linguagem: Inglês

10.2307/2491474

1475-679X

Keith Bockus, Frank Gigler,

Law, Economics, and Judicial Systems

In this paper we propose an economic rationale for auditors resigning from the engagements of risky clients and use this rationale to examine claims that increases in expected auditor liability are giving rise to an increase in auditor resignations.1 Given the relatively inelastic demand by publicly traded firms for audits, it seems puzzling that auditors would resign rather than simply risk-adjust their bids for the increase in expected liability. In addition, it is not clear why a successor auditor, who faces not only the threat of legal liability but also the information disadvantage accompanying a first-year audit, would accept the rejected client. Our theory explains how an incumbent auditor rationally resigns an engagement because any attempt at risk-adjusted pricing leaves him with only unprofitable clients, and how successor auditors who know less about the client than the incumbent auditor can profitably accept the engagement of a client whose auditor has rationally resigned. Several auditing models have specifically addressed why client firms switch auditors (Magee and Tseng [1990], Dye [1991], Teoh [1992], Kanodia and Mukherji [1994], and Gigler and Penno [1995]). The interest in auditor switches arises partly from regulatory concerns that