CFOs Advised to Fire Auditors Early

A study says firing an auditor “doubles the odds of a restatement and more than quadruple[s] the odds of a material weakness over the next two years,” CFO magazine recently reported.

CFOs considering firing their company’s independent auditors should do so before the end of their fiscal second quarter, an author of a new study of auditor dismissals advises.

If a company announces the dismissal of its auditor after the second quarter, it risks being “lumped in with the bad apples,” that want to end the relationship to cover up “nefarious” doings, Jeff Burks told the magazine. Burks is an associate professor of accountancy at Notre Dame’s Mendoza College of Business.

“Investors have a good idea that firms tend to sign up their auditors early in the year,” he says. “So if you’re changing auditors later in the year, that’s a pretty good sign you’ve changed your mind.” That message often results in questions such as, “What prompted you to change your mind? You knew what the auditors fee was going to be, so what’s likely is that you were prompted by some kind of conflict with the auditor,” Burks adds.

Auditors, who must maintain confidentiality, don’t talk about clients or even former clients, so an assumption may be made that the problem lies with the company’s financial reporting.

“Firms that dismiss auditors after the second fiscal quarter have markedly higher rates of future restatements, material weaknesses, and delistings compared with firms that dismiss auditors shortly after filing the prior year’s 10-K,” according to the unpublished paper, “Auditor Dismissals: Opaque Disclosures and the Light of Timing.”

For the study, the authors culled data from Audit Analytics, a research firm, to identify 16,096 auditor dismissals announced between 2000 and 2013. They studied dismissals falling within fiscal years 2001-2012 that matched data from Compustat, the Center for Research in Security Prices, and the Securities and Exchange Commission’s Edgar database, leaving 3,976 dismissals.

Citing earlier studies by other researchers, the paper says that when it’s the auditors who quit, it’s a clear sign of accounting woes or elevated audit risk at the company. The reason? Auditors “typically have little incentive to drop healthy, low-risk clients.”