An Empirical Analysis of Big N Auditor Switches:

Evidence from the pre- and post-Enron Eras

Wayne R. Landsman,a Karen K. Nelson,b and Brian R. Rountree b

a

Kenan-Flagler Business School, University of North Carolina

b
Jones Graduate School of Management, Rice University

August 2006

Abstract
Using a comprehensive sample of lateral switches among the largest auditors (i.e., the Big N)
this study documents that the probability of a lateral switch in Big N audit firms increases
significantly in both the audit and financial risk of the client in the pre-Enron period but not in
the post-Enron period. In both periods, clients switching downward to a non-Big N auditor pose
similar audit and financial risks as lateral Big N switches, but are smaller and tend to have going
concern opinions. We interpret our findings as evidence that the swapping of large, risky clients
between Big N auditors is less prevalent in the post-Enron era, suggesting that Big N auditors
may have become more sensitive to risky clients in recent years.
JEL classification: L14; L84; K22; M4
Keywords: Auditor switching; Audit risk; Financial risk;
We appreciate the helpful comments and suggestions of Bill Beaver, Allen Blay, Ling Lei, and
workshop participants at the 2005 American Accounting Association Annual Meeting. Scott
Whisenant generously provided some of the data for this study. We acknowledge funding from
the Center for Finance and Accounting Research at UNC-Chapel Hill.
Corresponding author: Wayne Landsman, Kenan-Flagler Business School, University of North
Carolina, Chapel Hill, NC, 27599-3490, wayne_landsman@unc.edu.

1. Introduction
Recent accounting scandals, including Enron, WorldCom, Global Crossing, and Qwest,
have brought about a sea of change in the audit industry, most notably the dissolution of Arthur
Andersen. The accounting industry has responded to the scandals in several ways, including an
assertion by the remaining top-tier accounting firms (i.e., the Big N) that they have since dropped
hundreds of clients that expose them to unacceptable levels of risk:
After watching former Big Five accounting firm Arthur Andersen implode after
its Enron (ENRNQ) Corp. entanglement, the surviving Big Four aren't leaving
much to chance. PricewaterhouseCoopers and Deloitte & Touche each have shed
about 500 clients in the past 18 months because of liability concerns. With
earnings being restated at a record clip, shareholder lawsuits have increased. We
have tightened up our standards, says Gregory Weaver, the head of Deloitte's
U.S. audit practice. Ernst & Young has parted ways with more than 200 clients.
KPMG declined to comment. (Hindo, 2003)
Although risk avoidance has perhaps become more salient in recent years, it is certainly
not a new issue. Beginning in the early 1990s, the Big N reportedly became more likely to
avoid high-risk clients because of concerns that the profession faced increased liability (Cook et
al., 1992]; POB, 1993; Holland et al., 1993; Berton, 1995; MacDonald, 1997). As a result, risky
clients switching from one of the Big N firms are viewed as having little choice but to engage a
smaller auditor that lacks the reputation and cachet of the Big N.
Although prior academic studies generally show a positive correlation, on average,
between client risk and the probability of an auditor switch (e.g., Krishnan and Krishnan, 1997;
Shu, 2000; Johnstone and Bedard, 2004), this research typically pools auditor switches of all
types. i.e., upward, downward, lateral Big N, and lateral non-Big N. As a result, it is impossible
to infer from prior evidence whether risky clients are switching to a lower-tier auditor as claimed
or laterally to another Big N auditor. The purpose of this paper is to directly examine lateral

switches among Big N auditors, the most economically significant set of auditor switches, both
in the decade leading up to Enrons collapse and in the subsequent years.
To investigate whether client risk factors are associated with lateral Big N auditor
switches, we estimate a logit regression that models this type of auditor switch as a function of
client audit risk and financial risk, as well as several control variables. The null hypothesis
predicts that the risk factors will not be associated with lateral Big N auditor switches if risky
clients are indeed excluded from the Big N audit market. In other words, risky clients leaving
their incumbent Big N auditor will not be able to engage another Big N auditor. Alternatively, if
risky clients are not excluded from the Big N auditor market but instead are able to switch
laterally to another Big N auditor, there will be a significant association between client risk and
the lateral Big N auditor switches in our sample.
Our results indicate that the probability of a lateral switch among Big N auditors is
significantly increasing in both client audit risk and financial risk. Thus, even though risky
clients are more likely to switch auditors, another Big N auditor is willing to accept the
engagement. These results hold regardless of whether the auditor resigned from the engagement
or was dismissed by the client, and for all Big N auditors.
To provide further evidence on the nature of lateral Big N auditor switches, we compare
the risk profile of clients switching laterally to another Big N auditor to that of clients switching
downward to a non-Big N auditor. The results indicate that these two types of auditor switches
are associated with similar client-related risks. Companies excluded from the Big N audit
market, however, are much smaller and tend to have going concern audit opinions, suggesting
that large, risky companies are able to switch laterally to another Big N auditor while small
companies that pose less economic risk to the auditor switch downward to a non-Big N auditor.

We also show that our findings for lateral Big N auditor switches cannot be explained by
auditor realignment or clientele adjustment (Johnson and Lys, 1990; Shu, 2000). These theories
of auditor switching predict that clients will replace their incumbent auditor with a substantially
larger or smaller firm. Therefore, we expect auditor realignment to be a factor for companies
switching downwards to a non-Big N auditor, but not for companies switching laterally to
another Big N auditor. Our results support these predictions, thus confirming the results of prior
studies for switches between large and small auditors and extending the literature to provide
evidence of risky clients switching between large auditors.
Finally, we examine the risk profile post-Enron auditor switches to determine whether
sensitivity to client risk has changed. Although these results should be interpreted with caution
because of limited data availability for the 2002-2004 post-Enron period, we find some evidence
of changes in the market for auditor switches. Specifically, we document that lateral Big N
switches occur with relatively lower frequency and are no longer significantly associated with
client audit and financial risk. Downward switches in the post-Enron environment, however, still
occur primarily for small clients with going concern opinions.
Although the evidence in this paper is broadly consistent with claims that risky clients are
more likely to switch auditors, suggesting that audit or financial risk cannot be fully priced
(OKeefe et al., 1994; Bockus and Gigler, 1998; Bell et al., 2001), we extend prior literature to
show that these risky clients are able to engage another Big N auditor. It is important to note,
however, that our results do not necessarily imply suboptimal behavior on the part of Big N
auditors. One possible explanation for our findings is that the successor Big N auditor is willing
to accept the risk posed in hopes of higher fees in the future, and when these fees do not
materialize the risky client again switches auditors. It is also possible that the risk faced by the

incumbent and successor auditors differ, even though the clients risk is unchanged. In
particular, to the extent the successor auditor is not exposed to client risk arising from
transactions that occurred under the incumbent auditor, client risk may be lower for the successor
auditor, making the risky client profitable. Further understanding of the economic forces
underlying lateral Big N auditor switches is thus a fruitful area for additional research.
The remainder of the paper is organized as follows. Section 2 discusses prior research,
and explains how our study builds on this literature. Section 3 outlines our research design.
Section 4 describes the sample data and presents the empirical findings for the pre-Enron era.
Section 5 presents results for the post-Enron era. Section 6 summarizes and concludes the study.
2. Relation to prior literature
Auditors frequently cite risk avoidance as a primary factor in managing their client
portfolios (e.g., Holland et al., 1993; Berton, 1995; MacDonald, 1997; Hindo, 2003). Consistent
with these claims, empirical evidence generally documents a positive association, on average,
between client risk factors and auditor switches, particularly when the auditor resigns from an
engagement (e.g., Krishnan and Krishnan, 1997; Shu, 2000; Johnstone and Bedard, 2004).
Bradshaw et al. (2001), however, finds that auditor switches are less likely for high accrual
companies even though such companies are riskier to the extent that high accruals increase the
likelihood of GAAP violations.
In addition to divesting risky clients, evidence suggests that risk assessments factor into
auditors client acceptance decisions (e.g., Johnstone, 2000; Johnstone and Bedard, 2003, 2004).
A related stream of literature examines whether auditors accept risky clients, but attempt to
manage this risk by adjusting audit fees, audit procedures, and/or engagement personnel. The
evidence in this regard, however, is mixed. The findings in Johnstone (2000) are not consistent

with auditors adopting such risk management strategies, whereas Bell et al. (2001) and Johnstone
and Bedard (2003) report that auditors do appear to respond to client risk factors. Bell et al.
(2001) also notes, however, that risk management strategies cannot, in principle, eliminate or
reduce auditor business risk below a certain level.
Conventional wisdom suggests that risky clients leaving a Big N firm will be forced to
hire smaller, lower tier accounting firms (e.g., Holland et al., 1993; Berton, 1995; MacDonald,
1997; Hindo, 2003). Consistent with this perception, Bockus and Gigler (1998) analytically
demonstrates that auditors will resign from riskier clients, and that these clients then engage a
smaller (i.e., more wealth-constrained) auditor. However, despite the general view that risky
clients drop to a lower tier auditor, prior empirical research typically pools auditor switches of all
types, i.e., upward, downward, lateral Big N, and lateral non-Big N.1 As a result, there is very
little direct evidence on the role of client risk in determining whether companies are excluded
from the Big N audit market. In other words, simply because auditor switches are associated
with client risk in general, one cannot conclude that client risk plays a role in all types of auditor
switches, or that auditor switches involving risky clients generally result in the client switching
to a non-Big N auditor.
Based on 1986 data, Haskins and Williams (1990) finds that client financial distress, size,
and growth, along with audit firm industry dominance, are the most important factors associated
with lateral Big N auditor switches.2 For a sample of auditor switches by failing companies,

In addition to the papers cited above, other work that does not differentiate the type of auditor switch in the
empirical analysis includes Chow and Rice (1982), Francis and Wilson (1988), and Krishnan (1994). Although
some of these studies present descriptive information on the frequency of auditor switches by type, none examines
the risk profile of clients switching laterally within the Big N, or compare the lateral Big N switches to clients
switching downward to a non-Big N auditor.
2
Unlike the other studies in the auditor change literature which rely on binary probability models, Haskin and
Williams (1990) employs a recursive partitioning algorithm that sequentially identifies the best model, i.e., the
model with the smallest apparent error rate. This approach, however, is subject to concerns about overfitting
tendencies.

Schwartz and Menon (1985) shows that downward switches to a non-Big N auditor (10
companies) are no more prevalent than lateral switches among Big N auditors (11 companies), or
upward switches to a Big N auditor (12 companies). In contrast, Shu (2000) finds that riskier
clients are less likely to engage another large auditor when the incumbent auditor resigns from
the engagement. However, Shu (2000) defines large auditor broadly to include not only Big N
auditors but also 18 non-Big N auditors with individual auditor codes on Compustat.
A related set of studies examines risk characteristics of Big N client portfolios across
periods of differing litigation risk. For a sample of small manufacturing companies, Jones and
Raghunandan (1998) shows that Big N auditors were less likely to audit risky clients over a
period of increasing litigation costs. Similarly, Choi et al. (2004) finds that the riskiness of Big
N client portfolios changes in response to changes in the litigation environment. Their results
show not only a significant increase since 1990 in the proportion of high risk clients departing
the Big N audit market, but also a significant increase in the proportion of high risk clients
entering the Big N audit market. Neither of these papers, however, examines the riskiness of
clients switching between Big N auditors.
We build on the prior literature in several important ways. First, we focus our analysis on
lateral Big N auditor switches, and directly investigate whether risky clients are excluded from
the Big N audit market. If this perception is correct, then risk factors should not play a role in
lateral Big N auditor switches as risky clients will be unable to engage another Big N auditor.
Contrary to this view, we present the first evidence of a significant association between lateral
Big N auditor changes and client risk. Second, we contrast the risk profile of companies
switching laterally between Big N auditors to that of companies switching downward to a nonBig N auditor. This analysis provides evidence on whether the sensitivity to client risk differs

for lateral Big N and downward switches. Again contrary to popular perceptions, we find that
these two types of auditor switches are associated with similar client-related risks.
Third, we differentiate our findings for lateral Big N auditor switches from theories of
auditor realignment or clientele mismatch offered in prior research (e.g., Johnson and Lys, 1990;
Shu, 2000). These theories predict that clients will replace their incumbent auditor with a
substantially larger or smaller firm, and thus should not explain lateral Big N switches in which
the incumbent auditor is replaced with a firm of similar size. Consistent with our expectations,
we find that auditor realignment is not a factor in lateral Big N switches, but is a factor in
downward switches to a non-Big N auditor. Thus, while our study reinforces the evidence of
realignment between auditors of different sizes presented in these studies, we also provide new
evidence of the swapping of risky clients among the Big N audit firms.
Finally, we present the first empirical evidence comparing the risk profiles of pre -and
post-Enron auditor switches. Following Enrons collapse, some suggest that auditors,
particularly the Big N, have become more sensitive to risky clients (e.g., Hindo, 2003). We find
some evidence consistent with this view, as lateral Big N switches are less frequent and are no
longer significantly associated with client risk factors.
3. Research design and data
3.1. Lateral Big N auditor switches
We model lateral switches among Big N auditors as a function of client-specific risk
characteristics and various controls, including year and industry fixed effects to allow for
differences in mean switch rates across time and industries:

SWITCHit = t t + I I + 1GROWTHit 1 + 2 ACCit 1 + 3 NEGACCit 1 + 4 ACCit 1 NEGACCit 1

+ 5GCit 1 + 6 MODOPit 1 + 7TENUREit 1 + 8 ROAit 1 + 9 LOSSit 1 + 10 LEVERAGEit 1
+ 11EXPERTit 1 + 12 SIZEit 1 + 13 M&Ait 1 + it
where the variables are defined as follows (Compustat data items in parentheses):
SWITCH

GROWTH

ACC

NEGACC
GC
MODOP

=
=
=

TENURE

ROA

LOSS
LEVERAGE
EXPERT

=
=
=

SIZE
M&A

=
=

i
t
I

1 if the client changed among Big N auditors during the year, and
0 otherwise;
total assets (#6) less beginning total assets, divided by beginning
total assets;
performance adjusted discretionary total accruals following
Kothari et al. (2005);
1 if ACC is negative, and 0 otherwise;
1 if the audit opinion is a going concern, and 0 otherwise;
1 if the audit opinion is modified for anything other than a going
concern, and 0 if unqualified;
number of years audited by the incumbent auditor, with a
maximum of 10 years;
return on assets, defined as net income before extraordinary items
(#18) divided by average total assets (#6);
1 if ROA < 0, and 0 otherwise;
ratio of debt (#9 + #34) to total assets (#6);
1 if the incumbent auditor has at least 5% more clients in a
particular industry and state, and 0 otherwise;
Natural logarithm of market value of equity (#25 #199);
1 if the client had a merger or acquisition (footnote code #1) in the
two most recent years , and 0 otherwise;
denotes client firm;
denotes year; and
denotes industry.

The regressors in the model are measures of client audit and financial risk identified in
the prior literature.3 The audit risk measures are GROWTH, ACC, GC, MODOP, and TENURE.
Stice (1991) finds a positive association between client growth and auditor litigation, and
conjectures that high growth may be accompanied by an ineffective internal control system and
3

As commonly defined, client financial risk is the risk of a decline in the clients economic condition, and audit risk
is the risk that the auditor will incorrectly give an unqualified opinion on financial statements that are materially
misstated. A third type of risk, auditor business risk, captures the audit firms risk of loss resulting from the
engagement. By definition, auditor business risk is significantly higher for public clients. Because our sample
consists entirely of publicly-traded firms, we do not include a dichotomous variable for public/private status as in
prior research (e.g., OKeefe, et al., 1994; Bell et al., 2001; Johnstone and Bedard, 2004). Client financial risk can
affect both the auditors business risk and audit risk (OKeefe et al., 1994).

misleading financial statements. Accordingly, the predicted coefficient on GROWTH is positive.

Similarly, Heninger (2001) finds that the risk of auditor litigation increases for clients reporting
more positive (income-increasing) abnormal accruals. The model therefore includes
performance-matched discretionary accruals, ACC, an indicator variable, NEGACC, for negative
discretionary accruals, and the interaction of these two variables.4 Because audit risk increases
when reported financial results are inflated, we expect a positive coefficient estimate on ACC.
On the other hand, large negative discretionary accruals are consistent with auditor conservatism,
creating an incentive for clients to dismiss the incumbent auditor in hopes of finding a more
reasonable successor (DeFond and Subramanyan, 1998). The total coefficient for negative
discretionary accruals is 2 + 4.
The remaining audit risk variables capture client-specific aspects of the audit
engagement. Following Krishnan and Krishnan (1997) and Johnstone and Bedard (2004), we
expect that companies with other than a clean opinion are more risky, increasing the likelihood
of a change in auditors. Thus, we predict a positive coefficient on GC and MODOP. Stice
(1991) and Krishnan and Krishnan (1997) assert that audit risk also relates to the tenure of the
auditor-client relationship; shorter tenure with a client results in less client-specific knowledge
and a greater likelihood of audit failure resulting in a negative prediction for the coefficient on
TENURE.
Following Johnstone and Bedard (2004), our measures of financial risk are ROA, LOSS,
and LEVERAGE. More profitable companies pose less financial risk to the auditor, and thus we
expect the coefficient estimate on ROA to be negative and that on LOSS to be positive.

Earlier research on the relation between auditor litigation and total accruals yields inconclusive results (e.g., Stice,
1991; Lys and Watts, 1994), and thus we focus on measures of discretionary accruals. Untabulated results indicate
that inferences are unchanged if we use deflated total accruals as in Krishnan and Krishnan (1997) and the portfolio
equivalent as in Bradshaw et al. (2001).

Similarly, higher debt levels pose more financial risk, which we expect will result in a positive
coefficient estimate on LEVERAGE.
Finally, in addition to year and industry fixed effects, we include three other controls in
the regression model, audit firm expertise (EXPERT), client firm size (SIZE), and an indicator
variable for merger and acquisition activity (M&A). Audit firms have been shown to exhibit
general tendencies consistent with investment in industry expertise (Hogan and Jeter, 1999). As
such, companies may switch auditors for expertise reasons unrelated to their risk profile.
Because the costs of changing auditors are expected to be higher for larger clients (DeAngelo,
1981), we predict a negative coefficient estimate on SIZE. We include M&A because companies
are more likely to change auditors after a merger or acquisition if the newly-combined entities
had previously engaged different auditors, and hence we expect a positive coefficient estimate on
this variable.
We estimate the auditor change model using two complementary approaches. The first
pools dismissals and resignations. The second permits coefficient estimates to differ for
dismissals and resignations using a multinomial logit technique. Multinomial logit is an
extension of the binary logit model to multiple choices. The procedure estimates the probability
of a particular alternative relative to the probabilities of all other alternatives. In the analysis of
lateral Big N auditor switches, there are three alternatives: (i) no change in auditor, (ii) client
dismissal, or (iii) auditor resignation. An advantage of multinomial logit is that it controls for the
probability of changing auditors when testing for coefficient differences between the dismissal
and resignation subsamples. Prior research finds that auditors are more likely to resign rather
than be dismissed from clients that pose greater risk (Krishnan and Krishnan, 1997), and that
clients associated with resignations are riskier than continuing clients (Shu, 2000; Johnstone and

10

Bedard, 2004). We therefore expect the sensitivity of auditor switches to a firms risk
characteristics to be greater for resignations than dismissals. However, there may be noise in the
classification of resignations and dismissals, which would bias against finding a difference in
coefficient estimates between the two subsamples.5
3.2. Comparison of lateral Big N auditor switches and downward auditor switches
The tests outlined in the preceding section limit auditor switches to client companies
switching between Big N auditors. We extend this analysis to consider whether client risk
characteristics distinguish between lateral and downward switches (i.e., switches to a non-Big N
auditor). Assertions in the financial press suggest that a downward switch is more likely than a
lateral switch for risky clients. To directly test this assertion, we estimate the above regression
model permitting the coefficient estimates to differ by the direction of the switch (lateral or
downward) and the type of the switch (dismissal or resignation).6 This specification permits us
to test whether the sensitivity to client risk differs for lateral Big N and downward switches. If
risky clients are more likely to be excluded from the Big N audit market, as many have
conjectured, downward switches (and, in particular, those triggered by an auditor resignation)
will be more highly associated with client risk characteristics than lateral switches.
3.3. Data
Our sample consists of auditor switches during fiscal years 1993-2001 reported on the
AuditorTrak database, as well as those occurring during fiscal years 2002-2004 on the Auditor
5

Firms are required to disclose in an 8-K filing whether the auditor resigned, declined to stand for re-election, or
was dismissed. We consider declining to stand for re-election as tantamount to a resignation, and code these few
observations accordingly. We note that the two-way partition, although common in prior research, does not
necessarily fully capture the underlying dynamics of the auditor change. For example, auditors may prefer to be
dismissed from an engagement because of concerns that resignations could harm their ability to attract new clients.
Alternatively, clients may rush to dismiss an auditor they believe is about to resign because of concerns that the
resignation will be viewed negatively by market participants and perhaps even regulators.
6
Because our sample consists of all firms with an incumbent Big N auditor, the only possible outcomes are a lateral
switch to another Big N auditor, a downward switch to a non-Big N auditor, or no switch. Thus, our analysis does
not include upward switches from a non-Big N auditor to a Big N auditor.

11

Analytics database, which only covers the period from 2000-present.7 We exclude companies in
the financial services sector (SIC codes 6000-6999) because of its unique operating environment
and differences in accounting classifications that make inferences difficult in subsequent
analyses. The sample period begins with the first year of available data, and in the pre-Enron
period ends in the year prior to the Enron scandal. The pre-Enron (1993-2001) sample thus
spans a period of relative stability in the audit market, with only one merger among the major
audit firms between Coopers & Lybrand and Price Waterhouse in 1998 and prior to the
dissolution of Arthur Anderson and subsequent governance reforms that together caused many
public companies and their auditors to reassess their business relationship.8 Our post-Enron
period is limited by data availability to the three fiscal years, 2002-2004, where fiscal year is
defined as on Compustat.
The databases obtain the identity of both the predecessor and successor auditors for all
switches from a search of SEC filings and other sources. Both databases also provide
information on whether the auditor resigned or was dismissed by the client, as reported in the 8K filing, the date of the change, and total sales revenue in the last fiscal year audited by the
predecessor auditor.
Table 1 reports the frequency of auditor switches during the pre-Enron (panel A) and
post-Enron (panel B) periods. We classify each change based on the identity of the predecessor
and successor auditor. Of the 5,369 switches in panel A, lateral switches among non-Big N
auditors occur with the greatest frequency (1,868 or 34.8%). Lateral switches among Big N

Source: Auditor-Trak. Copyright 2003 by Strafford Publications, Inc. All rights reserved. Used by permission.
We do not have access to AuditorTrak data post 2001, but do have access to Auditor Analytics. Both datasets are
comprehensive, and we are not aware of any biases in either database that would confound comparisons of results
across time periods.
8
We exclude all auditor switches after October 15, 2001 (the date Enron announced its restatement plans) from the
pre-Enron period.

12

auditors are the second most common type (1,632 or 30.4%), surpassing downward switches
from a Big N to a non-Big N auditor (1,181 or 22.0%). Finally, there are relatively few upward
switches to a Big N auditor (688 or 12.8%). A very different picture emerges, however, when
the data are weighted by the clients total sales revenue in the year prior to the change.9 These
findings reveal that the overwhelming majority of activity occurs among Big N firms,
representing 87.1% of sales-weighted auditor switches in the pre-Enron period.
The remaining columns in table 1, panel A, partition the data into auditor resignations
and client dismissals. The results are generally similar in both analyses, although lateral Big N
switches are relatively less common in the case of an auditor resignation, while downward
switches to a non-Big N auditor are relatively more common. However, in both partitions,
lateral Big N switches continue to dominate in economic importance. On a sales-weighted basis,
71.6% of auditor resignations and 90.2% of client dismissals are among Big N auditors.
The findings in table 1, panel A, provide clear evidence of the importance of lateral Big
N auditor switches relative to other types of auditor switches. Clearly, lateral Big N switches
represent the most economically significant set of auditor switches, and thus are of inherent
interest. Moreover, as discussed above, most prior research pools all types of auditor switches,
or concentrates on switches between Big N and non-Big N auditors. By focusing on lateral Big
N switches, this paper extends the literature to an important, yet mostly overlooked, segment of
auditor switches. Unless otherwise noted, the remainder of the analysis in this paper refers to
this set of lateral switches among Big N auditors.
Table 1, panel B documents similar statistics for the post-Enron period (2002-2004). The
findings here indicate lateral Big N switches have become less frequent than downward switches,
but still dominate on a sales-weighted basis (80.6%). The lower frequency of lateral Big N
9

All sales-weighted statistics reported in the paper have been adjusted for inflation.

13

switches relative to downward switches indicates the audit market has undergone some changes,
some of which are expected given the reduction in the number of Big N auditors in this period
because of the loss of Arthur Andersen. However, other changes, such as increased auditing
requirements, may also be affecting the statistics. For instance, Plitch and Wei (2004) notes a
recent escalation in auditor switches pooling across all types, which the authors attribute to
companies rotating auditors as part of an effort to strengthen corporate governance and a
reluctance on the part of large audit firms to retain smaller clients amid new and more extensive
auditing requirements. Whether these factors have led to any substantive post-Enron changes in
the risk profiles of companies switching auditors is an empirical question that we address in
section 5.
Table 2 reports descriptive statistics for lateral Big N switches by calendar year. The
findings reveal that the frequency of lateral Big N switches increased somewhat in the 19972001 time frame and have since slowed in the post-Enron period.10 A similar pattern is observed
for dismissals. Resignations appear to have peaked in the 1998-2000 time frame, with the
exception of a substantial spike in 2003. The last two columns present comparison statistics for
the Compustat population of non-switch observations with a Big N auditor. These findings also
show a somewhat higher frequency of observations, particularly on a sales-weighted basis, in the
latter half of the sample period.

10

The unusually high sales-weighted switch frequency of 17.0% in 2000 is largely attributable to both Hewlett
Packard and Compaq Computer changing auditors from PricewaterhouseCoopers to Ernst & Young because of
independence concerns arising from Hewlett Packards possible acquisition of Compaq and PWC Consulting. Also
in that year, Verizon merged with GTE and the merged entity concurrently changed auditors to Ernst & Young.
Without these four switches, all of which were considered dismissals, the sales-weighted switch frequency in 2000
is 15.0% in the pooled sample and 14.2% in the dismissals sample. Similarly, the unusually high sales-weighted
switch frequency in the 1998 resignations sample is attributable to the merger of British Petroleum and Amoco and
the concurrent resignation of PricewaterhouseCoopers as the combined entitys auditor. Without this change, the
sales-weighted switch frequency in the 1998 resignation sample is 6.8%.

14

4. Results from the pre-Enron era

4.1. Univariate tests
Table 3 presents means and medians for the regressors appearing in the estimating
equations for the pre-Enron (1993-2001) sample. Panel A presents statistics comparing
differences in means and medians for the switch and no switch subsamples; panel B presents
analogous statistics for dismissals and resignations within the switch subsample. Because of
missing data, the regression sample contains 1,203 lateral Big N auditor switches, consisting of
1,046 client dismissals and 157 auditor resignations. The corresponding sample of no switch
observations includes all firm-years on Compustat with a Big N auditor in both the current and
prior year (i.e., years t and t 1) that did not switch auditors (whether lateral, downward, or
upward) within 2 years, resulting in 26,302 non-switch observations. We winsorize all nonindicator variables at the 1% and 99% levels.
Panel A reveals that companies switching to another Big N auditor are more likely to
have received a going concern opinion from their incumbent Big N auditor (GC) and have a
shorter history with that incumbent (TENURE). In addition, companies switching between Big
N auditors are significantly less profitable (ROA and LOSS) and more highly levered
(LEVERAGE) than companies that do not switch Big N auditors. Finally, companies switching
between Big N auditors are less likely to have an incumbent auditor that is an expert in the
clients industry (EXPERT), are smaller (SIZE), and are more likely to have recently engaged in
merger and acquisition activity (M&A). The results in panel B indicate that among companies
that switch laterally between Big N auditors, those that do so because of an auditor resignation
are significantly less profitable, smaller, more likely to have received a going concern or other

15

modified opinion, and have a shorter track record with the incumbent than companies that
dismiss their Big N auditor.
In summary, the findings in table 3 suggest that companies switching laterally between
Big N auditors are riskier than those retaining their incumbent Big N auditor (panel A), and that
auditor resignations are associated with riskier clients than client dismissals (panel B). In
interpreting these results, we emphasize that the sample of auditor switches in our analysis is
distinctly different from prior research in that it contains only lateral Big N switches. By
implication, then, the risky clients in our sample are not excluded from the Big N audit market,
even when the incumbent Big N auditor resigns from the engagement. In the next section, we
further investigate the risk profile of companies changing laterally between Big N auditors using
the logistic regression model developed above.
4.2. Regression analysis of lateral Big N auditor switches
Table 4 presents regression summary statistics for estimations of the logistic regression
model. The first set of results, labeled Binary Logit Estimation, includes all lateral Big N
auditor switches in a binary logistic regression with the sample of companies not switching Big N
auditors as the reference category. The second set of results, labeled Multinomial Logit
Estimation, is for a single multinomial logistic regression that permits different coefficient
estimates for auditor switches identified as dismissals and resignations, with companies not
switching Big N auditors as the reference category. The final column in the table presents
significance levels for tests of coefficient differences between the dismissal and resignation
subsamples in the multinomial estimation. For parsimony, year and industry fixed-effects are not
tabulated, although some of the individual coefficients are significant.

16

Results for the sample of all lateral Big N switches reveal that many of the coefficient
estimates are significant and are consistent with audit risk increasing the probability of a lateral
Big N switch. Specifically, the coefficient estimate on GROWTH is significantly positive, which
is consistent with the findings of Stice (1991). In addition, the issuance of either a going concern
(GC) or otherwise modified audit opinion (MODOP) significantly increases the probability of a
lateral switch in Big N auditors, as does shorter tenure with the client (TENURE) and less
expertise in the clients industry (EXPERT). Finally, the control variables, SIZE and M&A, are
significant in the predicted direction, indicating that the likelihood of switching Big N auditors is
decreasing in client firm size and increasing in the incidence of recent merger or acquisition
activity. Among the audit risk measures, only the coefficient estimates on the discretionary
accruals variables are insignificant.
The results on the financial risk variables are also generally consistent with expectations
and the univariate tests in table 3. In particular, the positive and significant coefficient estimate
on LOSS indicates that loss companies are more likely to switch laterally to another Big N
auditor. The coefficient estimate on ROA, however, is insignificant, suggesting that reported
profitability is not incrementally important in the switch decision. Only when LOSS is excluded
from the estimation is the coefficient estimate on ROA significantly negative (results
untabulated). Also as expected, LEVERAGE has a significant positive effect on the probability
of switching between Big N auditors.
The remaining columns of table 4 present findings from the multinomial logit estimation
that permits coefficient estimates to differ for lateral Big N auditor switches identified by the
client as dismissals or resignations. With one exception, the findings for dismissals parallel those
of the pooled model; specifically, the issuance of a going concern audit opinion does not

17

significantly increase the probability that the incumbent will be dismissed in favor of another Big
N auditor. The results for resignations are also generally consistent with the pooled model,
although client growth, the issuance of a modified audit opinion, and auditor expertise are not
significant at traditional levels. Finally, it is not surprising that the coefficient estimate on the
control variable M&A is insignificant for resignations, as there is no reason to expect auditors to
resign from clients that have recently engaged in a merger or acquisition. The final column of
table 4 reveals that most of the differences in coefficient estimates between lateral Big N
dismissals and resignations are insignificant. However, the probability a Big N auditor will
resign rather than be dismissed from an engagement increases with the issuance of a going
concern audit opinion and decreases with auditor tenure.
Although the focus of our study is not on the distinction between resignations and
dismissals, we note that these findings are consistent with Krishnan and Krishnan (1997), which
pools all auditor switches, including downward switches to a non-Big N auditor. Krishnan and
Krishnan (1997) concludes, however, that the studys evidence supports claims that risk
avoidance by the Big N leads to the withdrawal of audit services for an important segment of the
market, even though they do not examine the direction of the auditor switch. Because our sample
consists entirely of lateral Big N auditor switches, our findings contradict this conclusion.
Instead, we show that even though Big N firms are more likely to resign from clients with certain
risk characteristics, another Big N firm is willing to audit these risky clients. Thus, although
prior studies document risk differences between clients whose auditor resigned and clients that
dismiss their auditor (Krishnan and Krishnan, 1997; Shu, 2000) or continue with their incumbent
auditor (Shu, 2000; Johnstone and Bedard, 2004), this is the first study to show that these same
risk characteristics also explain lateral switches among Big N auditors.

18

4.3. Comparison of lateral Big N and downward switches

Although the findings presented in table 4 are consistent with an increased likelihood of a
lateral switch in Big N auditors for riskier clients, the evidence does not address the related issue
of the extent to which client risk distinguishes between lateral and downward switches to a nonBig N auditor. The assumption in prior research is that riskier clients switching from one of the
Big N firms will engage a smaller, non-Big N auditor rather than another Big N auditor.
However, as discussed above, there is limited evidence on this question and the results are
inconclusive. In this section we present evidence from a multinomial logit estimation that
permits coefficient estimates to differ for lateral and downward switches. T-tests for pairwise
coefficient differences, conducted separately for dismissals and resignations, indicate whether
client risk factors distinguish between the likelihood a client will change laterally to another Big
N auditor or move downward to a non-Big N auditor. The sample of downward switches
includes all companies switching from a Big N to a non-Big N auditor, while the sample of nonswitch observations is the same as above.
Table 5, panel A, presents summary statistics from the multinomial logit estimation, and
panel B presents p-values for tests of coefficient differences. Because the estimation sample in
table 5 includes downward switches in addition to lateral Big N switches, the coefficient
estimates for lateral Big N dismissals and resignations are not identical to the coefficient
estimates reported in table 4. However, the results are quite similar, and none of our previous
inferences regarding lateral Big N switches is altered. More importantly, the findings show that
lateral Big N and downward switches are sensitive to the same client risk characteristics. For
example, of the 8 coefficient estimates that are significant at the 0.10 level or less for lateral Big
N dismissals, 6 are also significant in the same direction for downward dismissals. Unlike lateral

19

dismissals, LEVERAGE and M&A are insignificant for downward dismissals, while a going
concern audit opinion and negative discretionary accruals (ACC + ACC*NEGACC) are
incrementally significant. The latter result is consistent with the findings of DeFond and
Subramanyan (1998) showing that companies dismiss incumbent auditors that impose
conservative accounting choices in hopes of finding a less conservative successor auditor.
The findings in table 5, panel A, also reveal that 4 of the 5 variables that are significant
for lateral Big N resignations are also significant for downward resignations. Similar to the
dismissal results, however, LEVERAGE is insignificant for downward resignations. In addition,
the likelihood of a downward resignation increases significantly for companies with poor
financial performance (ROA), low growth (GROWTH), a modified audit opinion (MODOP), and
an incumbent auditor with less expertise in the clients industry (EXPERT).
Despite the similarities between lateral Big N and downward auditor switches observable
in panel A, the coefficient estimates for downward switches are generally of greater magnitude.
Inspection of the p-values for tests of coefficient differences reported in panel B, however,
reveals that many of the coefficient differences between lateral and downward switches are
insignificant. The likelihood of a downward switch, whether by dismissal or resignation, is
decreasing in client size and growth and the tenure of the incumbent Big N auditor. In addition,
downward dismissals are more sensitive than lateral dismissals to a going concern opinion and to
positive (ACC) and negative (ACC+ACC*NEGACC) discretionary accruals. Contrary to
expectations, lateral Big N switches, both dismissals and resignations, are more sensitive to
client leverage than downward switches. Finally, untabulated findings reveal that 20% of the
downward sample had switched upward to a Big N auditor within the previous five years.
Excluding these companies from the estimation generally does not affect inferences, although the

20

coefficient estimates on GC and negative discretionary accruals (ACC+ACC*NEGACC) are no

longer significantly different.
It is important to note that most of the significant differences between the lateral and
downward samples in table 5, panel B, are related to client dismissals, not auditor resignations.
Moreover, the downward switches appear to represent small clients with going concern opinions,
and thus are arguably no longer of interest to the Big N. Untabulated statistics indicate that
downward switch companies are much smaller than lateral switch companies. Specifically, the
lower size quartile of lateral Big N switches is larger than the upper size quartile of downward
switches. Additional untabulated statistics reveal that more than 25% of downward switches had
going concern opinions in the year prior to the change, compared to only 7% of lateral Big N
switches. Many of these going concern companies likely face bankruptcy, which could preclude
their ability to afford a Big N auditor or create independence issues if there are outstanding fees
to the incumbent Big N auditor. Consequently, our evidence suggests that large, risky
companies are able to switch laterally within the Big N audit tier, while small companies that
generally pose less risk to the auditor, all else equal, switch downward to a non-Big N auditor.
4.4. Sensitivity analyses
We conduct several additional analyses to assess the robustness of our results. First, we
examine whether our results are distinct from switches due to auditor realignment or clientele
mismatch (e.g., Johnson and Lys, 1990, Shu, 2000). Specifically, following the procedure in Shu
(2000), we calculate an annual index measure for each client that captures how well that client is
matched with its current auditor, and then determine an optimal cut-off probability that predicts
whether a client is better matched with a Big N or non-Big N auditor. If an actual auditor-client

21

pairing is opposite to the prediction in the current year but not in the prior year, then the client
has become mismatched with its auditor and the likelihood of a switch is expected to increase.
In untabulated analyses, we find that the clientele mismatch variable is incrementally
positive and significant at the 0.01 level for downward switches, whether dismissals or
resignations. This finding is consistent with the results reported by Shu (2000). Importantly,
however, we find that the clientele mismatch variable is insignificant in explaining lateral Big N
auditor switches, while none of the inferences regarding our client risk variables is altered.11
Thus, we show that our results regarding the lateral movement of risky clients between Big N
auditors are distinct from prior evidence regarding clientele adjustment or auditor realignment.
Second, we examine whether our results are robust across Big N auditors by permitting
the coefficient estimates in our logistic model to differ for each Big N successor auditor.
Untabulated results reveal no significant differences in the coefficient estimates across auditors.
Thus, our results do not appear to be driven by the behavior of one or a few of the Big N
auditors.
Third, we investigate the frequency of reportable events and accounting disagreements
for clients switching laterally between Big N auditors and downwards to a non-Big N auditor.
Reportable events and accounting disagreements disclosed at the time of the switch are generally
viewed to be indicative of client risk.12 The untabulated results reveal that lateral Big N
(downward) switches are accompanied by a reportable event 7.3% (9.1%) of the time and by an
11

For completeness, in these analyses we also include the summary measure of litigation risk that is the other
primary variable of interest in Shu (2000). Except for downward resignations, this variable is not incrementally
significant.
12
SEC rules require registrants to report a change in auditor by filing a Form 8-K within five days of the change.
Among other disclosure requirements, the company must reveal whether in the two most recent fiscal years the
auditor had advised them of any of the following reportable events: (i) internal controls necessary to develop
reliable financial statements do not exist; (ii) the auditor was unwilling to rely on managements representations;
(iii) the scope of the audit needs to be significantly expanded; or (iv) information has become available that
materially affects the fairness or reliability of a previously issued audit report or financial statements. The company
must also disclose any disagreements on accounting matters even if resolved to the auditors satisfaction.

22

accounting disagreement 4.6% (5.7%) of the time. These frequencies are not statistically
different at the 10% level. Thus, consistent with our primary results, riskier clients are no more
likely to be excluded from the Big N audit market.
5. Results from the post-Enron era
The results for the 1993-2001 period indicate that risky clients switch between Big N
auditors rather than being forced to move to lower tier auditors as the popular press suggests.
However, given the many legal and regulatory changes subsequent to Enrons collapse, the
auditing market experienced a significant number of changes including the loss of one of the Big
N auditors (Andersen), as well as restrictions on the services auditors are allowed to perform.
These changes, coupled with the realization that the risk posed by clients is likely higher than
previously thought, could have significantly affected the auditor switch market. To determine
whether this is the case, we repeat the analyses in tables 4 and 5 utilizing a sample of companies
from the post-Enron period (2002-2004). In conducting these analyses, we exclude all auditor
switches where Arthur Andersen was the predecessor auditor, as these companies were forced to
change auditors (Blouin et al., 2005), a fundamentally different situation from the auditor
switches examined in this paper and the prior literature.
In contrast to the pre-Enron findings, the results from the binary logit estimation reported
in table 6 indicate that only the control variables EXPERT, SIZE and M&A are significant in the
post-Enron period. The multinomial logistic regression that permits coefficient estimates to
differ for dismissals and resignations reveals similar findings for both types of auditor switches
with the exception of M&A which is insignificant for resignations. Tests of coefficient
differences in the last column of table 6 reveal no significant differences between lateral Big N
dismissals and resignations in the post-Enron period.

23

Table 7 compares lateral Big N and downward switches in the post-Enron period.
Although the coefficient estimates in the lateral Big N switch columns may differ from those
reported in table 6 because of the inclusion of downward switches in the estimation, all
inferences regarding post-Enron lateral Big N switches remain unchanged. Unlike the results for
the lateral Big N switches, several of the coefficient estimates for the downward switches,
whether dismissals or resignations, retain their significance in the post-Enron period.
To facilitate comparison of the findings of the pre- and post-Enron periods, table 8
reports a summary of the results from tests of coefficient differences in the pre- and post-Enron
periods. A Yes indicates the coefficients across the comparison categories (e.g., Lateral
Dismissal versus Lateral Resignation) are significantly different at or below the 10% level, while
a No indicates the coefficient differences are not significantly different. The comparison of
lateral Big N dismissals versus resignations reveals no significant coefficient differences in the
post-Enron period, compared to just two in the pre-Enron period. The results for lateral versus
downward dismissals and lateral versus downward resignations also indicate there are fewer
significant differences in the post-Enron period. However, in both instances, several of the
significant coefficient differences continue to exist in the post-Enron period. Moreover, as in the
pre-Enron period, the significant differences relate primarily to client dismissals, and appear to
represent small clients with going concern opinions.
Although the post-Enron findings should be interpreted with caution because of limited
data availability, the results reported above suggest there have been some changes in the market
for audit switches in the post-Enron era. Most importantly, lateral Big N switches, particularly
auditor resignations, have become less frequent relative to downward switches (table 1).
Although this decline in lateral Big N switches could be simply the result of a smaller number of

24

Big N auditors, we also find that audit and financial risk factors of clients are no longer
significantly associated with lateral Big N auditor switches (table 6). Taken together, these
findings provide some evidence that risky firms are less likely to switch laterally to another Big
N auditor in the post-Enron environment. There appears to be fewer post-Enron changes in
downward switches, as it is still small companies with going concern opinions that are excluded
from the Big N auditor market. As more data become available, exploration of post-Enron
auditor switches, both laterally between the remaining Big N auditors and downwards to non-Big
N auditors, is likely to provide further insights into the forces affecting auditors risk
management decisions.
6. Summary and conclusion
This study examines a comprehensive sample of lateral switches among Big N auditors to
investigate the extent to which risky clients are excluded from the Big N audit market in the preEnron (1993-2001) and post-Enron (2002-2004) eras. Understanding auditors risk management
practices is of great importance to auditors, managers, regulators, and academics, particularly in
light of the accounting scandals that have recently rocked the auditing industry. We examine the
decade preceding these events to better understand characteristics of lateral switches among Big
N auditors in general and as a means of establishing baseline results for our examination of
auditor switches in the new environment.
To investigate the client risk factors associated with lateral Big N auditor switches, we
estimate a logit regression that models auditor switches as a function of a set of variables that
measure client audit and financial risk. Our results show that the probability of a lateral Big N
auditor switch is significantly increasing in both dimensions of client risk. Moreover, we find
that similar risk factors are associated with lateral Big N dismissals and resignations. Findings

25

from robustness tests reveal no systematic differences between individual Big N auditors. We
also compare the risk profile of lateral Big N auditor switches with downward switches to a nonBig N auditor, and find that lateral and downward switches are sensitive to similar client risk
characteristics. The downward switches generally comprise much smaller companies with going
concern opinions, suggesting that the Big N are willing to accept large, risky clients that have left
another Big N firm, but are unwilling to accept clients that pose less risk because of their small
size but are also are likely to be less profitable.
The analysis of the post-Enron period indicates that downward switches have become
more frequent than lateral Big N switches. More importantly, several risk factors that were
significant determinants of lateral Big N auditor switches in the pre-Enron period are no longer
significant in the post-Enron period, consistent with a shift in the risk management practices of
the remaining Big N auditors. However, downward switches to a non-Big N auditor continue to
relate to small clients with going concern opinions.
Taken together, we provide several key new findings not documented in the prior
literature on auditor switches. By focusing on lateral Big N auditor switches, we are able to
show that although the relationship between risky clients and one Big N auditor may be
terminated, one of the other Big N firms is willing to accept the engagement. Our post-Enron
analysis, however, suggests that Big N auditors may have become more sensitive to risky clients
in recent years. As such, our study not only offers insights into prior research on auditor
switching, but also suggests opportunities for future research. Because our post-Enron analysis
is limited to a few years, additional work can be done as more data becomes available. In
addition, researchers could explore the economic forces underlying the swapping of risky clients.

26

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29

Table 1
Relative Importance of Auditor Switches for Big N and non-Big N Auditors
Panel A: Auditor Switches by Type (1993-2001)
Pooled
Direction of Change
Non-Big N to Big N (Up)
Big N to non-Big N (Down)
Lateral non-Big N
Lateral Big N
Total

Number Freq. (%)

688
12.8
1,181
22.0
1,868
34.8
1,632
30.4
5,369

100.0

Resignations
Sales
Wtd. (%)
2.4
6.0
4.4
87.1
100.0

Number Freq. (%)

58
4.6
443
35.2
532
42.3
226
18.0
1,384

Dismissals

Sales
Wtd. (%)
1.6
25.1
1.7
71.6

100.0

100.0

Number Freq. (%)

630
15.3
738
18.0
1,336
32.5
1,406
34.2
5,022

100.0

Sales
Wtd. (%)
2.6
2.2
5.0
90.2
100.0

Panel B: Auditor Switches by Type (2002-2004)

Pooled
Direction of Change
Number Freq. (%)
Non-Big N to Big N (Up)
112
3.0
Big N to non-Big N (Down) 796
21.6
Lateral non-Big N
2,397
65.0
Lateral Big N
380
10.3
Total

3,685

100.0

Resignations
Sales
Wtd. (%)
3.4
11.3
4.7
80.6
100.0

Number Freq. (%)

21
1.8
283
23.9
826
69.9
52
4.4
1,182

100.0

Dismissals

Sales
Wtd. (%)
4.3
31.7
12.2
51.8
100.0

Number Freq. (%)

91
3.6
513
20.5
1,571
62.8
328
13.1
2,503

100.0

Sales
Wtd. (%)
3.3
8.5
3.7
84.5
100.0

This table provides descriptive statistics on auditor switches between January 1, 1993 and October 15, 2001 in Panel A, and January 1,
2002 and December 31, 2004 in Panel B (Post-Enron), except for companies in the financial service industries (SIC codes 6000-6999).
Big N auditors are defined as Arthur Andersen, Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers or its
predecessor firms, Price Waterhouse and Coopers & Lybrand. All other auditors are classified as non-Big N. Switches from Arthur
Andersen as a result of their collapse are excluded in Panel B. Sales in the sales-weighted calculations is for the last fiscal year
audited by the predecessor auditor, per the AuditorTrak database in the 1993-2001 period and Auditor Analytics in the 2002-2004
period (supplemented by Compustat data if necessary), adjusted for inflation.

30

Table 2
Characteristics of Lateral Switches among Big N Auditors

Calendar
Year
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Total

Pooled

Resignations

Dismissals

Sales
Number Freq. (%) Wtd. (%)
153
7.6
2.0
168
8.3
4.8
177
8.8
6.4
142
7.1
4.3
199
9.9
7.3
192
9.5
8.7
197
9.8
9.0
205
10.2
17.0
199
9.9
8.4
122
6.1
4.7
159
7.9
14.9
99
4.9
12.5

Sales
Number Freq. (%) Wtd. (%)
10
3.6
0.5
20
7.2
1.1
21
7.6
2.9
21
7.6
1.2
24
8.6
1.3
37
13.3
40.8
36
12.9
10.9
38
13.7
9.4
19
6.8
10.9
10
3.6
6.2
28
10.1
11.9
14
5.0
3.0

Sales
Number Freq. (%) Wtd. (%)
143
8.2
2.2
148
8.5
5.3
156
9.0
6.8
121
7.0
4.7
175
10.1
8.1
155
8.9
4.5
161
9.3
8.8
167
9.6
18.0
180
10.4
8.1
112
6.5
4.5
131
7.6
15.3
85
4.9
13.8

2,012

100.0

100.0

278

100.0

100.0

1,734

100.0

100.0

Compustat Population
Sales
Freq. (%) Wtd. (%)
7.8
6.0
8.1
6.4
8.7
7.2
9.7
7.8
9.9
8.2
9.4
8.2
9.3
8.7
8.7
9.6
8.1
9.6
7.3
8.8
6.9
9.7
6.0
9.7
100.0

100.0

This table provides descriptive statistics on auditor switches between January 1, 1993 and May 31, 2005, except for companies in the
financial service industries (SIC codes 6000-6999). Big N auditors are defined as Arthur Andersen, Deloitte & Touche, Ernst &
Young, KPMG, and PricewaterhouseCoopers or its predecessor firms, Price Waterhouse and Coopers & Lybrand. Except for the
Compustat Population, sales in the sales-weighted calculations are for the last fiscal year audited by the predecessor auditor adjusted
for inflation. Data for the Compustat Population are obtained from Compustat, and are based on all firm-years on Compustat during
1993-2004 with a Big N auditor in both the current and prior year.

31

Table 3
Descriptive Statistics on Regression Variables, 1993-2001
Panel A: Comparison of Switch and No Switch Samples
Mean
Variable
GROWTH
ACC
NEGACC
GC
MODOP
TENURE
ROA
LOSS
LEVERAGE
EXPERT
SIZE
M&A
N

No Change
0.14
0.00*
0.52
0.03
0.14
6.89***
0.04***
0.32
0.23
0.31***
5.21***
0.31

Change
0.14
0.01
0.52
0.07***
0.16
6.08
0.13
0.48***
0.27***
0.25
4.42
0.36***

26,302

1,203

Median
No Change
Change
0.07
0.06
0.00
0.00
1.00
1.00
0.00
0.00***
0.00
0.00
7.00***
6.00
0.03***
0.00
0.00
0.00***
0.20
0.23***
0.00***
0.00
5.07***
4.27
0.00
0.00***
26,302

1,203

Panel B: Comparison of Resignations and Dismissals for the Switch Sample

Mean
Variable
GROWTH
ACC
NEGACC
GC
MODOP
TENURE
ROA
LOSS
LEVERAGE
EXPERT
SIZE
M&A
N

Dismissal
0.15
0.01
0.52
0.06
0.17**
6.21***
0.11***
0.46
0.27
0.26
4.47***
0.36

Resignation
0.12
0.01
0.52
0.17***
0.11
5.22
0.23
0.61***
0.28
0.22
4.05
0.34

1,046

157

32

Median
Dismissal
Resignation
0.07
0.02
0.00
0.02
1.00
1.00
0.00
0.00***
0.00*
0.00
6.00***
4.00
0.01***
0.05
0.00
1.00***
0.23
0.23
0.00
0.00
4.32**
3.98
0.00
0.00
1,046

157

Table 3 Continued
The Switch sample consists of firm-years during 1993-2001 with a lateral switch among Big N
auditors. The No Switch sample consists of firm-years during 1993-2001 with a Big N auditor in
both the current and prior year that did not switch auditors (whether lateral, downward, or
upward) within 2 years. GROWTH is total assets less beginning total assets, divided by
beginning total assets. ACC is performance-adjusted discretionary total accruals. NEGACC
equals 1 if ACC is negative, and 0 otherwise. GC equals 1 if the audit opinion is a going
concern, and 0 otherwise. MODOP equals 1 if the audit opinion is modified for anything other
than a going concern, and 0 otherwise. TENURE is the number of years audited by the
incumbent auditor, with a maximum of 10 years. ROA is net income before extraordinary items,
divided by average total assets. LOSS equals 1 if ROA < 0, and 0 otherwise. LEVERAGE is
long-term debt divided by total assets. EXPERT equals 1 if the incumbent auditor has at least
5% more clients in a particular industry and state than any other auditor, and 0 otherwise. SIZE
is the natural logarithm of market value of equity. M&A equals 1 if the client engaged in a
merger or acquisition in the preceding two years, and 0 otherwise. All non-indicator variables
are winsorized at the 1% and 99% levels.
*, **, and *** indicate variable is significantly greater than the corresponding value at the 10%,
5%, and 1% levels, respectively, using two-tailed tests.

33

Table 4
Regressions of Lateral Big N Auditor Switches on Client Risk Characteristics, 1993-2001

SWITCH it = t t + I I + 1GROWTH it 1 + 2 ACCit 1 + 3 NEGACCit 1 + 4 ACCit 1 NEGACCit 1

Model:

+ 5GCit 1 + 6 MODOPit 1 + 7TENUREit 1 + 8 ROAit 1 + 9 LOSSit 1 + 10 LEVERAGEit 1

+11 EXPERTit 1 + 12 SIZEit 1 + 13 M & Ait 1 + it

Variable
GROWTH
ACC
NEGACC
ACC*NEGACC
GC
MODOP
TENURE
ROA
LOSS
LEVERAGE
EXPERT
SIZE
M&A
ACC + ACC*NEGACC

Binary Logit Estimation

All Switches
Coeff. Est.
p-value
0.21
0.00
0.40
0.25
0.03
0.74
0.32
0.50
0.33
0.01
0.39
0.00
0.05
0.00
0.09
0.54
0.38
0.00
0.46
0.00
0.19
0.01
0.16
0.00
0.21
0.00
0.08

0.77

Multinomial Logit Estimation

Dismissals
Resignations
Coeff. Est.
p-value
Coeff. Est.
p-value
0.24
0.00
0.07
0.56
0.50
0.19
0.08
0.92
0.04
0.59
0.09
0.69
0.34
0.51
0.25
0.82
0.15
0.31
0.96
0.00
0.40
0.00
0.22
0.42
0.04
0.00
0.14
0.00
0.05
0.74
0.15
0.64
0.36
0.00
0.57
0.01
0.44
0.00
0.62
0.05
0.17
0.02
0.31
0.12
0.16
0.00
0.19
0.00
0.22
0.00
0.14
0.44
0.16

0.59

0.33

0.63

Tests of
Differences
p-values
0.17
0.51
0.57
0.94
0.00
0.54
0.00
0.78
0.35
0.60
0.51
0.52
0.69
0.50

Switch
1,203
1,046
157
No Switch
26,302
26,302
26,302
See table 3 for variable definitions. The columns labeled Binary Logit Estimation includes all lateral Big N auditor switches for the
1993-2001 period in a binary logistic regression with the sample of companies not changing Big N auditors as the reference category
(pseudo R2 = 0.05). The columns labeled Multinomial Logit Estimation are for a single multinomial logistic regression for the
1993-2001 period that permits different coefficient estimates for auditor switches identified as dismissals and resignations, with
companies not changing Big N auditors as the reference category (pseudo R2 = 0.06). The Tests of Differences are for a comparison
of the coefficient estimates for Dismissals and Resignations. All p-values are two-tailed.
34

Table 5
Regression of Lateral Big N and Downward Auditor Switches on Client Risk Characteristics, 1993-2001

SWITCH it = t t + I I + 1GROWTH it 1 + 2 ACCit 1 + 3 NEGACCit 1 + 4 ACCit 1 NEGACCit 1

Model:

+ 5GCit 1 + 6 MODOPit 1 + 7TENUREit 1 + 8 ROAit 1 + 9 LOSSit 1 + 10 LEVERAGEit 1

+11 EXPERTit 1 + 12 SIZEit 1 + 13 M & Ait 1 + it

Panel A: Summary Statistics from Multinomial Logit Estimation

Variable
GROWTH
ACC
NEGACC
ACC*NEGACC
GC
MODOP
TENURE
ROA
LOSS
LEVERAGE
EXPERT
SIZE
M&A

Lateral Big N Switches

Dismissals
Resignations
Coeff. Est. p-value
Coeff. Est. p-value
0.24
0.00
0.07
0.57
0.49
0.20
0.13
0.87
0.04
0.60
0.10
0.64
0.31
0.54
0.18
0.87
0.17
0.25
0.99
0.00
0.41
0.00
0.23
0.41
0.14
0.00
0.04
0.00
0.04
0.78
0.17
0.60
0.36
0.00
0.55
0.01
0.45
0.00
0.64
0.04
0.17
0.02
0.31
0.11
0.20
0.00
0.16
0.00
0.22
0.00
0.16
0.40

ACC + ACC*NEGACC

0.18

Switch
No Switch

1,046
26,302

0.54

0.32

0.64

157
26,302

Downward Switches
Dismissals
Resignations
Coeff. Est. p-value
Coeff. Est. p-value
0.30
0.00
0.33
0.01
0.72
0.11
0.72
0.21
0.04
0.76
0.12
0.55
1.94
0.00
1.39
0.09
0.56
0.00
1.06
0.00
0.55
0.00
0.76
0.00
0.19
0.00
0.26
0.00
0.25
0.17
0.67
0.00
0.42
0.00
0.65
0.00
0.11
0.56
0.19
0.46
0.29
0.02
0.56
0.00
0.84
0.00
0.66
0.00
0.07
0.63
0.19
0.28
1.22
473
26,302

35

0.00

0.67
227
26,302

0.19

Table 5 Continued
Panel B: p-values for Tests of Coefficient Differences
Variable
GROWTH
ACC
NEGACC
ACC*NEGACC
GC
MODOP
TENURE
ROA
LOSS
LEVERAGE
EXPERT
SIZE
M&A
ACC + ACC*NEGACC

Lateral
Dismissals versus Resignations
0.16
0.48
0.53
0.92
0.00
0.54
0.00
0.72
0.39
0.58
0.49
0.44
0.76

Lateral versus Downward

Dismissals
0.00
0.03
1.00
0.00
0.05
0.39
0.00
0.38
0.68
0.01
0.40
0.00
0.06

Lateral versus Downward

Resignations
0.02
0.55
0.45
0.25
0.80
0.12
0.00
0.20
0.75
0.04
0.35
0.00
0.90

0.50

0.03

0.24

See table 3 for variable definitions. The results are from a single multinomial logistic regression for the 1993-2001 period with the
sample of companies not changing Big N auditors as the reference category (pseudo R2 = 0.19). In panel B, reported p-values are for
the indicated tests of differences in coefficient estimates reported in panel A. All p-values are two-tailed.

36

Table 6
Regressions of Lateral Big N Auditor Switches on Client Risk Characteristics, 2002-2004
SWITCH it = t t + I I + 1GROWTH it 1 + 2 ACCit 1 + 3 NEGACCit 1 + 4 ACCit 1 NEGACCit 1
Model:

+ 5GCit 1 + 6 MODOPit 1 + 7TENUREit 1 + 8 ROAit 1 + 9 LOSSit 1 + 10 LEVERAGEit 1

+11 EXPERTit 1 + 12 SIZEit 1 + 13 M & Ait 1 + it

Variable
GROWTH
ACC
NEGACC
ACC*NEGACC
GC
MODOP
TENURE
ROA
LOSS
LEVERAGE
EXPERT
SIZE
M&A
ACC + ACC*NEGACC
Switch
No Switch

Binary Logit Estimation

All Switches
Coeff. Est.
p-value
0.17
0.30
0.37
0.57
0.08
0.62
-0.03
0.98
-0.36
0.37
0.15
0.36
-0.03
0.13
0.20
0.44
-0.20
0.24
-0.13
0.67
-1.13
0.00
-0.18
0.00
0.34
0.02
0.34
0.69
245
10,315

Multinomial Logit Estimation

Dismissals
Resignations
Coeff. Est.
p-value
Coeff. Est.
p-value
0.20
0.24
-0.07
0.88
0.62
0.38
-1.42
0.49
0.10
0.57
-0.04
0.93
-0.32
0.78
2.17
0.49
-0.53
0.26
0.24
0.76
0.12
0.50
0.25
0.51
-0.02
0.32
-0.09
0.11
0.18
0.53
0.26
0.70
-0.21
0.25
-0.15
0.72
-0.29
0.41
0.51
0.47
-1.07
0.00
-1.55
0.04
-0.19
0.00
-0.15
0.08
0.40
0.01
-0.02
0.97
0.29
0.75
0.75
0.74
207
38
10,315
10,315

Tests of
Differences
p-values
0.59
0.34
0.76
0.46
0.40
0.76
0.27
0.91
0.90
0.30
0.54
0.73
0.33
0.85

See table 3 for variable definitions. The estimations use only post-Enron data (2002-2004) and exclude all auditor switches related to
the collapse of Arthur Andersen. The columns labeled Binary Logit Estimation includes all lateral Big N auditor switches in a
binary logistic regression with the sample of companies not changing Big N auditors as the reference category (pseudo R2 = 0.05).
The columns labeled Multinomial Logit Estimation are for a single multinomial logistic regression that permits different coefficient
estimates for auditor switches identified as dismissals and resignations, with companies not changing Big N auditors as the reference
category (pseudo R2 = 0.05). The Tests of Differences are for a comparison of the coefficient estimates for Dismissals and
Resignations. All p-values are two-tailed.
37

Table 7
Regression of Lateral Big N and Downward Auditor Switches on Client Risk Characteristics, 2002-2004

SWITCH it = t t + I I + 1GROWTH it 1 + 2 ACCit 1 + 3 NEGACCit 1 + 4 ACCit 1 NEGACCit 1

Model:

+ 5GCit 1 + 6 MODOPit 1 + 7TENUREit 1 + 8 ROAit 1 + 9 LOSSit 1 + 10 LEVERAGEit 1

+11 EXPERTit 1 + 12 SIZEit 1 + 13 M & Ait 1 + it

Variable
GROWTH
ACC
NEGACC
ACC*NEGACC
GC
MODOP
TENURE
ROA
LOSS
LEVERAGE
EXPERT
SIZE
M&A
ACC + ACC*NEGACC
Switch
No Switch

Lateral Big N Switches

Dismissals
Resignations
Coeff. Est. p-value
Coeff. Est. p-value
0.20
0.24
-0.07
0.88
0.60
0.39
-1.33
0.51
-0.04
0.93
0.10
0.60
-0.37
0.75
2.04
0.52
-0.51
0.29
0.27
0.74
0.13
0.48
0.25
0.52
-0.02
0.32
-0.09
0.11
0.12
0.90
0.24
0.55
-0.21
0.30
-0.19
0.66
-0.30
0.39
0.48
0.48
-1.07
0.00
-1.54
0.04
-0.19
0.00
-0.15
0.09
0.00
0.99
0.40
0.01
0.23
207
10,315

0.80

0.71

0.76

38
10,315

Downward Switches
Dismissals
Resignations
Coeff. Est. p-value
Coeff. Est. p-value
-0.24
0.07
-0.75
0.00
0.18
0.70
0.98
0.09
-0.19
0.23
0.11
0.60
-1.58
0.04
-1.25
0.21
0.56
0.00
0.82
0.00
0.37
0.01
0.23
0.26
0.01
0.55
0.03
0.32
-0.69
0.00
-1.10
0.00
-0.29
0.06
0.32
0.16
-0.42
0.06
-0.50
0.10
0.02
0.90
0.00
0.98
-0.77
0.00
-0.58
0.00
-0.15
0.37
0.07
0.75
-1.40
367
10,315

0.01

-0.27
185
10,315

See table 3 for variable definitions. The estimations use only post-Enron data (2002-2004) and exclude all auditor switches related to
the collapse of Arthur Andersen. The results are from a single multinomial logistic regression with the sample of companies not
changing Big N auditors as the reference category (pseudo R2 = 0.18).

38

Table 8
Summary of Tests of Coefficient Differences for the pre- and post-Enron Periods

Variable
GROWTH
ACC
NEGACC
ACC*NEGACC
GC
MODOP
TENURE
ROA
LOSS
LEVERAGE
EXPERT
SIZE
M&A
ACC + ACC*NEGACC

Lateral
Dismissals versus Resignations
Pre-Enron
Post-Enron
No
No
No
No
No
No
No
No
Yes
No
No
No
Yes
No
No
No
No
No
No
No
No
No
No
No
No
No
No

Lateral versus Downward

Dismissals
Pre-Enron
Post-Enron
Yes
Yes
Yes
No
No
No
Yes
No
Yes
Yes
No
No
Yes
No
No
Yes
No
No
Yes
No
No
Yes
Yes
Yes
Yes
Yes

No

Yes

No

Lateral versus Downward

Resignations
Pre-Enron
Post-Enron
Yes
No
No
No
No
No
No
No
No
No
No
No
Yes
Yes
No
No
No
No
Yes
No
No
Yes
Yes
Yes
No
No
No

No

See table 3 for variable definitions. A Yes indicates the coefficients across the comparison categories (e.g., Lateral Dismissal versus
Lateral Resignation) are significantly different at or below the 10% level, while a No indicates the coefficient differences are not
significantly different. The Pre-Enron (Post-Enron) columns refer to findings for the 1993-2001 (2002-2004) time period.

39