December 17, 2021

Auditor Terminations: Are Disclosures Useless?

A new study from Notre Dame & Ohio U business school professors finds that the SEC’s demanding disclosure regime for auditor terminations is useless when it comes to determining the likelihood of restatements. Here’s an excerpt from an article on the study:

While most seasoned investors realize that companies tend to be cagey about their reasons for firing auditors, the research finds the disclosures are useless to an extreme. “Opaque Auditor Dismissal Disclosures: What Does Timing Reveal that Disclosures Do Not?” is forthcoming in the Journal of Accounting and Public Policy from Jeffrey Burks, the Thomas and Therese Grojean Family Associate Professor of Accountancy in Notre Dame’s Mendoza College of Business, and Jennifer Sustersic Stevens of Ohio University.

In a sample of some 1,400 auditor firings, company revelations of disagreements with the auditor or other auditor concerns exhibit no systematic ability to forecast whether the company will restate its financial statements.

“The lack of predictive ability suggests that companies’ decisions to disclose such auditor concerns are so inconsistent and uncommon — even though the regulation requires their disclosure — that no predictive power results,” said Burks, who researches financial accounting and misstatements.

The authors say that investors should focus on the timing of the dismissal rather than 8-K disclosure, because companies that fire auditors after the second quarter have a roughly 40% greater chance of a future restatement. A WSJ article on the study quotes one commentator as saying that the problem is the disclosure rules’ focus on disagreements with auditors, and that accounting firms “try hard to avoid differences of opinion escalating to the point that they have to be reported.”

Instead of tweaking disclosure rules, the study’s authors say that the PCAOB & SEC should inquire about the reasons for changes in auditors during the examination and comment letter process and cite Blue Wave Group’s extremely frank response to a 2010 SEC comment about its disclosures concerning a change in auditors as an example of the kind of disclosure such an inquiry might elicit.

John Jenkins