Scott Whisenant
University of Houston
Srinivasan Sankaraguruswamy
Georgetown University
K. RAGHUNANDAN
Texas A&M International University
Abstract: Since 1988 (FRR No. 31), the SEC has required that firms disclose separately information about auditor-client disagreements and reportable events related to internal control weaknesses or concerns about financial statement reliability communicated by the auditor in the two years prior to the auditor change. Using sample evidence in post-FRR No. 31 reporting periods, we investigate if firms disclosing reportable events differ from firms disclosing disagreements in terms of economic characteristics and stock price performance over long-term return windows.
The results indicate that firms disclosing reportable events have higher levels of risk, higher change in risk, and a greater incidence of going-concern modified audit opinions than do firms disclosing auditor-client disagreement. We find evidence that stock price performance of firms disclosing reportable events with auditor-change announcements are associated with reliably negative stock price performance in 36-month pre- and post-announcement periods. This finding is robust to the use of buy-and-hold returns, which presumably measures investor experience, using a skewness-corrected parametric test (Hall 1992), as well as calendar-time portfolio regressions (Fama and French 1993). However, we find firms disclosing disagreements are not associated with abnormal returns that are statistically different from zero in 36-month pre- and post-announcement periods. This suggests that investors may be under-reacting to disclosures of reportable events. The results provide empirical support to the SECs decision to separate the disclosure of reportable events from the disclosure of disagreements, and suggest that results from prior research related to auditor-client disagreements must be interpreted with caution.
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