Auditor resignation and risk factors

Although auditor litigation risk is considered as a leading explanation for auditor resignations, audit risk and business risk might also trigger resignations. Auditor litigation risk is defined as the risk of the auditor being involved in a lawsuit, audit risk is defined as the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated and, finally, business risk is defined as the risk associated with the client’s survival and profitability. Because the three risk factors are not mutually exclusive, we examine their relevance and incremental importance using measures from the pre- and post-resignation periods. Using summary indices from the pre-resignation period, we find that all of the three ex ante risk indices are incrementally important for resignations, especially when the predecessor auditor is a Big 4 firm. Because the ex ante risk factors are prone to measurement errors and are less likely to capture the auditor’s proprietary information about the client, we analyze data from the post-resignation period when the auditor’s proprietary information is likely to become publicly known. We find that within a three-year period following an auditor’s resignation, clients are more likely to (1) be involved in class-action lawsuits (ex post litigation risk), (2) have internal control problems (ex post audit risk), and (3) to be delisted from a national stock exchange (ex post business risk). Our research demonstrates that auditors consider all three risk factors, and not just litigation risk, in resignation decisions.