Accounting Horizons Vol. 24, No. 4 2010 pp.

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American Accounting Association DOI: 10.2308/acch.2010.24.4.671

Audit Report Lags after Voluntary and Involuntary Auditor Changes

Paul Tanyi, K. Raghunandan, and Abhijit Barua
SYNOPSIS: We nd that the audit report lag is signicantly higher for former Andersen clients that did not follow their Andersen partner to the new audit rm than for clients voluntarily changing auditors from another Big 5 predecessor for the scal year ended December 31, 2002 the rst year with the new auditor for ex-Andersen clients. The differences in audit reporting lags between the two groups are not signicant for scal years ended December 31, 2000 the last year before Andersens Enron related problems surfaced, or 2003 the second year with the successor auditor. We also nd that clients with voluntary i.e., non-Andersen auditor changes have only marginally higher audit reporting lags compared to clients without auditor changes. Our results, focusing on a cost component of involuntary auditor changes, thus provide relevant empirical evidence for debates surrounding mandatory auditor rotation. We also nd that exAndersen clients that followed the Andersen partner to the new audit rm had shorter audit report lags than ex-Andersen clients that did not follow their Andersen partner. Our ndings highlight the importance of individual relationships in the auditing process, and suggest new avenues for future research.

INTRODUCTION ection 207 of the Sarbanes-Oxley Act SOX, U.S. House of Representatives 2002 requires the Comptroller General of the United States to conduct a study and review of the potential effects of requiring the mandatory rotation of registered public accounting rms. This requirement was spurred by concerns that the independence of a public accounting rm is adversely affected by a rms long-term relationship with the client and the desire to retain the client GAO 2003. Some recent studies have sought to derive implications about the effect of mandatory rotation by investigating the association between auditor tenure and various measures of audit quality. These studies examine measures such as earnings management by clients Johnson et al. 2002; Myers et al. 2003, forecast errors Ghosh and Moon 2005, and the likelihood of issuing goingconcern modied audit opinions Geiger and Raghunandan 2002; Choi and Doogar 2005. Generally, these studies have concluded that contrary to the concerns expressed by legislators and

Paul Tanyi is a Ph.D. student, K. Raghunandan is a Professor, and Abhijit Barua is an Assistant Professor, all at Florida International University.
We thank two anonymous reviewers and Karla Johnstone associate editor for their many useful and constructive comments on earlier versions of this paper.

Submitted: July 2009 Accepted: March 2010 Published Online: December 2010
Corresponding author: K. Raghunandan Email: raghu@u.edu

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regulators auditor tenure has a positive association with audit quality and that the empirical evidence does not support calls for mandatory rotation. The auditor tenure studies note that their results may be relevant to the debate about mandatory auditor rotation. The studies cited above have examined instances where auditor tenure has been impacted by voluntary decisions of the client to dismiss the auditor or the auditor to resign from a client. The controversy about auditor tenures, fueled by legislators and regulators comments and actions, relates to mandatory auditor turnover. While relevant, the ndings of auditor tenure studies noted above do not directly provide evidence about the consequences of involuntary auditor changes because of the endogenous nature of the decision in voluntary auditor changes Nagy 2005; Krishnan et al. 2007. The auditor changes that occurred following the collapse of Arthur Andersen in 2002 provide a unique situation of involuntary auditor changes. The indictment of the rm in March 2002 created considerable uncertainty about the ability of Andersen to survive, which led to forced auditor changes for the vast majority of Andersens clients. The forced auditor changes that occurred after the demise of Arthur Andersen reect some elements of the mandatory auditor changes advocated by legislators and regulators. This unique setting enables researchers to provide empirical evidence about auditor decisions and audit quality in the context of involuntary auditor changes. Some prior studies have examined if successor auditors treated former Andersen clients differently than other clients by focusing on accruals quality and audit opinions Nagy 2005; Cahan and Zhang 2006; Krishnan et al. 2007. These studies compare former Andersen clients with other continuing clients of other Big 4 rms. The latter group typically includes only a small proportion of clients that had a voluntary auditor change in the same period as the forced change from Andersen. In this paper we compare the effects of mandatory versus voluntary auditor changes by examining audit report lagsthat is, the time lag between the scal year-end and the date of the audit report. We focus on audit report lag admittedly an imperfect proxy because it is the only publicly observable quantitative proxy for the extent of auditors work.1 Audit report lag, and the associated nancial reporting lag, has recently been an issue of signicant concern to regulators and the auditing profession SEC 2002b, 2002c. We recognize that clients changing auditorsvoluntarily or involuntarilyare quite different from other continuing clients. Hence, we compare the audit report lags for former Andersen clients and other clients voluntarily changing auditors during 2002. We argue that mandatory auditor changes would lead to higher reporting lags than voluntary auditor changes; hence, the audit reporting lag would be greater for ex-Andersen clients than other clients that voluntarily changed auditors, in the initial year with the successor auditor. Our tests thus examine a cost component of mandatory auditor changes. Some recent studies have sought to differentiate between former Andersen clients by classifying such rms into followers i.e., those that followed their former Andersen partner to a new audit rm and non-followers. Blouin et al. 2007 nd that discretionary accruals are greater that is, higher levels of earnings management are present for companies that followed their former Andersen partner; further, non-followers were likely to have greater agency and switching related costs. Kohlbeck et al. 2008 and Vermeer et al. 2008 nd that audit fees are lower for follower former Andersen clients than for non-follower former Andersen clients in the rst year

Audit fees also are publicly observable after February 5, 2001, but audit fees represent a product of both quantity audit work and price dollars per unit of work.

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with the new auditor. In the non-prot sector, Vermeer 2008 nds that switching costs, the nancial condition of a non-prot, and the size of the market are associated with the likelihood of a non-prot audit client being a follower. Following prior research, we argue that follower former clients of Andersen would be treated differently than the non-follower former Andersen clients. Further, we argue that follower switches by ex-Andersen clients represent auditor changes in form, but perhaps not in substance. This suggests that for a proper examination of the differences arising from voluntary versus involuntary auditor changes the comparisons should be between non-follower exAndersen clients and non-Andersen clients that switched auditors during the same period. In addition, we also examine the partner change effect by comparing the two types of ex-Andersen clients: we argue that the audit reporting lag will be smaller for follower ex-Andersen clients than for non-follower ex-Andersen clients. The latter tests, examining differences between ex-Andersen clients that did or did not follow their Andersen partner to the new audit rm, are also relevant in the context of the mandatory audit partner change rules of SOX. Section 203 of SOX states that:
It shall be unlawful for a registered public accounting rm to provide audit services to an issuer if the lead or coordinating audit partner having primary responsibility for the audit, or the audit partner responsible for reviewing the audit, has performed audit services for that issuer in each of the 5 previous scal years of that issuer.

Thus, we also provide empirical evidence about the costs associated with the mandatory audit partner rotation rules of SOX. We test our hypotheses by comparing the audit report lags for the following three groups: ex-Andersen clients that followed their partner to the new audit rm followers, ex-Andersen clients that did not follow their Andersen partner to the new audit rm non-followers, and clients that switched auditors during 2002 from a Big 5 predecessor other than Andersen nonAndersen switchers. Given the rapid demise of Andersen, we limit our analysis to rms with scal year ends of December 31, 2002. We nd that non-follower ex-Andersen clients had longer audit report lags 62.57 days versus 56.08 days than clients of other Big 5 auditors who switched to a new auditor in 2002. This provides empirical evidence related to the differences between mandatory and voluntary auditor changes. Further, we nd also that audit report lags are, on average, 4.56 days 7.8 percent lower for follower clients than for non-follower clients. This nding quanties some of the benets associated with partner familiarity, or the costs associated with mandatory audit partner changes. Finally, we compare clients without an auditor change against the three types of clients with an auditor change discussed above. We nd that clients with voluntary auditor changes have only marginally higher audit reporting lags p 0.10 compared to clients without auditor changes; in contrast, both types of clients with mandatory auditor changes ex-Andersen followers and ex-Andersen non-followers have signicantly higher p 0.01 audit report lag than clients without auditor changes. Overall, our results provide evidence that voluntary auditor changes lead to modest increases in audit report lags, and that mandatory auditor changes signicantly increase the audit report lag when compared with voluntary auditor changes. We recognize that the post-Andersen auditor changes are different from those under a mandatory auditor rotation regime. First, under mandatory rotation, everyone knows ahead of time when a change is scheduled. Second, incoming auditors following mandated changes also would know that their tenure is limited to a maximum period specied by the rotation regime rules. Yet, the failure of Andersen represents a unique situation that captures some elements of a mandatory auditor rotation regime in that the clients were involuntarily required to go with a new auditor at a specied time.

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Our paper adds to the auditing literature along several different streams. First, given the interest of legislators and the public in mandatory auditor rotation, we provide empirical evidence about differences in audit report lags arising from voluntary and involuntary auditor changes. Second, audit report lags have been of recent interest to the SEC, auditors, and public companies; we provide empirical evidence about audit report lags following three different types of auditor changes: voluntary auditor changes by clients of other Big 5 rms; involuntary auditor changes in form, but perhaps not in substance follower ex-Andersen clients; and involuntary auditor changes in form and substance non-follower ex-Andersen clients. Third, our paper adds to research about the personal nature of auditing relationshipsnamely, clients associations with specic audit partners and the production efciencies arising from such relationships. The next section discusses the background and develops the hypotheses. This is followed by a discussion of data and method. The results follow, and the paper ends with a summary and discussion. BACKGROUND AND HYPOTHESES Mandatory Rotation of Auditors More than a quarter century before SOX, the Metcalf Committee report had expressed similar concerns about the effects of long tenure on auditor judgments. The Staff Report of the Committee on Government Affairs U.S. Senate 1976, 21 noted:
Long association between a corporation and an accounting rm may lead to such close identication of the accounting rm with the interests of its clients management that truly independent action by the accounting rm becomes difcult. One alternative is mandatory change of accountants after a given period of years.

Even earlier, nearly 50 years ago, Mautz and Sharaf 1961 suggested that long associations with the same client can lead to problems with independence. Though Mautz and Sharaf 1961, 208 did not call for mandatory auditor rotation, they noted that the greatest threat to his the auditors independence is a slow, gradual, almost casual erosion of his honest disinterestedness. Periodically, the SEC continued to express its concerns about the possible adverse effects from long auditor tenures SEC 1994; Turner and Godwin 1999. However, the SEC did not take any regulatory action related to mandatory auditor rotation. Proponents of auditor rotation suggest that long-term relationships between the auditor and the client could undermine perceptions of auditor independence U.S. Senate 2002. Since the incentives associated with keeping a particular client are smaller, and since there would be another audit rm reviewing the work within a specied period of time, auditors might be less likely to succumb to management pressure GAO 2003. The opposition to mandatory auditor rotation is based on the fact that effective audits require a thorough understanding of the clients business and processes; such understanding develops over time and there is a steep learning curve that lasts a year or more. Hence, audit quality is likely to be lower in the initial years of an audit GAO 2003. Along these lines, Loebbecke et al. 1989 nd that irregularities are more likely in the initial years of an audit engagement. A related point is that the disruption to the client caused by rotation leads to nontrivial commitment of resources personnel and nancial in educating the auditor about the clients operational and accounting matters. In addition, Geiger and Raghunandan 2002 note an incentive-related argument: incumbent auditors earn quasi-rents due to the start-up costs associated with audits and lowballing the pricing of initial-year audits below economic cost arises as a natural phenomenon. Hence, auditors would be interested in recouping their initial-year losses in the future; consequently, the threats to auditor independence may in fact be higher in the initial years of an audit engagement.

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Legislators considered imposing mandatory auditor changes during the hearings that preceded SOX; many former SEC chairs supported such a rule U.S. Senate 2002. Nevertheless, in the face of opposition from auditors and others, the nal rules adopted a compromise. With respect to audit rm rotation, Section 207 of SOX required the GAO to conduct a study and review of the potential effects of requiring the mandatory rotation of registered public accounting rms and report back to Congress within one year of enactment of the law. However, Section 203 of SOX required mandatory rotation of the audit partner every ve years. Related Research Some recent studies have examined the association between auditor tenure and various measures of audit quality. Johnson et al. 2002 and Myers et al. 2003 use clients abnormal accruals as a measure of audit quality and document a positive association between tenure and audit quality. Davis et al. 2009 nd that rms with both short and long tenure are more likely to use discretionary accruals to meet or beat earnings forecasts, suggesting that audit quality is lower in rms with short or long tenures. Ghosh and Moon 2005 show a positive association between auditor tenure and investors perceptions of earnings quality as measured by the earnings response coefcient. Geiger and Raghunandan 2002 nd, for a sample of bankrupt rms, that going-concern modied audit opinions are positively associated with auditor tenure. However, Choi and Doogar 2005 use a general sample of stressed rms and nd that there is no association between auditor tenure and the likelihood of a going-concern opinion. The auditor tenure variable in all of the above studies is impacted by voluntary decisions made by the clients to dismiss the auditor or the auditor to resign. Voluntary auditor changes are quite different from involuntary auditor changes, such as those arising from mandatory auditor turnover Nagy 2005; Krishnan et al. 2007. It is this difference that makes the auditor changes that occurred in the aftermath of Andersens failure unique. The forced auditor change for exAndersen clients provides a unique opportunity to empirically examine issues related to involuntary auditor changes. Audit Report Lag, Auditor Changes, and Andersens Demise Audit report lag, and the associated nancial reporting lag, has recently been an issue of signicant concern to regulators and the auditing profession SEC 2002b, 2002c.2 As part of the changes made to nancial reporting subsequent to SOX, the SEC reduced the 10-K ling lag i.e., the number of days from the scal year-end to the ling of the 10-K with the SEC starting in 2003 SEC 2002c. Krishnan and Yang 2009 nd that audit report lags have increased in recent years, both prior to the introduction of new rules shortening the 10-K ling lag and also after the introduction of the new rules. Any auditor change creates disruption; both the client and the auditor incur substantial switching costs. In the aftermath of an auditor switch the client spends a signicant amount of resourcesboth nancial and humaneducating the new auditor about company operations and accounting matters GAO 2003. The new auditor has to learn about the business practices, operations, and nancial reporting systems of the client, and incur substantial extra effort becoming familiar with the client in the year following an auditor change Flanigan 2002. Hence, the audit risk is also higher in an initial-year engagement; in turn, this suggests that the auditor would likely perform more work in an initial-audit engagement.
2

For example, the SEC 2002b sought to shorten the ling due dates for annual and quarterly reports led with the commission as a step in modernizing the periodic reporting system and improving the usefulness of quarterly and annual reports to investors. Following concerns expressed by auditors and others, the SEC 2002c modied the proposals but noted that technological advances have made it easier for registrants to capture, process, and disseminate nancial information.

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A former chief accountant of the SEC noted in congressional testimony that on average, you provide about a third additional hours in the rst year Turner 2002. To the extent at least a part of such additional work is done at the end of the scal year as opposed to interim work, the audit reporting lag should be higher following auditor changes. This argument also suggests that if ex-Andersen clients are to be compared with other clients on audit-related issues in general, or audit reporting lag in particular, then the appropriate comparison group should be clients that also had voluntarily an auditor change around the same time as the involuntary auditor changes that occurred due to Andersens demise. On October 16, 2001, Enron announced major restatements; events unfolded rapidly, with Enron declaring bankruptcy on December 2, 2001. Almost immediately, legislators and the media began asking questions about the role of Andersen in Enrons failure. Andersen admitted to shredding Enron-related documents on January 10, 2002, and was indicted for such document destruction on March 14, 2002; the SEC 2002a issued a special release in which it required companies to obtain extra assurances from Andersen for audit reports signed after March 14, 2002. The special release made references to clients who may wish to leave Andersen and to the need for orderly transitions to new auditors. Andersen was found guilty of criminal wrong doing on June 15, 2002, and the rm responded by formally announcing it would cease to practice.3 Thus, Andersen clients had to involuntarily switch auditors and do so quite quickly. Such switches were made somewhat easier by the fact that many Andersen ofces were purchased by the other large audit rms see Kohlbeck et al. 2008 for a more detailed description of the acquisition process. Many former Andersen clients followed their former Andersen partner to the new audit rm, thereby easing the transition. Blouin et al. 2007, Kohlbeck et al. 2008, Vermeer 2008, and Vermeer et al. 2008 use publicly available data about the purchase of former Andersen ofces to document differences between ex-Andersen clients who likely followed their former partner to the successor auditor follower and those who did not follow their former Andersen partner non-followers.4 In the context of our study, it is likely that the typical extra work associated with a new client would be much less for a follower client than for a non-follower client. This is because the prior experience with a follower client means that for such clients the audit team will not have to navigate the steep learning curve typically experienced in initial-audit engagements. That is, for the follower ex-Andersen clients the auditor change after Andersens demise can be viewed as an auditor change in form, but not in substance. This in turn means that the extra audit effort associated with new audit clients should be either nonexistent or lower if the client followed the Andersen partner than if the client switched to a different rm with a new audit partner and team. Hypotheses In this study, we examine if the audit reporting lag differs for clients with mandatory auditor changes when compared clients with voluntary auditor changes. We do this by comparing the audit reporting lags for ex-Andersen clients that did not follow their Andersen partner against audit reporting lags for other clients that changed auditors during the same period. This leads to the rst hypothesis in the null form: H1: There would be no differences in audit reporting lag, in the rst scal year with the new auditor, between non-follower ex-Andersen clients and non-Andersen clients changing auditors.
3 4

On May 31, 2005, the U.S. Supreme Court reversed Andersens conviction. We use the qualier likely because publicly available data about the purchase of Andersen ofces are only at the rm level; it is possible that a former Andersen partner decided not to go to the new rm. However, such actions by individual partners would introduce a bias against nding differences between follower and non-follower ex-Andersen clients.

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The follower Andersen clients can be viewed as simply having an auditor change in form, but not in substance. Therefore, we expect that follower ex-Andersen clients would have a lower audit reporting lag in the rst year with a new audit rm than non-follower ex-Andersen clients. This leads to the following hypotheses in the null form: H2: Audit reporting lag in the rst scal year with the new audit rm would not be higher for non-follower ex-Andersen clients than for follower ex-Andersen clients. Thus, H1 examines the effect of mandatory, as opposed to voluntary, auditor changes. Hypothesis 2 examines the partner familiarity effect and thus provides evidence related to mandatory audit partner rotation. METHOD AND DATA We compare the audit reporting lags for scal year 2002, which is the rst year with the successor auditor following Andersens demise. Further, since Andersen was a member of the Big 5, in our tests we restrict the control group to those clients that had another non-Andersen Big 5 rm as the predecessor auditor and had an auditor change in 2002. We use the same model to explain audit report lags as Krishnan and Yang 2009 and add one specic variable to the regression model depending on the research question of interest.5 Thus, to test the rst hypothesis we use the following regression model: SQLAG = 0 + 1AA + 2EXTRAORD + 3SEGMENTS + 4FOREIGN + 5HIGROWTH + 6HILITIG + 7HITECH + 8FINCOND + 9LOSS + 10GC + 11LNTA + error 1 where: SQLAG square root of the number of days between scal year-end and the date of the audit report; AA 1 if the rm is an ex-Andersen client, 0 otherwise; EXTRAORD 1 if the rm has extraordinary items on its nancial statement, 0 otherwise; SEGMENTS square root of the number of business segments; FOREIGN 1 if the rm has foreign operations, 0 otherwise; HIGROWTH 1 if the rm belongs to high-growth industries two-digit SIC codes 35, 45, 48, 49, 52, 57, 73, 78, and 80, 0 otherwise; HILITIG 1 if the rm belongs to litigious industries two-digit SIC codes 28, 35, 36, 38, and 73, 0 otherwise; HITECH 1 if the rm belongs to high-tech industries three-digit SIC codes 283, 284, 357, 366, 367, 371, 382, 384, and 737, 0 otherwise; FINCOND probability of bankruptcy, estimated from Zmijewskis 1984 model for nonnancial rms calculated as of the end of the scal year; LOSS 1 if the rm reports a loss before extraordinary items, 0 otherwise; GC 1 if the rm receives a going-concern opinion, 0 otherwise; and LNTA natural log of total assets measured as of the end of the scal year.
5

Krishnan and Yang 2009 have three additional variables: FIN nance industry client, BIG4 whether auditor is a Big 4 auditor, and BUSYYREND whether scal year-end is in December or January. We do not have these three variables in our model because our sample includes only nonnancial rms having a Big 4 auditor and with a December 31 scal year end.

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Since we are using the same model as Krishnan and Yang 2009, our discussion of the control variables is relatively brief. Briey, audit report lag is expected to be higher for rms with more complex operations, so we include EXTRAORD, SEGMENTS, and FOREIGN in the model. Financial problems and going-concern uncertainties add to the auditors work, so we expect that FINCOND, LOSS, and GC will have positive coefcients. High growth is typically with more changes, leading to more new things to audit so we expect the coefcient of HIGROWTH to be positive. We also control for the fact that the auditors business risk varies across industries, and hence include HILITIG and HITECH. We include our nal control variable, LNTA, for two reasons. First, larger clients can exercise greater inuence on their auditor to complete the audit quicker e.g., Ashton et al. 1989. Second, almost all prior accounting and auditing research includes client size as a control factor. The treatment sample for testing H1 includes ex-Andersen clients that did not follow their former Andersen partner to the new audit rm. The control sample includes clients that changed auditors from another other than Andersen Big 5 auditor during 2002. Our second hypothesis compares audit reporting lags for follower and non-follower exAndersen clients. We use the same model as for hypothesis one but with two changes. First, the sample now includes all and only ex-Andersen clients. Second, since we are only comparing two groups of ex-Andersen clients, we replace the AA variable in the model with a variable called FOLLOW that takes a value of 1 when the client follows the former Andersen partner to a new audit rm, and is 0 otherwise. Data The Andersen sample consists of all nonnancial rms that had a December 31 scal year-end in 2002, and have data available about 1 audit report lag, audit rm name, and audit opinion type for scal year 2002 available in the Audit Analytics database; and 2 relevant nancial and other control variables in the Compustat database. The control sample consists of all rms that 1 had a December 31 scal year-end for 2002; 2 had an auditor change during 2002 from a Big 5 predecessor other than Andersen; and 3 meet the same data requirements as the Andersen sample i.e., data available in Audit Analytics and Compustat databases. We use a December 31 scal year-end restriction because of the relatively rapid nature of Andersens collapse; hence, it would not be appropriate to compare a client with a December 31, 2002 scal year-end with a client that had a scal year ending June 30, 2002. We examine also the change in audit report lags from scal year 2000; hence, to simplify the analysis and presentation we require that the data be available for sample rms for both scal years 2000 and 2002. Our analyses partition the ex-Andersen clients based on whether they followed their Andersen partner to a new audit rm. Kohlbeck et al. 2008 and Vermeer et al. 2008 provide detailed instructions based on data provided by PAR 2002 about classifying ex-Andersen clients as followers or non-followers both studies use data provided by PAR 2002. We use the data provided in Kohlbeck et al. 2008 and Vermeer et al. 2008 to classify our sample of exAndersen clients as followers or non-followers. RESULTS Panel A of Table 1 presents descriptive statistics about two groups of rms changing auditors in 2002: 198 ex-Andersen clients that did not follow their Andersen partner to the new audit rm and 120 clients that switched from another Big 5 auditor other than Andersen. The average audit report lag for ex-Andersen clients is 6.49 days higher than for clients of other Big 5 auditors changing auditors during 2002 62.57 versus 56.08; ex-Andersen clients are less likely to be in nancial distress, and are signicantly larger than the control sample of other companies that changed auditors.

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TABLE 1 Comparison of Ex-Andersen (Non-Follower) Clients with other Auditor Change Clients
Panel A: Descriptive Data: Mean (Median) Values of Variables for Fiscal Year 2002 Ex-Andersen (NonOther Big 5 Clients with Follower) Clients Auditor Change Variable (n 198) (n 120) LAG SQLAG EXTRAORD SEGMENTS FOREIGN HIGROWTH HILITIG HITECH FINCOND LOSS GC LNTA 62.57 62.00 7.76 7.72 0.37 0.0 1.41 1.0 0.31 0.0 0.42 0.0 0.43 0.0 0.30 0.0 0.32 0.16 0.50 1.0 0.16 0.0 5.92 5.77 56.08 49.00 7.26 7.07 0.34 0.0 1.33 1.0 0.26 0.0 0.42 0.0 0.55 1.0 0.41 0.0 0.51 0.53 0.71 1.0 0.33 0.0 3.48 3.08 p-values from t (median) [Chi-square] Test 0.01 0.01 0.01 0.01 0.35 0.28 0.93 0.17 0.96 0.23 0.01 0.02 0.02 0.01 0.01 0.01 0.01 (continued on next page)

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Panel B: Audit Report Lag Regression Results Model: SQLAG = 0 + 1AA + 2EXTRAORD + 3SEGMENTS + 4FOREIGN + 5HIGROWTH + 6HILITIG + 7HITECH + 8FINCOND + 9LOSS + 10GC + 11LNTA + error Analysis of Change in SQLAG (FY2002 FY2000) Coefcient p-value 0.20 0.62 0.14 0.01 0.01 0.62 0.52 0.11 0.09 0.85 0.45 0.01 0.35 0.17 0.81 0.04 0.06 0.57 Model F 3.5 p 0.01 Adj. R2 = .04

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Analysis of SQLAG in FY 2002 Variable Intercept AA EXTRAORD SEGMENTS FOREIGN HIGROWTH HILITIG HITECH FINCOND LOSS GC LNTA Coefcient 7.30 0.38 0.73 0.19 0.40 0.17 0.06 0.39 1.34 0.26 0.26 0.05 p-value 0.01 0.01 0.01 0.40 0.07 0.41 0.86 0.19 0.01 0.01 0.43 0.43 Model F 7.6 p 0.01 Adj. R2 = 0.17

Analysis of SQLAG in FY 2003 Coefcient 7.51 0.21 0.49 0.19 0.10 0.34 0.04 0.06 1.23 0.32 0.57 0.04 p-value 0.01 0.23 0.04 0.31 0.53 0.04 0.72 0.46 0.01 0.10 0.05 0.42 Model F 6.3 p 0.01 Adj. R2 = 0.16 Tanyi, Raghunandan, and Barua

Panel A provides descriptive data about 198 ex-Andersen clients that did not follow their former Andersen partner to the new audit rm and 120 other rms that had an auditor change with a Big4 predecessor in 2002. All rms included in the analyses had 1 scal years ending December 31, 2002, 2 audit report lag data for both 2002 and 2000 available in Audit Analytics, and 3 accounting data available in Compustat to estimate the regression model. Panel B provides the results from three regressions. In the regressions for scal years 2002 and 2003, the dependent variable is the square root of audit report lag i.e., number of days between scal year-end and the audit report date. In the changes regression i.e., the second of the three regressions, the dependent variable is the change in square root of the audit report lag 2002 minus 2000. The sample for the rst two regressions for FY 2002 and the change from FY 2000 includes 198 ex-Andersen clients that did not follow their auditor and 120 other rms that had an auditor change with a Big 4 predecessor. All rms included in the analyses had 1 scal years ending December 31, 2002, 2 audit report lag data for both 2002 and 2000 available in Audit Analytics, and 3 accounting data available in Compustat to estimate the model. The last regression FY 2003 excludes, from the preceding, ve ex-Andersen clients and four non-Andersen clients that had an auditor change in 2003.

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p-values are two-tailed. Variable Denitions: LAG number of days between scal year-end and the date of the audit opinion; SQLAG the square root of LAG; EXTRAORD 1 if the rm has extraordinary items on its nancial statement, 0 otherwise; SEGMENTS the square of the number of business segments; FOREIGN 1 if the rm has foreign operations, 0 otherwise; HIGROWTH 1 if the rm belongs to high-growth industries two-digit SIC codes 35, 45, 48, 49, 52, 57, 73, 78, and 80, 0 otherwise; HILITIG 1 if the rm belongs to industries two-digit SIC codes 28, 35, 36, 38, and 73, 0 otherwise; HITECH 1 if the rm belongs to industries three-digit SIC codes 283, 284, 357, 366, 367, 371, 382, 384, and 737, 0 otherwise; FINCOND probability of bankruptcy estimated fromZmijewskis 1984 model for nonnancial rms; LOSS 1 if the rm reports a loss before extraordinary items, 0 otherwise; GC 1 if the rm receives a going-concern opinion, 0 otherwise; LNTA the natural log of total assets; and AA 1 of the rm is an ex-Andersen non-follower client, 0 otherwise.

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Panel B of Table 1 provides results from three different regressions. The rst regression relates to scal year ending December 31, 2002, or the rst year for ex-Andersen clients with the new auditor. The overall model is signicant, with an adjusted R2 of 17 percent; the coefcients of EXTRAORD and FINCOND are positive and signicant. The variable of interest, AA, is positive and signicant p 0.01 indicating that when compared with other clients changing auditors during 2002 with another Big 5 predecessor the non-follower, ex-Andersen clients have a higher audit report lag for scal year 2002 after controlling for other factors. A competing argument is that such ex-Andersen clients always had higher reporting lags. Hence, we compute the change in audit reporting lag from scal year 2000 to scal year 2002 and test if the change is different for ex-Andersen and other clients; we examine scal year 2000 because that is the last full year prior to the disclosure of Andersens problems. For such analysis, we use the same model as the one above but instead of data for scal year 2002 we use the corresponding values of audit report lag and the dependent variables from scal year 2000. The second regression in Panel B of Table 1 is the changes regression. The dependent variable here is the difference in square root of audit report lags of 2002 and 2000. The explanatory variablesexcept AAare changes in the levels of the independent variables from 2002 to 2000.6 The overall model is signicant; FINCOND and GC have the expected coefcient signs and are signicant at conventional levels. The signicant positive coefcient of AA indicates that the change in audit report lag from 2000 to 2002 was higher for the non-follower, ex-Andersen clients compared to clients of other Big 5 auditors that changed auditors during 2002.7 The last regression in Panel B of Table 1 examines the audit reporting lag during 2003. The sample for this third regression excludes ve ex-Andersen clients and four non-Andersen clients that either had an auditor change in 2003 or had missing data for 2003. The coefcient of AA is positive but not signicant at conventional levels in this regression. This suggests that by the second year with the new auditor the ex-Andersen clients who experienced an involuntary auditor change were not at a disadvantage compared to clients of other Big 5 rms that voluntarily changed auditors during 2002. These ndings suggest that the differential costs associated with mandatory auditor changes when compared to voluntary auditor may be short-lived. Overall, the results in Panel B of Table 1 indicate that the mandatory auditor change i.e., ex-Andersen clients: 1 had higher audit report lag for scal year 2002; and 2 had a greater increase in audit lag from 2000 to 2002, compared to clients of other Big 5 rms that had an auditor change during 2002. Together the results provide strong evidence in support of the hypothesis that the non-follower ex-Andersen clients were treated by auditors differently than other clients that switched from a Big 5 predecessor in scal year 2002. Partition of Ex-Andersen Clients by Follower Status Panel A of Table 2 provides descriptive data about ex-Andersen clients, partitioned by follower status. The audit report lag for follower ex-Andersen clients is, on average, 4.56 days lower than for non-follower clients 58.01 versus 62.57. The two subsamples do not differ along any of the other control variables, except that the follower group has a lower proportion in high-growth industries.

6 7

We measure changes, for the dependent and independent variables, from 2002 to 2000 as opposed to vice versa simply for the sake of expositional convenience. We also examined the regression for scal year 2000 using a levels approachthat is, we measured the level of the dependent and independent variables as in the rst regression for scal 2002 and used such variables in the regression. In such a regression, the AA coefcient is not signicant in the scal year 2000 regression, conrming the ndings from the changes regression.

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TABLE 2 Comparison of Follower versus Non-Follower Ex-Andersen Clients

Panel A: Descriptive Data: Mean (Median) Values of Variables for Fiscal Year 2002 Variable LAG SQLAG EXTRAORD SEGMENTS FOREIGN HIGROWTH HILITIG HITECH FINCOND LOSS GC LNTA Follower Clients (n 186) 58.01 57.00 7.24 7.14 0.34 0.0 1.38 1.0 0.26 0.0 0.40 0.0 0.41 0.0 0.31 0.0 0.35 0.27 0.48 0.0 0.13 0.0 5.80 5.66 Non-Follower Clients (n 198) 62.57 62.00 8.147 7.62 0.37 0.0 1.41 1.0 0.31 0.0 0.42 0.0 0.43 0.0 0.30 0.0 0.32 0.16 0.50 1.0 0.16 0.0 5.92 5.77 p-values from t (median) [Chi-square] Test 0.01 0.01 0.01 0.01 0.73 0.81 0.92 0.29 0.34 0.84 0.93 0.89 0.58 0.82 0.95 0.86 0.33 (continued on next page)

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Panel B: Regression Results Model: SQLAG = 0 + 1FOLLOW + 2EXTRAORD + 3SEGMENTS + 4FOREIGN + 5HIGROWTH + 6HILITIG + 7HITECH + 8FINCOND + 9LOSS + 10GC + 11LNTA + error Analysis of Change in SQLAG (FY2002 FY2000) Coefcient 0.55 0.16 0.54 0.10 1.58 1.07 0.09 0.16 0.03 Model F 3.1 p 0.01 Adj. R2 = 0.04 p-value 0.01 0.01 0.02 0.07 0.23 0.01 0.14 0.01 0.83

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Analysis of SQLAG in FY 2002 Variable Intercept FOLLOW EXTRAORD SEGMENTS FOREIGN HIGROWTH HILITIG HITECH FINCOND LOSS GC LNTA Coefcient 7.14 0.45 0.53 0.20 0.45 0.04 0.22 0.17 1.12 0.17 0.67 0.14 p-value 0.01 0.02 0.01 0.15 0.03 0.85 0.43 0.53 0.01 0.38 0.05 0.01

Analysis of SQLAG in FY 2003 Coefcient 7.26 0.25 0.30 0.14 0.19 0.19 0.13 0.03 0.68 0.01 0.89 0.04 p-value 0.01 0.14 0.28 0.31 0.29 0.24 0.50 0.94 0.01 0.97 0.01 0.33 Model F 4.0 p 0.01 Adj. R2 = 0.06 Tanyi, Raghunandan, and Barua

Model F 8.4 p 0.01 Adj.R2 = 0.16

Panel A provides descriptive data for scal year 2002 for ex-Andersen clients partitioned by follower status. Follower rms followed their former Andersen partner to the new audit rm, while non-follower rms did not do so. Panel B provides the results from three regressions. In the regressions for scal years 2002 and 2003, the dependent variable is the square root of audit report lag i.e., number of days between scal year-end and the audit report date. In the changes regression i.e., the second of the three regressions, the dependent variable is the change in square root of the audit report lag 2002 minus 2000. The sample for the rst two regressions includes 186 follower and 198 non-follower ex-Andersen rms that had 1 scal years ending December 31, 2002, 2 audit report lag data for both 2002 and 2000 available in Audit Analytics, 3 information about FOLLOW available, and 4 accounting data available in Compustat to estimate the model. The last regression FY 2003 excludes, from the preceding, ve ex-Andersen non-follower clients that had an auditor change in 2003. FOLLOW 1 if the client followed the Andersen partner to the new audit rm, 0 otherwise. Other variables are dened as in Table 1. p-values are two-tailed.

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Panel B of Table 2 provides results from three different regressions. The dependent variable in the rst regression is the square root of the audit report lag for scal year 2002. The overall regression is signicant, with an adjusted R2 of 16 percent. The FOLLOW variable is negative and signicant p 0.01. This indicates that ex-Andersen clients who followed the Andersen partner to the new audit rm had signicantly lower audit report lag for scal year 2002. The second regression in Panel B of Table 2 has the change in square root of the audit report lag as the dependent variable; all control variables except for FOLLOW also are measured in terms of the change value for scal year 2002 minus the corresponding value for scal year 2000. The overall model is signicant, and the coefcient of FOLLOW is negative and signicant. This conrms that ex-Andersen clients who followed their former audit partner to the new audit rm had signicantly lower audit report lag in the rst year with the new audit rm. The third regression in Panel B of Table 2 examines the audit reporting lag during scal year 2003 for the ex-Andersen clients. The coefcient of FOLLOW is negative but not signicant p 0.14 in this regression. This indicates that the follower effect is also short-lived, and that by the second year with the new auditor the non-follower ex-Andersen clients were not at a signicant disadvantage compared to the follower ex-Andersen clients. The above ndings suggest that the differential costs associated with new audit partners may be short-lived. The results can also be viewed as indirectly providing evidence that the costs associated with mandatory audit partner changes may be short-lived. When the SEC was considering implementation of SOX Section 203 relating to mandatory audit partner rotation the Big 4 and others provided input about the direct dollar costs associated with mandatory audit partner rotation. Our results, focusing on audit report lag, provide another perspective on the costs associated with mandatory audit partner rotation. Further Analysis: Comparing No-Change Clients with Change Clients We compare audit report lags for clients without an auditor change in 2002 against the three types of clients with auditor changes discussed above non-Andersen changes, ex-Andersen nonfollowers, and ex-Andersen followers. The no-change sample includes all other clients of the other Big 5 non-Andersen rms that meet the same selection criteria outlined earlier for the auditor change rms. This procedure yields a sample of 1,919 no-change rms. The mean audit report lag for the no-change sample is 54.81 days; univariate t-tests indicate that audit report lag for the no-change clients is marginally lower p 0.08 than for the voluntary change i.e., change from a non-Andersen Big 5 predecessor clients, and signicantly lower p 0.01 than for either type of ex-Andersen clients followers or non-followers. We then perform three different regressions examining audit report lag for 2002; the models are similar to those in Panel B of Tables 1 and 2, except that we now use a dummy variable called CHANGE 1 if there is an auditor change, 0 otherwise to examine the effects of having an auditor change on the audit report lag. The coefcient of CHANGE is marginally signicant p 0.10 in the regression comparing the no-change and non-Andersen change clients, but is highly signicant p 0.01 in the regression comparing the no-change clients and either type of ex-Andersen follower or non-follower clients. Overall, the results indicate that voluntary auditor changes have a marginal effect on audit report lags. The effects are magnied when the changes are involuntary, and are highest when the mandatory auditor change also includes an audit partner change. Further Analysis: Timing of Dismissal of Arthur Andersen Some clients dismissed Andersen even before the criminal indictment; conversely, at least a few ex-Andersen clients did not switch from Andersen until they were alerted by the SEC in August 2002 that since Andersen was prohibited from being the certifying accountant, they had to

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switch. It is likely that the timing of Andersens dismissal will affect the audit report lag with the new auditor. Hence, we calculate the number of days from the end of the last scal year with Andersen to the date when Andersen was dismissed. In the regression analyzing ex-Andersen clients, we include a variable called TIMING measured as the square root of the number of days to dismiss Andersen calculated as above. This new variable is positive and signicant, indicating that those clients who took their time to dismiss Andersen and appoint a new auditor had longer audit delays for scal year 2002. Importantly, the FOLLOW variable continues to remain negative and signicant in the regression as in Table 2, Panel B. SUMMARY AND CONCLUSIONS Legislators and regulators have long expressed an interest in restricting auditor tenures because of perceptions that such long tenures can impair auditor independence. During the congressional hearings that preceded the enactment of SOX, mandatory auditor rotation was examined in some detail. Section 207 of SOX required the Comptroller General of the United States to conduct a study and review of the potential effects of requiring the mandatory rotation of registered public accounting rms. Long before SOX, the Metcalf Committee U.S. Senate 1976 report had expressed concerns about the effects of long audit rm tenure on auditor judgments. Periodically, the Securities and Exchange Commission SEC continued to express its concerns about the possible adverse effects from long auditor tenures SEC 1994; Turner and Godwin 1999. Thus, it is clear that auditor tenure and mandatory auditor rotation has been, and continues to be, an issue of interest to legislators and regulators. Some recent studies have examined the association between auditor tenure and various measures, including audit opinions Geiger and Raghunandan 2002, abnormal accruals Johnson et al. 2002; Myers et al. 2003, and earnings response coefcient Ghosh and Moon 2005. The auditor tenure variable in such studies is impacted by voluntary decisions made by the clients to dismiss the auditor or the auditor to resign. Nagy 2005 argues that the involuntary auditor changes following Andersens failure capture some elements of mandatory auditor rotation, and thus enable researchers to provide empirical evidence about various issues such as, auditor decisions, audit cost, and audit quality arising from involuntary auditor changes. Opponents of mandatory auditor rotation argue that involuntary auditor changes impose signicant costs and that there is a steep learning curve associated with new audit engagements, because effective audits require a thorough understanding of the clients business and processes; such understanding develops over time and there is a learning curve that lasts a year or more GAO 2003. In this study we provide empirical evidence about the extent of the extra audit work following involuntary auditor changes by examining audit reporting lags after the forced auditor changes arising from Andersens demise. Some ex-Andersen clients followed their former Andersen partner to the new audit rmthat is, there was an auditor change in form but perhaps not in substance. Hence, we compare nonfollower that is, not following the former Andersen partner to the new audit rm ex-Andersen clients with other clients that switched from another non-Andersen Big 5 predecessor during 2002. Our hypothesis is that audit report lag would be greater for non-follower ex-Andersen clients in their rst full year with the successor auditor than for clients who switched from another non-Andersen Big 5 audit rm. We test our hypothesis using data for the scal year ending December 31, 2002. The empirical results indicate that the non-follower ex-Andersen clients had a signicantly longer audit report lag for scal year 2002 than clients that switched from another non-Andersen Big 5 auditor, after controlling for other factors associated with audit report lag. However, there were no signicant differences in audit report lags between the two groups of rms during scal years 2000 or 2003. Together, the results indicate that the clients who experienced in substance a forced auditor change

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had a higher audit reporting lag during the year of the change when compared with clients that voluntarily changed auditors.8 The results also indicate that the effect is relatively short-lived and does not persist beyond the rst year. Some recent studies have examined if ex-Andersen clients who followed their audit partner to the new audit rm were treated differently than ex-Andersen clients who did not follow the partner. We argue that familiarity with the audit partner would lead to a lower audit report lag for the follower clients when compared with clients that did not follow the former Andersen partner to the new audit rm. Our analysis indicates that the audit report lag was signicantly lower for follower ex-Andersen clients than for non-follower clients. Our ndings reinforce the importance of personal relationships in auditing, and suggest that examining the effect of individual relationships in other auditing settings may be worthwhile. For example, Section 203 of SOX requires audit partner rotation; the SEC 2003 subsequently issued rules related to the rotation of lead and concurring audit partners for scal years beginning after May 6, 2003. Will the audit report lag be higher when there is a partner rotation pursuant to the new SEC rules? More generally, to what extent does partner familiarity with the client affect auditor actions and judgments in a variety of audit contexts? The other side of partner changes is auditor familiarity with individual executives; hence, one can think about auditor familiarity with specic individuals serving as the CFO or CEO affecting audit judgments. This is also relevant in the context of auditors evaluations of tone at the top. To what extent does turnover of the CEO or CFO affect audit judgments, such as those related to audit program planning, nature and extent of testing, and audit opinions? These are some interesting issues for future research.

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