Aud 2004 23 2 131

131
Submitted: March 2003

Accepted: November 2003
AUDITING: A JOURNAL OF PRACTICE & THEORY
Vol. 23, No. 2
September 2004
pp. 131146
The Effect of Audit Committee and
Board of Director Independence
on Auditor Resignation
Ho Young Lee, Vivek Mande, and Richard Ortman
SUMMARY: This study examines the relationship between audit committee and board
independence and auditor resignations. Independent audit committee and board mem-
bers, who are concerned about incurring legal liability and harming their reputations,
support the external auditors in accomplishing their assurance duties. We use a logit
model to compare audit committee and board independence between two types of
auditor switches: 190 auditor-initiated switches versus 190 matched client-initiated
switches during the time period 1996 to 2000. Our results show that audit committee and
board of director independence are both negatively associated with the likelihood of an
auditor resignation. Our results also show that audit committee independence is posi-
tively related to the quality of the firms successor auditor. This suggests that indepen-
dent audit committees also play a mitigating role in reducing the negative consequences
associated with an auditor resignation.
Keywords: audit committee and board independence; auditor resignation; litigation
risk; auditor switches.
Data Availability: Data are publicly available from sources identified in the paper.
INTRODUCTION
I
n this paper we provide empirical evidence about the association between audit committee and
board characteristics and auditor resignations. Motivation for this study comes from the recent
changes related to the role of audit committees in the corporate governance process and in
ensuring the quality of financial reporting. Our analysis of 190 firms with auditor resignations and a
matched sample of 190 firms with auditor dismissals during the period from 1996 to 2000 indicates
that audit committee and board independence are both negatively and significantly related to the
likelihood of an auditor resignation. We also find that the financial expertise of the audit committee
members is inversely related to auditor resignations.
Ho Young Lee is an Assistant Professor at the University of Nebraska at Omaha, Vivek Mande is a
Professor at California State University, Fullerton, and Richard Ortman is a Professor at the
University of Nebraska at Omaha.
We thank K. Raghunandan (associate editor) and two anonymous reviewers for their helpful comments. We also thank Jack
Armitage, Kil-Cho Kim, Sooyoung Kwon, participants of the 2003 Western AAA meetings and the workshops held at the
Securities and Exchange Commission, California State University, Fullerton and the University of Nebraska at Omaha. We
are grateful to Don Cram and Vijay Karan for their insights on the use of matched samples in logistic regressions.
132 Lee, Mande, and Ortman
Auditing: A Journal of Practice & Theory, September 2004
Recent legislation recognizes the importance of requiring audit committee independence and
financial expertise in order to assure a high quality of financial reporting. In 1999, the Blue Ribbon
Committee (BRC) recommended that audit committees of listed firms be fully independent and that
they have at least one member who possesses financial expertise. In that same year, the New York
Stock Exchange (SEC 1996b) and the National Association of Securities Dealers (SEC 1999a)
adopted the BRCs recommendations. However, in wake of recent financial scandals, Congress, in
an attempt to regain investor confidence in our financial markets, found it necessary to legislate these
requirements passing the Sarbanes-Oxley Act of 2002, which mandates that audit committees be
fully independent and have at least one financial expert. Sarbanes-Oxley (U.S. House of Representa-
tives 2002) requires that audit committees also be responsible for selecting, compensating, oversee-
ing the external auditor, and resolving disagreements between management and the external auditor.
The Securities and Exchange Commission (SEC) has since adopted final rules implementing these
Sarbanes-Oxley provisions (SEC 2003). Our studys results support Sarbanes-Oxleys requirements
that audit committees: (1) be independent and (2) possess financial expertise by showing that such
audit committee characteristics are significantly, negatively related to auditor resignations.
Accounting literature to date has primarily focused on auditors liability costs as the most
significant reason why auditors resign. Pratt and Stice (1994) suggest that auditors manage client
audit risk by selectively refusing to accept new, risky engagements or by declining to continue with
engagements where audit risk has increased. Using an analytical model, Bockus and Gigler (1998)
demonstrate that auditors are more likely to resign from engagements where they perceive that the
probability of hidden audit risk is high. Both Krishnan and Krishnan (1997) and Shu (2000) find
empirical evidence that auditor resignation is positively associated with the likelihood of litigation.
We build on this literature by providing direct evidence on the association between auditor
resignation and audit committee and board characteristics. Audit committees and boards perform a
variety of tasks including appointing the external auditors, overseeing management reporting prac-
tices, and improving firms internal control systems. We argue that when audit committees or boards
of directors are effective, auditors perceive that the probability of hidden audit risk is lower and,
thus, are less likely to resign.
HYPOTHESIS DEVELOPMENT
Audit Committee Independence and Auditor Resignation
The literature discusses what attributes an audit committee should possess to be defined as
effective. First, such audit committees assure themselves that their firms have designed and have
operating internal control processes
1
that prevent or detect financial reporting failures and reduce
opportunities for management fraud, both of which decrease audit risk and assist in accomplishing
the auditors assurance duties.
2
These audit committees have frequent contact with their companies
internal auditors and monitor the relationships between the external and internal auditors. Second,
effective audit committees, by assuming the responsibilities of hiring and dismissing external audi-
tors (Abbott and Parker 2001) and also setting their compensation (Abbott, Parker, Peters, and
Raghunandan 2003), reduce managements influence on the auditors, thus strengthening the audi-
tors position in their relationships with management.
3
Third, effective audit committees decrease the
likelihood that auditors will resign when auditor-client disagreements arise by mediating such dis-
agreements and supporting the external auditors position.
1
For example, DeZoort (1997, 210) argues that audit committee members perceive internal control evaluation as the most
important audit committee oversight area.
2
See, for example, Audit Committee Resource Guide published by Deloitte & Touche (2003), which lists all the functions
discussed in this paragraph as core duties of an effective audit committee. We argue later that independent audit
committees discharge these functions more effectively.
3
Since our study predates Sarbanes-Oxley, audit committees examined in our study were not required to perform these
duties. However, we argue that effective audit committees voluntarily performed these functions even prior to being
required to do so. See also Wild (1996).
The Effect of Audit Committee and Board of Director Independence on Auditor Resignation 133
We view independence as the most critical attribute of an effective audit committee (see Klein
2002). Independent members are more concerned about harming their reputations than inside or gray
members (Abbott and Parker 2000; Abbott, Parker, Peters, and Raghunandan 2003) and thus can be
expected to provide greater oversight of the financial reporting process than would non-independent
members. Independent audit committees increase financial reporting and audit quality by reducing
opportunities for management fraud (e.g., Beasley et al. 2000), improve the effectiveness of the
firms internal audit function (Scarborough et al. 1998) and positively influence the amount of audit
fees paid to the external auditor (Abbott, Parker, Peters, and Raghunandan 2003).
Board of Director Independence and Auditor Resignation
The ultimate responsibility for all corporate activity, however, lies with the companys board of
directors. Independent boards increase financial reporting quality by playing a crucial role in moni-
toring senior management. Research suggests that, as the proportion of independent board members
increases, the likelihood of financial fraud in a firm decreases (Beasley 1996; Beasley et al. 2000);
earnings overstatement is less frequent (Dechow et al. 1996); the magnitude of abnormal accruals is
lower (Klein 2002); and the external audit fee is greater (Carcello et al. 2002).
We are interested in examining whether audit committee independence alone affects auditor
resignations or whether board independence also plays a significant role. Carcello and Neal (2003)
find that in the dismissal of an auditor following a going-concern report, audit committee variables
play a more significant role than nonaudit committee board variables.
4
They suggest that boards
delegate oversight duties regarding external audits to audit committees. However, in contrast to
client-initiated auditor changes, an auditor resignation often occurs in the context of grave economic
circumstances and is accompanied by a significant, negative, stock price reaction.
5
Because board
members reputational capital suffers when a firm experiences deteriorating economic and stock
price performance, we argue that in situations involving the possibility of auditor resignations there
may be incentives for the entire board to prevent such occurrences.
6
In addition to independence, the diligence of audit committee and board members and their
financial expertise are important factors affecting the quality of the firms audit and financial report-
ing. To be effective, board and audit committee members must be willing to invest a substantial
amount of time and energy to their respective responsibilities. While we cannot observe the extent of
the commitment made by individual board or audit committee members, the number of times they
meet during a year is potentially a measure of their diligence (see, for example, Levitt 1998). The
BRC (1999) noted that audit committees also have a recognizable need for members to possess
the requisite amount of accounting and/or related financial expertise in order to ask probing ques-
tions of management.
4
Klein (2002) examines the separate associations between earnings management and audit committee and board charac-
teristics and finds significant separate associations with both types of variables. However, when Peasnell et al. (2000) use
U.K. board and audit committee variables jointly in their tests, they find that board, but not audit committee variables,
influence the magnitude of discretionary accruals.
5
The SEC regards an auditor resignation to be different from a dismissal, requiring firms to state in the Form 8-K filings
whether the auditor resigned or was dismissed. Auditor resignations occur more frequently than dismissals in firms facing
high litigation risk and deteriorating financial health (DeFond et al. 1997; Shu 2000), when there are disagreements with
the auditors (Krishnan and Krishnan 1997) and when there are internal control weaknesses and financial reporting
reliability concerns reported in Form 8-K filings (Whisenant et al. 2001). The negative stock market returns associated
with an auditor resignation are also significantly greater than those resulting from a dismissal (DeFond et al. 1997).
6
Indeed, the Form 8-K filings indicated that, for several auditor-resigned firms, the boards of directors were engaged in
discussions with their auditors attempting (unsuccessfully) to prevent their auditors from resigning. In the case of
Swisher International (Form 8-K filed on February. 27, 1998) an individual director met with the auditor; in the case of
Data Systems (Form 8-K filed on March 20, 1998) the board appointed a special committee to resolve the issues raised by
the auditors; and in still other cases entire boards met with their auditors to discuss the auditors concerns (see, for
example, Premier Laser s Form 8-K filed on June 1, 1998).
Recent studies examining corporate governance in an audit context have found that the number
of meetings of the audit committee and board (e.g., Abbott, Parker, Peters, and Raghunandan 2003;
Abbott, Parker, and Peters 2004) and the financial expertise of its members (Carcello and Neal 2003)
do indeed proxy for effective monitoring. Abbott, Parker, Peters, and Raghunandan (2003), for
example, find that the number of audit committee and board meetings, as well as the financial
expertise of the audit committee, are positively associated with audit fees. Abbott, Parker, and Peters
(2004) find that meeting frequency of the audit committee and its financial expertise are significantly
associated with the likelihood of a financial restatement. Carcello and Neal (2003) find that audit
committee financial expertise is related to auditor dismissals following a going-concern report, but
the financial expertise of the rest of the board is not.
Motivated by the above discussion, the hypotheses examined in this study, stated in the alterna-
tive form, are as follows:
H1a: There is a negative association between auditor resignation and the independence of
the audit committee/board of directors.
H1b: There is a negative association between auditor resignation and the meeting fre-
quency of the audit committee/board of directors.
H1c: There is a negative association between auditor resignation and the financial exper-
tise of the audit committee/board of directors.
We extend the current literature by also exploring the influence of the audit committee and the
board of directors in engaging a successor auditor following an auditor resignation. The quality of
such successor auditor is generally lower than that following a dismissal (Raghunandan and Rama
1999; Shu 2000; Whisenant and Sankaraguruswamy 2000), suggesting that negative economic con-
sequences of an auditor resignation extend to the quality of future external audits. We argue that
independent audit committees/boards are more likely to choose a successor auditor of higher quality
than non-independent audit committees/boards, thus mitigating the negative consequences of an
auditor resignation. We argue also that there is positive association between the quality of successor
auditor and meeting frequency and financial expertise of audit committees/boards. The hypotheses
stated in the alternative form are:
H2a: There is a positive association between the quality of the successor auditor and the
independence of the audit committee/board of directors.
H2b: There is a positive association between the quality of the successor auditor and the
meeting frequency of the audit committee/board of directors.
H2c: There is a positive association between the quality of the successor auditor and the
financial expertise of the audit committee/board of directors.
DATA SELECTION
Auditor-resignations are identified from 8-K and 10-K filings found on the Lexis/Nexis SEC
sub-library of the COMPNY library from 1996 through 2000 using various combinations of key-
words such as: resign, refuse, auditor resignation, and auditor declined to stand for re-election. Six
hundred nine auditor resignations that provide the date of the resignation and the name of old auditor
are identified.
7
7
This initial sample covers 57 auditor resignations in 1996, 83 in 1997, 108 in 1998, 111 in 1999, and 250 in 2000.
On the SECs EDGAR database, we found proxy statements (used to obtain corporate gover -
nance data) for 280 firms. The remaining 329 firms were either not publicly traded on the exchanges,
went bankrupt or were delisted, or were very small.
8
For instance, there was no stock price data
available for any of the 329 firms on CRSP and only 56 of these firms were found on Compustat, and
even then financial data was missing in many cases. The SEC exempts companies with less than $10
million in assets and less than 500 shareholders from filing forms electronically through EDGAR,
which is also a reason why our data does not include very small firms.
9
Of the 280 firms filing proxy
statements on EDGAR, we could not find Compustat or CRSP data for 82 firms; thus, these firms
were excluded. We then eliminated eight firms whose auditors had resigned because the auditors had
lost independence with regard to their clients. This gave us a final sample of 190 auditor resigned
firms, including eight instances where the auditor declined to stand for reappointment.
10
For testing H1, the group of companies whose auditors resigned (hereafter the resignation
group) was then compared to companies whose auditors were dismissed (hereafter the dismissal
group). The dismissal and resignation groups were matched by year, industry, and the type of auditor
prior to the switch.
11
Where multiple matches were available, we chose the dismissal firm closest in
size to the auditor-resigned firm. The dismissal group firms were first identified from Compustat by
choosing all firms whose auditors had changed and excluding from this group those firms whose
auditors had resigned. We, then, included a dismissed firm in our control group only if we were able
to confirm the dismissal using Form 8-K filings.
12
EMPIRICAL TESTS AND RESULTS
Empirical Tests of Hypothesis 1
We use logistic regression analyses to compare firms whose auditors had resigned with firms whose
auditors were dismissed. Our dependent variable, RESIGN, is 1 when an auditor resigned, and 0 otherwise.
8
Our initial sample includes resignations of auditors of OTC firms not listed on any of the exchanges. Of the 3,500 firms
on the OTC Bulletin Board, Compustat only covers about 1,000 firms while CRSP does not cover any OTC firms.
Because we require CRSP and Compustat data for our tests, our final sample does not include resignations of auditors of
OTC firms. Proxies for OTC firms were mostly unavailable on EDGAR during our sample period. It was not until 1999
that OTC firms were required to file their reports and proxies with the SEC to be eligible for real-time quotation reporting
on the OTC Bulletin Board (see http://www.otcbb.com/news/EligibilityRule/eligrulepressrel.stm). To better understand
our data, telephone calls were placed to about 25 firms whose auditors had resigned in 2000 and for which there was no
data on CRSP, Compustat or EDGAR. All of these firms were OTC firms not listed on any exchange and were audited by
non-Big 5 auditors. They belonged to mostly the following industries: e-business, technology and biotechnology, health
food, and exercise-equipment-related.
9
As indicated our sample only includes exchange-listed firms. The recent scrutiny and reforms regarding audit committees
and boards of directors have mostly focused on exchange-listed firms. (See Klein [2003] for a discussion on recent
exchange-led changes in governance.) OTC firms are also generally smaller than the exchange traded firms and, to the
extent markets view the larger exchange traded firms to be of greater interest, our study makes a contribution. Finally, as
discussed, the unavailability of corporate governance and financial data on OTC firms precludes us from using OTC
firms in our empirical tests.
10
The criteria used to construct our sample are similar to those used by empirical studies examining auditor resignations
(DeFond et al. 1997; Krishnan and Krishnan 1997; Wells and Loudder 1997; Beneish et al. 2001). A limitation of our
study (and the prior studies cited) is that the results may not be generalizable to nonlisted firms and those firms for which
data is not available on Compustat and CRSP.
11
The matching criteria are similar to that used by Krishnan and Krishnan (1997). We define industries using the same
classification scheme used by Frankel et al. (2002, Table 1, Panel C). These categories are agriculture (SIC Codes 0100
0999), chemicals (28002824, 28402899), computers (73707379, 35703579, 36703679), durable manufacturers
(30003999, excluding 35703579 and 36703679), extractive (29002999, 13001399), financial (60006999), food
(20002111), mining and construction (10001999, excluding 13001399), pharmaceuticals (28302836), retails (5000
5999), services (70008999, excluding 73707379), textiles and printing/publishing (22002799), transportations (4000
4899) and utilities (49004999). We also compared the resigned firms to firms that did not change auditors during the
sample period matched on the basis of reporting period, industry group, type of auditor prior to the switch (i.e., either Big
5 or Non-Big 5), and client firm-size. Results supporting our hypotheses were statistically stronger compared to using the
dismissal firms (not reported).
12
When we could not find a Form 8-K filing, we found a replacement auditor-dismissed firm for which a Form 8-K was
available. Similar to dismissals, we verified all resignations using the Form 8-K filings. A few observations were
reclassified as a result of these procedures.
Audit committee independence, ACINDEP, is measured using a dummy variable that takes the
value 1 if all members on the audit committee are independent, and 0 otherwise (Abbott, Parker,
Peters, and Raghunandan 2003); independence of the rest of the board, BDINDEP, is measured by
the proportion of independent directors on the board who are not on the audit committee. An audit
committee or board member is considered to be independent if he/she is not an employee or a gray
director. A gray director is a former officer or employee of the firm or of a related entity, an
interlocking director, a relative of an executive, a person having a business relationship with the firm,
or a large customer of or supplier to the company, unless the transaction occurred in the normal
course of business (see also Beasley 1996; Carcello and Neal 2003). ACMEET is a dummy variable
equal to 1 if the audit committee met four or more times during the year, and 0 otherwise (Abbott,
Parker, Peters, and Raghunandan 2003; Abbott, Parker, and Peters 2004).
13
BDMEET is the number
of meetings held each year by the board. ACEXPERT ( BDEXPERT) is the proportion of financial
expert directors on an audit committee (rest of the board).
14
We define financial expertise following
the Blue Ribbon Committee (BRC 1999) and Abbott, Parker, and Peters (2004).
Before testing our hypothesis, we control for several variables obtained from Forms 8-K that are
filed whenever an auditor change occurs. These Form 8-K events that have been found (Whisenant
et al. 2001) to discriminate resignations from dismissals are: disclosures on disagreements between
auditor and management (DISAGREE), reportable events relating to internal control weaknesses or
financial reporting reliability problems (ICWFRR), and the nature of the auditors opinion (GC).
15
For
each 8-K event, we use a dummy control variable taking the value 1 when an event occurs, and 0 otherwise.
We also control for additional variables that may affect the likelihood of an auditor resignation,
such as, the stock ownership of audit committee/board members that can negatively affect the
likelihood of an auditor resignation. Audit committee/board members who own more stock have
greater incentives to avoid losses on their own stockholdings due to the negative stock price reaction
that generally follows an auditor resignation. In addition, significant stock ownership potentially
provides greater incentives to act in the interests of the shareholders and exert more effort in
preventing the auditor from resigning. (See also Carcello and Neal [2003] for the effect of stockholdings
on auditor dismissals.) ACOWN (BDOWN) is the proportion of shares outstanding held by all
directors on the audit committee (rest of the board). We could also expect auditor resignations to be
affected by the organizational structure of the firm. Prior research suggests that when the CEO is the
chair of the board, the boards effectiveness in monitoring managements behavior is reduced (see
Abbott, Parker, and Peters 2004). We argue that if the CEO is the chair of the board of directors, the
power of the board/audit committee to reduce managements influence on the external auditor is
reduced and board/audit committee support of the external auditor is likewise diminished.
16
CEOCHR
is a dummy variable equal to 1 if the CEO is also the chair of the board, and 0 otherwise.
13
Using the number of audit committee meetings in our tests did not change any of the results reported in this paper.
14
According to the BRC (1999) financial expertise is demonstrated by employment experience in accounting or finance, a
CPA certification or comparable experience that includes a position of CEO, or other senior executive with financial
oversight responsibilities. Following Abbott, Parker, and Peters (2004), we define an expert as a director who is a CPA,
investment banker, or venture capitalist, served as CFO, Vice-President of Finance, controller, treasurer, or CEO. Rather
than using the proportion of financial experts, we denoted the presence of a financial expert on an audit committee and
the rest of the board with dummy variables. The coefficients on both dummy variables were not statistically significant.
15
Item 304(a)(1) of Regulation S-K [CFR 229.304(a)(1)] requires that firms disclose in a Form 8-K filing: (1) any
disagreements with the former principal accountant and (2) reportable events such as internal control deficiencies and
financial statement reliance issues during the period under consideration and two prior years. Audit opinions qualified or
modified as to uncertainty, audit scope, or accounting principles, adverse opinions, or disclaimers of opinion during the
two fiscal periods preceding the auditor change must also be disclosed. In virtually all cases where there was a disclosure
about the auditors opinion in a Form 8-K, the auditors opinion was unqualified with an explanation about going concern
uncertainty.
16
The corporate governance variables were manually collected. In the case of nominee and continuing directors, we were
generally able to obtain their biographical information from the firms proxies filed after the auditor resigned (i.e., the
current proxies). However, this information was not available in the current proxies for non-continuing directors, and, for
some firms, for continuing directors. For these firms we obtained the directors biographical information from the proxies
of the two previous years. Before concluding whether a director was independent or not independent, we searched, using
the directors name as a keyword, the current and two prior years proxies for information on any ties the director may
have had to the firm. In some cases, we also checked a firms 10-K for additional information on its directors.
Krishnan and Krishnan (1997) show that the probability of litigation is greater for firms whose
auditors have resigned (see also, Bockus and Gigler 1998; Shu 2000) and, therefore, we control for
litigation risk by first estimating Stices (1991) litigation score.
17
Then, we rank the data set by the
magnitude of the litigation scores and use the decile ranks as our proxy for litigation risk (LITRISK).
DeFond et al. (1997) find that auditor-resigned firms are more highly leveraged than other firms.
Therefore, we included the variable, FINLEV, which is the ratio of long-term debt to total assets.
Because specialist auditors are more likely to resign to protect their reputation than non-specialist
auditors, we included a variable for an auditors industry market share (MSHARE) using a measure
similar to that employed by Eichenseher and Danos (1981), Cullinan (1999), and Abbott and Parker
(2000).
18
Auditors perceive more uncertainty when clients experience losses (Wells and Loudder
1997) and so we control for client losses by including a variable (CLILOSS), which is assigned a
value of 1 if a firm has experienced a loss in the year immediately preceding the resignation, and 0
otherwise. McMullen (1996) finds that there are fewer accounting irregularities and restatements by
NYSE firms. Therefore, we code exchange listing (EXCH) to equal 1 if the client-firm is listed on the
NYSE, and 0 otherwise. Finally, we include the natural log of the clients total assets (CLISIZE) to
control for the residual effects of firm-size on auditor resignation arising from our inability to exactly
match the samples by firm-size.
Logistic Regression Model Used to Test Hypothesis 1
Pr (RESIGN = 1)
it
= F [ +
1
ACINDEP
it
+
2
ACMEET
it
+
3
ACEXPERT
it
+
4
BDINDEP
it
+
5
BDMEET
it
+
6
BDEXPERT
it
+
7
ICWFRR
it
+
8
GC
it
+
9
DISAGREE
it
+
10
ACOWN
it
+
11
BDOWN
it
+
12
CEOCHR
it
+
13
LITRISK
it
+
14
FINLEV
it
+
15
MSHARE
it
+
16
CLILOSS
it
+
17
EXCH
it
+
18
CLISIZE
it
]
where F(
.
) denotes the cumulative logistic function.
Table 1, Panel A provides a Pearson correlation matrix, which shows that, in general, the
variables are not highly correlated. The largest correlations are between CLISIZE and EXCH
( = 0.40) and between ICWFRR and DISAGREE ( = 0.44).
19
From Panel B, we find that auditor
resignation situations have fewer fully independent audit committees (ACINDEP), higher risk of
litigation (LITRISK), and greater occurrences of losses (CLILOSS). Auditor-resigned firms also have
more instances of Form 8-K events (ICWFRR, GC, and DISAGREE), are smaller in size, and
have fewer listings on the NYSE than dismissal firms. The preceding differences are all significant at
the 1 percent level of testing. The differences in BDINDEP and BDEXPERT are significant
(p < .10) using the parametric t-test, but using the nonparametric test, we find that only the difference
in BDINDEP is significant (p < .05). There are also differences in FINLEV and MSHARE that are
significant (p < .10), but only when using the nonparametric Wilcoxon Z test.
Table 2 presents the estimated coefficients for the logistic function used in our test of H1.
20
17
For each firm, each year, we compute a litigation score using model coefficients estimated by Stice (1991). Specifically, a
litigation score for each firm, each year is: 315.74 0.273*A/R + 0.423*INV + 1.053*GROWTH 0.18*FC + 2.276*NAME
1.517*TENURE 323.44*INDEPNT + 2725.8*VAR + 0.269*MV, where A/R is the ratio of accounts receivable to total
assets; INV is the ratio of inventory to total assets; GROWTH is the change in client sales; FC is the Z-score of the client;
NAME is the size classification of the auditor (Big 5 = 1, non-Big 5 = 0); TENURE is 1 if audit tenure is more than three
years and 0 otherwise; INDEPNT is (1 client sales/total sales of all clients of a given auditor); VAR is the variance of
abnormal returns for the client; and MV is the natural log of the market value of the firm.
18
Market share is defined as the percentage of client sales audited in each industry. Consistent with Palmrose (1986), we
also defined an industry specialist as an auditor with the greatest market share or one with market share exceeding 15
percent within a two-digit industry code and obtained similar results in our regression. We also use a 20 percent cutoff
and the results were qualitatively similar.
19
Dropping one or both of these variables does not change our conclusions.
20
We also estimate the model including a dummy variable for each matched pair (190 dummy variables) to control
explicitly for the effects of our matching variables (year, industry, auditor type, and size), which, as Cram et al. (2003)
indicate, is necessary for results to be internally and externally valid. We find that the statistical significance on some of
the coefficients increases when we use pair-dummies.
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TABLE 1
Summary Statistics
(n = 380)
Panel A: Pearson Correlation Matrix
Variable AC- AC- BD- BD- BD- ICW- DIS- AC- BD- CEO- LIT- FIN- CLI- CLI-
(p-value) MEET EXPERT INDEP MEET EXPERT FRR GC AGREE OWN OWN CHR RISK LEV MSHARE LOSS EXCH SIZE
ACINDEP 0.0574 0.0736 0.1945 0.0691 0.1071 0.1572 0.1363 0.0751 0.3296 0.0053 0.0325 0.0447 0.0195 0.0251 0.0892 0.2044 0.1743
(0.264) (0.151) (0.000) (0.178) (0.036) (0.002) (0.007) (0.143) (0.000) (0.917) (0.526) (0.383) (0.703) (0.624) (0.082) (0.000) (0.006)
ACMEET 0.0065 0.0996 0.1657 0.1506 0.0957 0.0667 0.1149 0.1334 0.1523 0.0289 0.1118 0.0978 0.1052 0.1092 0.1670 0.2963
(0.899) (0.052) (0.001) (0.003) (0.062) (0.194) (0.025) (0.009) (0.002) (0.573) (0.029) (0.056) (0.040) (0.033) (0.001) (0.000)
ACEXPRT 0.0139 0.0221 0.1754 0.0123 0.0016 0.0983 0.0013 0.0462 0.0207 0.0398 0.0225 0.0011 0.0184 0.0091 0.0233
(0.787) (0.667) (0.001) (0.811) (0.973) (0.055) (0.980) (0.369) (0.686) (0.438) (0.661) (0.981) (0.720) (0.858) (0.650)
BDINDEP 0.0014 0.0568 0.0631 0.0140 0.0227 0.0327 0.1667 0.0428 0.0231 0.1326 0.0519 0.0129 0.1589 0.1010
(0.977) (0.268) (0.219) (0.785) (0.657) (0.525) (0.001) (0.405) (0.652) (0.009) (0.312) (0.801) (0.001) (0.049)
BDMEET 0.0240 0.0764 0.0165 0.0990 0.0915 0.1203 0.0260 0.0072 0.0045 0.0847 0.0386 0.0175 0.0793
(0.639) (0.136) (0.747) (0.053) (0.074) (0.018) (0.612) (0.888) (0.929) (0.099) (0.452) (0.732) (0.122)
BDEXPERT 0.0026 0.0722 0.0309 0.0828 0.0562 0.0415 0.1404 0.0115 0.0141 0.1097 0.0926 0.1440
(0.958) (0.160) (0.547) (0.107) (0.274) (0.419) (0.006) (0.822) (0.783) (0.032) (0.071) (0.004)
ICWFRR 0.1340 0.4426 0.0384 0.0275 0.0024 0.0665 0.0078 0.0132 0.0877 0.0678 0.0617
(0.008) (0.000) (0.454) (0.592) (0.961) (0.195) (0.879) (0.796) (0.087) (0.186) (0.229)
GC 0.1008 0.0833 0.0664 0.0737 0.3327 0.0827 0.0675 0.3251 0.1807 0.3002
(0.049) (0.104) (0.196) (0.151) (0.000) (0.107) (0.188) (0.000) (0.000) (0.000)
DISAGREE 0.0014 0.0196 0.0378 0.0330 0.0414 0.0130 0.0819 0.0505 0.0645
(0.976) (0.702) (0.462) (0.521) (0.420) (0.800) (0.110) (0.326) (0.209)
ACOWN 0.1037 0.0705 0.0753 0.0861 0.1076 0.0028 0.1348 0.2259
(0.043) (0.169) (0.142) (0.093) (0.035) (0.956) (0.008) (0.000)
BDOWN 0.0355 0.0692 0.0026 0.0845 0.0174 0.1044 0.0085
(0.489) (0.178) (0.959) (0.099) (0.734) (0.041) (0.867)
CEOCHR 0.0562 0.1061 0.0810 0.0594 0.0699 0.0576
(0.273) (0.038) (0.114) (0.247) (0.173) (0.262)
LITRISK 0.0673 0.0313 0.3158 0.1787 0.2925
(0.189) (0.542) (0.000) (0.001) (0.000)
FINLEV 0.0914 0.0204 0.0920 0.0556
(0.075) (0.691) (0.073) (0.279)
MSHARE 0.0628 0.0584 0.1445
(0.221) (0.256) (0.004)
CLILOSS 0.2023 0.3229
(0.000) (0.000)
EXCH 0.3990
(0.000)
p-values are in parentheses.
*, **, and *** indicate significance (two-tailed tests) at the 10, 5, and 1 percent levels, respectively.
Variable Definitions:
ACINDEP = a dummy variable equal to 1 if all members on the audit committee are independent, and 0 other-
wise;
ACMEET = a dummy variable equal to 1 if the audit committee met four or more times during the year, 0
otherwise;
ACEXPERT = the proportion of financial experts on the audit committee;
BDINDEP = the proportion of nonaudit committee board members who are independent;
BDMEET = the number of board of director meetings during the year;
BDEXPERT = the proportion of nonaudit committee board members who are financial experts;
ICWFRR = a dummy variable equal to 1 if a firms Form 8-K indicates an internal control weakness problem
or if a firms Form 8-K indicates a financial reporting reliability issue, and 0 otherwise;
GC = a dummy variable equal to 1 if a firms Form 8-K indicates that there was an audit opinion quali-
fied or modified as to uncertainty, or if there was an adverse opinion or a disclaimer of opinion
during the two fiscal periods preceding the auditor change, and 0 otherwise;
DISAGREE = a dummy variable equal to 1 if a firms Form 8-K indicates that there was a disagreement on some
matter of accounting principles or practices, financial statement disclosure, or auditing scope or
procedure issue with the companys auditor, and 0 otherwise;
ACOWN = the proportion of shares outstanding owned by audit committee members;
BDOWN = the proportion of shares outstanding owned by nonaudit committee board members;
CEOCHR = a dummy variable equal to 1 if the firms CEO is also the chair of board of directors, and 0
otherwise;
LITRISK = the decile position of a firm based on the distribution of Stices (1991) litigation score;
FINLEV = the long-term debt divided by total assets at the beginning of the year of auditor resignation;
MSHARE = the auditors industry market share defined as the percentage of client sales audited in each
industry;
CLILOSS = a dummy variable equal to 1 if a firm has a loss in the year preceding the resignation, and 0
otherwise;
EXCH = a dummy variable equal to 1 if a firm is listed in NYSE, and 0 otherwise; and
CLISIZE = the log of total assets (in million dollars) at the beginning of the year of the auditor resignation.
TABLE (1 (continued)
Panel B: Univariate Tests Results: Resignation Firms Compared to Dismissal Firms
Mean Median
Dismissal Resign Dismissal Resign
Variables n = 190 n = 190 t-statistic n = 190 n = 190 Wilcoxon Z
ACINDEP 0.6526 0.4684 3.67*** 1.0000 0.0000
ACMEET 0.2526 0.1842 1.62 0.0000 0.0000
ACEXPERT 0.7170 0.6940 0.90 0.6667 0.6667 0.86
BDINDEP 0.3483 0.2961 1.89* 0.3333 0.2857 2.14**
BDMEET 7.0105 6.9474 0.15 6.0000 6.0000 0.63
BDEXPERT 0.4604 0.4081 1.74* 0.5000 0.5000 1.22
ICWFRR 0.0368 0.2263 5.68*** 0.0000 0.0000
GC 0.1105 0.3579 5.94*** 0.0000 0.0000
DISAGREE 0.0263 0.1421 4.14*** 0.0000 0.0000
ACOWN 0.0508 0.0515 0.08 0.0119 0.0181 0.82
BDOWN 0.1839 0.2013 0.91 0.1056 0.1409 0.89
CEOCHR 0.5736 0.5526 0.41 1.0000 1.0000
LITRISK 3.9526 5.2316 4.47*** 4.0000 6.0000 4.36***
FINLEV 0.2106 0.2137 0.08 0.1348 0.0674 1.96*
MSHARE 0.1357 0.1608 1.60 0.1009 0.1354 0.94*
CLILOSS 0.5578 0.7474 3.95*** 1.0000 1.0000
EXCH 0.1842 0.0474 4.26*** 0.0000 0.0000
CLISIZE 3.9956 3.2305 4.50*** 3.7620 3.1054 4.48***
TABLE 2
Logit Model Relating Corporate Governance Variables to Auditor Resignations
Pr (RESIGN = 1)
it
= F [ +
1
ACINDEP
it
+
2
ACMEET
it
+
3
ACEXPERT
it
+
4
BDINDEP
it
+
5
BDMEET
it
+
6
BDEXPERT
it
+
7
ICWFRR
it
+
8
GC
it
+
9
DISAGREE
it
+
10
ACOWN
it
+
11
BDOWN
it
+
12
CEOCHR
it
+
13
LITRISK
it
+
14
FINLEV
it
+
15
MSHARE
it
+
16
CLILOSS
it
+
17
EXCH
it
+
18
CLISIZE
it
]
*, **, and *** indicate significance at the 10, 5, and 1 percent levels, respectively. One-tailed tests are used when coeffi-
cients have predicted signs.
ACINDEP = a dummy variable equal to 1 if all members on the audit committee are independent, and 0 otherwise;
ACMEET = a dummy variable equal to 1 if the audit committee met four or more times during the year, 0 otherwise;
ICWFRR = a dummy variable equal to 1 if a firms Form 8-K indicates an internal control weakness problem or if a
firms Form 8-K indicates a financial reporting reliability issue, and 0 otherwise;
GC = a dummy variable equal to 1 if a firms Form 8-K indicates that there was an audit opinion qualified or
modified as to uncertainty, or if there was an adverse opinion or a disclaimer of opinion during the two
fiscal periods preceding the auditor change, and 0 otherwise;
DISAGREE = a dummy variable equal to 1 if a firms Form 8-K indicates that there was a disagreement on some matter
of accounting principles or practices, financial statement disclosure, or auditing scope or procedure issue
with the companys auditor, and 0 otherwise;
ACOWN = the proportion of shares outstanding owned by audit committee members;
CEOCHR = a dummy variable equal to 1 if the firms CEO is also the chair of board of directors, and 0 otherwise;
LITRISK = the decile position of a firm based on the distribution of Stices (1991) litigation score;
FINLEV = the long-term debt divided by total assets at the beginning of the year of auditor resignation;
MSHARE = the auditors industry market share defined as the percentage of client sales audited in each industry;
CLILOSS = a dummy variable equal to 1 if a firm has a loss in the year preceding the resignation, and 0 otherwise;
EXCH = a dummy variable equal to 1 if a firm is listed in NYSE, and 0 otherwise; and
CLISIZE = the log of total assets (in million dollars) at the beginning of the year of the auditor resignation.
Expected Wald
Variable Sign Coefficient Chi-square
Intercept +/ 1.0717 (2.287)*
ACINDEP 0.5850 (4.741)**
ACMEET 0.2729 (0.712)
ACEXPERT 0.6433 (1.659)*
BDINDEP 0.9764 (4.281)**
BDMEET 0.0166 (0.346)
BDEXPERT 0.3890 (0.876)
ICWFRR + 1.7024 (12.417)***
GC + 0.8948 (7.472)***
DISAGREE + 1.3600 (5.253)**
ACOWN 1.6325 (1.334)
BDOWN 0.2176 (0.104)
CEOCHR + 0.2108 (0.745)
LITRISK + 0.0776 (2.766)**
FINLEV + 0.1063 (0.092)
MSHARE + 1.8720 (5.020)**
CLILOSS + 0.1558 (0.319)
EXCH 0.5693 (1.475)
CLISIZE +/ 0.1774 (3.746)*
Liklihood Ratio Chi-squared 104.93***
Pseudo R
2
0.2164
Number of Observations = 380
Coefficient estimates are generally consistent with the univariate results and also with our expectations
about the effects of these variables on the likelihood of auditor resignation. The coefficients on the
variables of greatest interest, ACINDEP and BDINDEP, are negative and statistically significant (p <
.05).
Consistent with expectations that independence would be the most important attribute of effec-
tive audit committees, the relationship of the other governance variables with an auditor resignation
is not as strong. The coefficient on ACEXPERT is statistically significant (p < .10), while ACMEET,
BDMEET, BDEXPERT, BDOWN, ACOWN, and CEOCHR are not statistically significantly associ-
ated with auditor resignations.
Regarding our control variables, we find that the coefficients on all of the Form 8-K variables
(internal control weakness/financial reporting reliability problems [ICWFRR], auditor opinion [GC],
and auditor-management disagreements [DISAGREE]) are positive and statistically significant
(p < .05). The coefficient on CLILOSS is not significant once we include Form 8-K variables, which
suggests that the Form 8-K variables possibly proxy for the firms financial condition. Also, consis-
tent with expectations, we find that the coefficients on LITRISK and MSHARE are positive and
significant (p < .05). The coefficient on CLISIZE is negative and significant (p < .10), which suggests
that auditors are more likely to resign from small firms that account for a relatively smaller propor-
tion of their firms revenues (DeAngelo 1981). Finally, FINLEV and EXCH are not statistically
associated with auditor resignations.
21
Empirical Tests of Hypothesis 2
Our analyses assume three levels of audit quality: Big 5, national firms and local firms (Shu
2000).
22
We find (results not reported) that about 77 percent of the auditor-resigned firms were
audited by Big 5 auditors. In 54 percent of these resignations, the firms successor auditor was a
national firm (25 percent) or a local firm (29 percent). By way of comparison, we find that when a
Big 5 auditor is dismissed, the quality of the successor auditor decreases in only 16 percent of the
cases.
23
In Table 3 we present results from estimating an ordered logistic regression model of changes in
audit quality (AQ) using the sample of auditor -resigned firms. The largest (smallest) value that
AQ takes is +2 (2) that occurs when audit quality increases (decreases) by two levels, from local
(Big 5) to Big 5 (local) auditor. We include as independent variables the dummy variables represent-
ing the Form 8-K events
24
and the corporate governance variables previously used to test H1. Prior
research (Francis and Wilson 1988; DeFond 1992) suggests that firms switch to a higher-quality
21
We conduct several tests to verify robustness of our results. Following Shu (2000), who excludes utilities and financial
institutions from her sample because she believes that these industries are subject to various regulations and have unique
operating and reporting characteristics, we reanalyze our data after deleting firms in these industries. We also measured
independence using the proportion of members of the audit committee who were independent and based on whether the
majority of the members of the audit committee or nonaudit committee board were independent. We examined the
separate associations of the percentages of employee and gray directors with auditor resignation. Our results were robust
to these measures. We also examined whether the degree of audit committee and board independence had changed during
the period of our study. We find that there is no significant trend in the mean values of ACINDEP and BDINDEP.
22
The test results presented in Table 3 assume that national auditors consist of the Next Big Six or Class B accounting
firms, while local auditors are assumed to consist of the remaining firms. See Whisenant and Sankaraguruswamy (2000).
Similar to those authors, we use the number of SEC registrants obtained from Who Audits America (2000) published by
Spencer Phelps Harris, 44th edition, as a basis for ranking the auditors by size. The national firms had between 53 and
350 clients that were SEC registrants.
23
These results appear to be consistent with Raghunandan and Rama (1999), Whisenant and Sankaraguruswamy (2000),
and Shu (2000), who show that, compared to an auditor-dismissed firm, an auditor-resigned firm is constrained to
choosing a successor auditor of lower quality. However, because in our study the dismissal group is a non-randomly
selected group of firms, any comparison with the dismissal group can only be limited to the firms within our sample and
is not generalizable outside our sample.
24
When we include ICWFRR and DISAGREE as two separate variables, these variables are not individually significant. Our
conclusions regarding the other variables in the model are not affected.
TABLE 3
Ordered Logit Model Relating Corporate Governance Variables to Quality of Successor Auditors
Pr (AQ
it
>k) = F [
k
+
1
ACINDEP
it
+
2
ACMEET
it
+
3
ACEXPERT
it
+
4
BDINDEP
it
+
5
BDMEET
it
+
6
BDEXPERT
it
+
7
ICWFRRDA
it
+
8
GC
it
+
9
ACOWN
it
+
10
BDOWN
it
+
11
CEOCHR
it
+
12
CLISIZE
it
+
13
GROW
it
+
14
LEV
it
+
15
MGTOWN
it
+
16
NEWISSUE
it
]
Expected Wald
Variable Sign Coefficient Chi-square
Intercept 1 +/ -5.7709 (32.550)***
Intercept 2 +/ 3.8613 (21.237)***
Intercept 3 +/ 0.8221 (1.156)
Intercept 4 +/ 0.6013 (0.620)
ACINDEP + 0.6929 (4.420)**
ACMEET + 0.5142 (1.372)
ACEXPERT + 0.1543 (0.071)
BDINDEP + 0.0474 (0.006)
BDMEET + 0.0356 (0.767)
BDEXPERT + 0.6144 (1.495)
ICWFRRDA 0.8114 (5.089)**
GC 0.8339 (6.073)***
ACOWN + 0.7147 (0.222)
BDOWN + 0.4582 (0.302)
CEOCHR 0.0309 (0.010)
CLISIZE + 0.2488 (5.501)***
GROW + 0.4440 (8.591)***
LEV + 1.3936 (3.883)**
MGTOWN 0.0039 (0.077)**
NEW ISSUE + 0.1798 (1.967)*
Liklihood Ratio Chi-squared 62.33***
Pseudo R
2
0.2706
Number of Observations = 168
*, **, and *** indicate significance at the 10, 5, and 1 percent levels, respectively. One-tailed tests are used when coeffi-
cients have predicted signs.
AQ = the change in auditor quality which takes values from 2 to + 2. A two-step increase in audit quality
represented by a switch from local to Big 5 auditors is coded +2, while a one-step increase in audit
quality represented by a switch from a local to a national auditor or from a national to a Big 5 auditor is
coded +1. Likewise, two-level and single-step decreases in audit quality are coded 2 and 1, respectively;
ACINDEP = a dummy variable equal to 1 if all members on the audit committee are independent, and 0 otherwise;
ACMEET = a dummy variable equal to 1 if the audit committee met four or more times during the year, and 0 otherwise;
ICWFRRDA = a dummy variable equal to 1 if a firms Form 8-K indicates an internal control weakness problem, or a
financial statements reliability issue, or a disagreement with the auditor, and 0 otherwise;
GC = a dummy variable equal to 1 if a firms Form 8-K indicates that there was an audit opinion qualified or
modified as to uncertainty, or if there was an adverse opinion or a disclaimer of opinion during the two
fiscal periods preceding the auditor change, and 0 otherwise;
ACOWN = the proportion of shares outstanding owned by all audit committee members;
CEOCHR = a dummy variable equal to 1 if the firms CEO is also the chair of board of directors, and 0 otherwise;
CLISIZE = the log of total assets (in million dollars) at the beginning of the year of the auditor resignation;
GROW = the growth rate of total assets which is equal to the total assets at t+1 minus total assets at t1, divided
by total assets at t1, where 0 is the year of the auditor resignation;
LEV = the change in leverage ratio (long-term debt divided by total assets) over the period 1 to +1, where year
0 is the year of the auditor resignation
DMGTOWN = the change in the percentage of shares outstanding held by all directors and officers as a group over the
period +1 to 1, where 0 is the year of the auditor resignation; and
NEWISSUE = the dollar value of stock issued in the first year of the new auditor scaled by total assets. For those firms
where no values were provided on Compustat (i.e., issuance data was missing) we assume that the firm
did not issue any stock during that year.
auditor to reduce agency conflicts unanticipated in the current reporting period or anticipated in
future periods. Proxies used for agency conflicts have been changes in leverage (LEV) and changes
in management ownership (MGTOWN). In addition, firms that are growing (GROW) or those
anticipating a securities issuance (NEWISSUE) also tend to increase audit quality.
25
Finally, large
firms (firm size is proxied using CLISIZE) are less likely to choose a national or local auditor than
are small firms.
Ordered Logistic Regression Model Used to Test Hypothesis 2
Pr (AQ
it
> k) = F [
k
+
1
ACINDEP
it
+
2
ACMEET
it
+
3
ACEXPERT
it
+
4
BDINDEP
it
+
5
BDMEET
it
+
6
BDEXPERT
it
+
7
ICWFRRDA
it
+
8
GC
it
+
9
ACOWN
it
+
10
BDOWN
it
+
11
CEOCHR
it
+
12
CLISIZE
it
+
13
GROW
it
+
14
LEV
it
+
15
MGTOWN
it
+
16
NEWISSUE
it
]
where k represents the categories of changes in auditor quality and F () is the cumulative distribution
that is distributed logistic.
Our results show that the coefficients on ICWFRRDA and GC are negative and statistically
significant (p < .05 and p < .01, respectively). This suggests that when there are internal control
weaknesses or auditor-management disagreements, or financial reporting reliability concerns, as
well as, going concern issues, the successor auditor is likely to be of lower quality. As expected,
the coefficients on GROW, CLISIZE, and LEV are positive and statistically significant (p < .05).
The coefficient on NEWISSUE is significant at the 10 percent level while that on MGTOWN is
insignificant. Finally, we find that the coefficient on ACINDEP is positive and statistically significant
(p < .05) indicating that fully independent audit committees choose a successor auditor of higher
quality than non-independent audit committees. Consistent with the board of directors delegating
duties regarding auditor selection to the audit committee, our results do not show statistically signifi-
cant coefficients on the board variables.
CONCLUSION
This study provides new evidence regarding the influence of audit committees and boards upon
an auditor resignation. Our results support the hypothesis that independent audit committees and
boards significantly reduce the likelihood of auditor resignation, suggesting that independent audit
committees and boards are more likely to exert greater effort working with the firms auditor, thus
reducing hidden audit risks. There is weaker statistical evidence that, as the proportion of financial
experts on the audit committee increases, the likelihood of an auditor resignation decreases. Finally,
our results show that the likelihood of engaging a successor auditor of lower quality increases when
the audit committee is not fully independent. These results underscore the importance of having
independent members on audit committees and boards.
Our results contribute to the body of literature that analyzes differences between auditor dis-
missals and auditor resignations (DeFond et al. 1997; Krishnan and Krishnan 1997; Whisenant et al.
2001). While Carcello and Neal (2003) find that in dismissal situations only audit committee charac-
teristics, not nonaudit committee board characteristics, are significant, our results are consistent with
the notion that in auditor resignation situations, the board realizes its reputation is at stake and joins
the audit committee in attempting to prevent the auditor from resigning.
25
We measure changes in leverage (long-term debt dividend by total assets), changes in management ownership (percent-
age of total shares outstanding held by insiders and directors), and percentage changes in total assets or GROW over a
two-year period beginning one year before (year1) the resignation and ending one year (year+1) after the resignation.
There is no theory that indicates what the appropriate period over which changes in agency costs should be measured.
However, when we measure the changes over a four-year period (2 to +2), our sample size suffers significantly because
of bankruptcies and delistings, so we only report results that compute changes over a two-year period. NEWISSUE is the
issuance of securities in year+1. Of the 190 auditor-resigned firms, we lose 22 firms (12 firms were delisted and 10 went
bankrupt) when we estimate the ordered logit model.
In 2002, broad reforms affecting U.S. audit committees, proposed by Sarbanes-Oxley, were
signed into law. New rules require audit committees to be fully independent (SEC 2003) and changes
have been approved for increasing the independence of the entire board including redefining what
constitutes an independent director.
26
A key element of the new legislation is that audit committees
be responsible for the appointment, compensation, termination, and the oversight of the work of the
external auditor, which includes resolving disagreements between management and the external
auditor. Our studys results suggest that there are significant benefits from Sarbanes-Oxley requiring
audit committees to be fully independent, to have at least one person who possesses financial
expertise, and to exercise their oversight responsibilities. Future research could examine whether
after Sarbanes-Oxley and the passage of the new SEC rules, the influence of audit committees and
boards in preventing auditor resignations is even more significant than it was before Sarbanes-Oxley,
when this study was conducted.
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26
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