Do Financial Restatements Lead to Auditor Changes?

This paper examines whether financial restatements are associated with subsequent auditor changes. A financial restatement represents a breakdown in a company's financial reporting, but, importantly, also of its audit. We argue that in response to pressure from capital markets, restating firms will dismiss their auditors to increase audit quality and restore reputational capital lost when the restatements are announced to the investing public. Using a large sample of restatements and auditor changes we find that, consistent with our hypothesis, the likelihood of auditor-client realignments increases after firms announce restatements. As expected, we also find that the positive association between restatements and auditor turnovers is more pronounced when restatements are more severe and the quality of corporate governance is high. Finally, we find that stock market returns surrounding auditor changes increase as the severity of restatements increases. The last result supports the idea that stock markets have a positive view of auditor changes following restatements.