Do markets react to required and voluntary disclosures associated with auditor

realignments?
George R. Aldhizer III, a, , Dale R. Martina, and James F. Cottera,
a
Wake Forest University, The Calloway School of Business and Accountancy, Kirby Hall,
Wingate Road, Winston-Salem, NC, 27106-7285, United States

Available online 21 March 2009.

Abstract
This manuscript investigates whether required and voluntary Form 8-K (Item 4.01) auditor
realignment disclosures in 2004 and 2005 convey information content to investors in a post SOX
era. Unlike prior research, our results indicate that internal control material weakness and non-
reliance on management representation disclosures convey negative information content, while
audit scope limitation, earnings restatement and client–auditor disagreement disclosures do not
convey information content in a post SOX era. Also, unlike prior research, voluntary disclosures
such as fee disputes do not convey information content. Similar to prior research, auditor
resignation disclosures convey information content. Our results also indicate that other required
disclosures such as when an auditor realignment occurs after a company has received a going
concern opinion and when a company switches to a larger audit firm (e.g., from a local/regional
firm to a Big 4 firm) are associated with positive CARs.
Keywords: Controls; Cumulative abnormal returns (CARs); Disagreements; Earnings
restatement; 8-K; Going concern; Non-reliance; Required disclosures; Resignation; Verifiable;
Voluntary disclosures
Article Outline
1. Introduction
2. 8-K disclosures
2.1. Reportable events
2.2. Other required disclosures
2.3. Voluntary disclosures
3. Research hypotheses
3.1. Impact of reportable events on abnormal returns
3.2. Impact of other required disclosures on abnormal returns
3.3. Impact of voluntary disclosures on abnormal returns
3.4. Impact of change in firm type on abnormal returns
4. Data and methodology
4.1. Control variables
5. Results
5.1. Internal control material weaknesses
5.2. Service
5.3. Changes in firm type
5.4. Multivariate impact of realignment disclosures on abnormal returns
5.4.1. Impact of reportable events on abnormal returns
5.4.2. Impact of other required disclosures on abnormal returns
5.4.3. Impact of voluntary disclosures on abnormal returns
5.4.4. Impact of firm type on abnormal returns
6. Implications, limitations and directions for future research
6.1. Implications
6.1.1. Reportable events
6.1.2. Other required disclosures
6.1.3. Voluntary disclosures
6.1.4. Firm type
6.2. Limitations
6.3. Future research
7. Conclusions
Acknowledgements
References
1. Introduction
The purpose of this study is to examine whether required and voluntary disclosures in auditor
realignment 8-Ks (Item 4.01) convey meaningful information to investors in a post Sarbanes–
Oxley Act (SOX) era. Our a priori belief is that investors will react negatively to some required
disclosures and will react positively to some voluntary disclosures as companies try to put a
positive spin on auditor changes. For example, required disclosures such as an auditor's inability
to rely on management representations may convey negative information, while voluntary
disclosures such as a client's desire to receive better audit service may convey positive
information.
Whisenant, Sankaraguruswamy, and Raghunandan (2003) examined a relatively large number of
auditor realignment 8-Ks in the mid 1990s and found that many required disclosures, excluding
internal control material weaknesses, convey negative information to investors.
Sankaraguruswamy and Whisenant (2004) found that many voluntary disclosures convey
positive information to investors in the mid 1990s. However, recent accounting scandals, the
demise of Andersen, and the passage of SOX in 2002 have all dramatically changed the audit
environment and the perception of the value of an audit. Thus, does it make sense to reexamine
auditor realignment 8-Ks in the context of a post SOX era? For example, as investors become
more aware of the importance of required internal control material weakness disclosures as an

2
early warning sign for management fraud, are they more likely to convey negative information
(Internal Auditing Report, 2007)? Are other required disclosures, such as client–auditor
disagreements, fewer in number and less severe because of more proactive audit committees and
top management's financial statement “certification” requirements1 and thus no longer
transmitting negative information to investors? Are voluntary disclosures, such as fee disputes,
viewed less favorably as investors change their perception of an external audit's importance as a
result of recent accounting scandals and thus no longer value cost savings resulting with these
disputes over possible reductions in audit effectiveness?
Turner, Williams, and Weirich (2005) examined the reasons behind many recent U.S. public
company auditor changes and found that stock prices often decline substantially after an auditor
change. However, they stated that since it is difficult to attribute a significant stock price reaction
to just one event (e.g., an internal control material weakness disclosure) that further research is
necessary to assess the impact on stock prices of reported reasons for auditor realignments.
The number of auditor realignments increased significantly in 2004 and 2005, and yet most of
the 8-Ks provide no reason(s) for the change. Glass Lewis & Co., Grant Thornton and the U.S.
Treasury have urged the SEC to require all U.S. public companies to provide reason(s) for every
auditor change ([Glass Lewis and Co., 2007] and [U.S. Treasury, 2008]). Would this requirement
provide more meaningful information to investors or would the additional disclosures have little
impact on investor decisions? To help answer this question, we examine investors' reactions to
current auditor realignment disclosures to determine whether they convey meaningful
information. If the current disclosures are impacting investors' decisions, then the above
recommendation may be warranted and may help remove the shroud of secrecy that currently
surrounds many auditor realignments.
For these reasons, we examined detailed descriptive data for all 3201 auditor realignments in
2004 and 2005 (1607 in 2004 and 1594 in 2005). Since stock price data is not available for over-
the-counter (OTC) companies, our statistical sample is reduced to 713 companies. Our
examination of the information content within required and voluntary auditor realignment
disclosures focuses on the cumulative abnormal returns (CARs) surrounding the 8-K (Item 4.01)
filing date.
Unlike prior research conducted in a pre SOX era, internal control material weakness and auditor
non-reliance on management representation disclosures are associated with negative CARs,
while audit scope limitation, earnings restatement and client-auditor disagreement disclosures are
associated with non-significant CARs in a post-SOX era. Also, unlike prior research, all
voluntary disclosures including fee disputes are associated with non-significant CARs. Similar to
prior research, auditor resignation disclosures are associated with negative CARs.

3
We believe that this is the first study to analyze the impact of required 8-K going concern
disclosures on CARs. Results indicate that auditor realignments that occur after a company has
received a going concern opinion are associated with positive CARs. Further analysis reveals
that investors react negatively to initial 10-K going concern disclosures, but then view
subsequent auditor changes as an opportunity for a troubled company to be exposed to a fresh set
of eyes that may provide value added recommendations that can help turn around the company.
Companies that switch to a larger audit firm (e.g., from a local/regional firm to a Big 4 firm) also
are associated with positive CARs. We believe that this is the first study to report this
relationship which provides some support for the product differentiation hypothesis (Dopuch &
Simunic, 1982).
The remainder of the paper is organized as follows. Section 2 provides background information
on auditor realignment 8-K (Item 4.01) disclosures, while Section 3 reviews the relevant
literature and summarizes the research hypotheses. Section 4 discusses the research methodology
and Section 5 reports the descriptive and statistical data results. Section 6 discusses the study's
implications, limitations and possible areas for future research, while Section 7 presents the
study's conclusions.
2. 8-K disclosures
In 1971, the Securities and Exchange Commission (SEC) began requiring registrants to disclose
details of auditor realignments in a timely manner in their Form 8-K, Item 4, filings (SEC, 1971).
Required 8-K disclosures have evolved over time to provide expanded information about auditor
realignments within the following categories: reportable events, other required disclosures and
voluntary disclosures.
2.1. Reportable events
One of the most significant changes occurred in 1988 when the SEC enacted Financial Reporting
Release (FRR) No. 31 (SEC, 1988) which requires the disclosure of the following four
reportable events: (1) internal controls that are not adequate to generate reliable financial
statements (e.g., material weaknesses); (2) a substantial expansion of audit scope (or a scope
limitation) resulting from the discovery of information that potentially impacts the reliability of
financial statements (that may be subsequently withheld by the client); (3) the auditors inability
to rely on management's representations or their unwillingness to be associated with the financial
statements based on recently obtained information; and (4) earnings restatement(s) resulting
from information that materially impacts the reliability of current and/or prior year financial
statements.
Internal control material weakness disclosures are required when auditors discover a deficiency,
or combination of deficiencies, within a client's internal control over financial reporting, such

4
that there is a reasonable possibility that a material misstatement within the financial statements
will not be prevented or detected on a timely basis (PCAOB, 2007).
The second reportable event involves audit scope disclosures that are required when auditors
discover one or more material misstatement “red flags” that in their judgment require substantial
increases in audit testing. Prior to completing this additional testing, however, clients may
dismiss their auditors to hopefully obtain a less skeptical successor auditor or a predecessor
auditor may resign without issuing an audit opinion because of concerns about being associated
with potentially materially misstated financial information.
Auditors also may encounter management that appears to be limiting their ability to conduct
necessary audit procedures. For example, management may attempt to prevent auditors from
discovering material misstatements by withholding key documents or providing misleading
documents. Auditors may respond by resigning from these engagements without issuing an audit
opinion (or by issuing a disclaimer of opinion) and disclosing a scope limitation within their
Form 8-K.
The third reportable event involves the auditors' inability to rely on managements'
representations. Auditors who state that they can no longer rely on management's representations
may have discovered at least one of the following: material misstatements that have not yet
triggered an earnings restatement, integrity issues surrounding individuals within the financial
reporting function, contradictory or misleading statements by management, etc. These concerns
may be so egregious that they result in auditors withdrawing all previous audit reports and
opinions and stating that they are unwilling to be associated with any financial statements
prepared by management.
The fourth reportable event involves whether an earnings restatement(s) has occurred in the
current and/or prior fiscal year. Auditors who resign after the release of earnings restatements
may be signaling concerns about issues such as the tone at the top or the control environment
that may increase the risk of additional restatements in the future. Companies who dismiss their
auditors after the release of earnings restatements may be retaliating against the auditors'
demands to disclose the restatement and may be hoping to obtain more sympathetic successor
auditors.
However, since many of these earnings restatements may be previously disclosed in the
company's current and/or prior year 10-K, the market impact of the 8-K restatement disclosure
may be significantly eroded by the potential long lag between the earliest disclosure and the
subsequent 8-K disclosure.
2.2. Other required disclosures
The SEC also mandates that companies disclose the following other required disclosures (SEC,
1989): (1) whether the predecessor auditor resigned; (2) whether there are any disagreements

5
with the predecessor auditor (e.g., GAAP issues); and (3) whether there are modifications to the
audit report in the previous two years, including going concern opinions.
Although other forms of audit report modification exist (e.g., emphasizing the adoption of newly
issued GAAP), going concern disclosures are more likely to be viewed negatively by investors
since auditors indicate “substantial doubt” about a company's ability to continue as a “going
concern” in the foreseeable future.2 The SEC, however, requires companies to disclose any
modifications to their audit report in either of the two preceding years. Thus, similar to earnings
restatements, the market impact of going concern disclosures may be significantly eroded by the
potential long lag between their initial disclosure in a 10-K and their subsequent 8-K disclosure.
2.3. Voluntary disclosures
The SEC encourages registrants to voluntarily disclose any additional reasons for audit
realignments. These disclosures may be divided into the following three categories: (1) client-
service related reasons, (2) fee disputes and (3) verifiable or previously disclosed reasons. Client-
service related reasons may be defined as non-verifiable or more subjective realignment reasons,
such as a client's desire to receive better audit service. Fee disputes indicate that the client or the
firm has initiated an auditor change due to dissatisfaction with the fee structure. Verifiable
disclosures are those that have been previously announced such as auditor consolidations
resulting from company mergers.
3. Research hypotheses
3.1. Impact of reportable events on abnormal returns
As discussed in Section 2, the four reportable events include internal control material
weaknesses, auditors' desire to expand their audit scope (or a client-imposed scope limitation),
auditors' inability to rely on management representations, and earnings restatements in either of
the two preceding years.
Few studies have investigated the market reaction to reportable events as required under FRR
No. 31 in Form 8-K (Item 4.01). Krishnan (2002) found negative information content after
combining all four reportable event disclosures into a single explanatory variable, but only when
the predecessor auditor's exhibit letter is not filed concurrently with the initial Form 8-K.
However, Whisenant et al. (2003) examined a relatively large number of reportable events
(n = 118) in the mid 1990s and found negative information content when they combined three
reportable event disclosures into a single explanatory variable (audit scope concerns, non-
reliance on management's representations and earnings restatements) within both non-concurrent
and concurrent exhibit letter samples.3 However, the authors did not find a significant
association between internal control material weakness disclosures and CARs in the mid 1990s.
The PCAOB recently stated that internal control material weaknesses are intended to act as an
early warning system for management fraud (Internal Auditing Report, 2007). In addition, recent

6
surveys of professional fraud examiners indicate that strong internal controls are among the most
effective means for preventing and/or detecting management fraud. Specifically, a strong tone at
the top or control environment is considered to be the most effective means for preventing
management fraud4, and strong control procedures are considered to be the third most effective
means (Oversight Systems, 2005). The Association of Certified Fraud Examiners (ACFE, 2006)
reports that strong internal controls are more than four times as likely to detect management
fraud within public companies as external auditors. If this is true, then we would expect that the
disclosure of internal control material weaknesses would imply an increased risk of management
fraud and thus convey negative information content to investors.
Based on the above discussion, the reportable events research hypothesis is as follows:

H1

When an auditor realignment occurs, required 8-K reportable event disclosures convey negative
information to investors.
3.2. Impact of other required disclosures on abnormal returns
In addition to reportable events, other required Form 8-K (Item 4.01) disclosures include whether
the predecessor auditor resigned (or is dismissed), whether there are any disagreements (e.g.,
GAAP issues) with the predecessor auditor and whether there are any going concern audit report
modifications in either of the two preceding years.
Several prior studies have examined whether auditor resignations (versus client dismissals)
convey negative information to investors ([DeFond et al., 1997], [Krishnan and Krishnan, 1997],
[Shu, 2000], [Whisenant et al., 2003] and [Wells and Loudder, 1997]). Each study's results
provide at least some support for the hypothesis that auditor resignations generate negative
market reactions since they signal an auditor's private information about the true state of a
company's financials and/or its management.
The second other required disclosure involves disagreements with the predecessor auditor.
Several prior studies have examined whether client–auditor disagreements convey negative
information to investors ([DeFond and Jiambalvo, 1993], [Dhaliwal et al., 1993], [Smith and
Nichols, 1982], [Sankaraguruswamy and Whisenant, 2004] and [Whisenant et al., 2003]). Except
for Sankaraguruswamy and Whisenant (2004), each prior study's results support this hypothesis.
This fairly consistent result appears to be driven by material GAAP disputes involving such
contentious issues as improper revenue recognition and expense incurrence resulting in an
increased risk of material misstatements that may adversely affect earnings.
The final other required disclosure involves going concern audit report modifications in either of
the two preceding years. We believe that this is the first study to investigate the association

7
between audit report modifications disclosed in Form 8-Ks (Item 4.01s) and CARs.
Based on the above discussion, the other required disclosure research hypothesis is as follows:

H2

When an auditor realignment occurs, other required 8-K disclosures convey negative information
to investors.
3.3. Impact of voluntary disclosures on abnormal returns
As discussed in Section 2, our study separates voluntary realignment disclosures into the
following three categories: (1) client-service related reasons, (2) fee disputes and (3) verifiable or
previously disclosed reasons.5
Sankaraguruswamy and Whisenant (2004) separated the voluntary auditor change disclosures
into non-verifiable and verifiable reasons. The authors found that non-verifiable or more
subjective realignment reasons, such as a desire for greater auditor industry expertise, indicates
a company's desire to receive better service from its auditor and signals “good news” to investors
about a company's future prospects. Thus, the authors contend that client service-related
disclosures should generate positive CARs.
Sankaraguruswamy and Whisenant (2004) contended that client fee-related reasons signal their
ability to obtain fee concessions from successor auditors. This conveyed positive information to
investors in the mid 1990s since they appeared to value cost savings over perceived audit
effectiveness in a “loss leader” or “commoditized” audit environment (Craswell, Francis, &
Taylor, 1995).
Sankaraguruswamy and Whisenant (2004) further stated that verifiable or previously disclosed
reasons do not provide information content. The authors contend that verifiable reasons can be
surmised from previous media disclosures or other verifiable reasons, such as the need (for a)
bigger audit firm, can be revealed through significant pre-alignment company growth (Healy &
Lys, 1986). Based on the above discussion, the voluntary disclosure research hypothesis is as
follows:

H3

When an auditor realignment occurs, voluntary 8-K disclosures convey positive information
content to investors.
3.4. Impact of change in firm type on abnormal returns
Dopuch and Simunic (1982) contended that the audit industry's monopolistic tendencies can be
explained by the product differentiation hypothesis. More specifically, they hypothesized that

8
different firms provide auditing services that are perceived by investors to be of different quality,
and in particular, that Big 8 firms were perceived as being more credible than non-Big 8 firms.
Nichols and Smith (1983), Whisenant et al. (2003), and Sankaraguruswamy and Whisenant
(2004) tested this hypothesis by examining whether a change to a larger audit firm is associated
with positive information content to investors (and vice versa). In contrast to Nichols and Smith's
two categories (Big 8 versus non-Big 8), Whisenant et al. (2003) use a three category variable
(e.g., a value of “1” if the change was from a non-Big 6 to a Big 6 firm; a value of “− 1” if the
change was from a Big 6 to a non-Big 6 firm; and a value of “0” if there was no change in the
predecessor/successor auditor type). Although the direction of the market's reaction is consistent
with the above hypothesis, the statistical results are not significant within these studies.6
Our study differs from prior research by examining three categories of predecessor/successor
changes in firm type (e.g., Big 4 to 2nd Tier, Big 4 to local/regional, 2nd Tier to local/regional
and vice versa). By establishing a separate category for 2nd Tier firms (BDO, Grant Thornton
and RSM McGladrey), our study may be more likely to identify significant differences in market
returns based on changes in firm type since investors also may perceive that 2nd Tier firms are
more credible than local/regional firms. This may be due, in part, because most local/regional
firms are significantly smaller than the 2nd Tier and often do not have many public company
clients. Thus, local/regional firms may not be able to devote as many resources to their public
company clients as the 2nd Tier and may not have enough public company clients to afford their
auditors the benefits of industry specialization. Since different industries have unique audit risks,
investors may perceive that 2nd Tier firms are better equipped to detect and report material
misstatements.
Based on the above discussion, the final research hypothesis is as follows:

H4

When an auditor realignment occurs, changes in firm type convey information content to
investors.
4. Data and methodology
We obtained auditor change data for 2004 and 2005 from Glass-Lewis & Co., LLC and from the
SEC's website (www.sec.gov). We focused on data after 2003 because we were concerned that
2002 and 2003 data might be distorted by former Andersen clients changing auditors and by the
initial impact of SOX requirements such as implementing new corporate governance initiatives.
We found 3,201 instances of auditor changes over the two-year period including 21 companies
who changed auditors in both 2004 and 2005. In contrast, only 1338 companies changed auditors

9
in 2003 (Read, Rama, & Raghunandan, 2004), and in the mid 1990s (1993 to 1996), an average
of only 726 companies changed auditors each year (Whisenant et al., 2003).
Table 1 reports the sample attrition. We deleted 2488 observations from our statistical sample for
the following reasons: (1) stock price data was not available on Center for Research in Security
Prices (CRSP, 2005) for 2095 small public companies that were traded on the over-the-counter
market (OTC), instead of the NYSE/AMEX/NASDAQ; (2) sufficient data was not available to
compute financial distress (the probability of bankruptcy per Altman's z-score) for 163
companies, especially financial institutions; (3) financial data from the Standard & Poor's 2005
COMPUSTAT Industrial and Research files were not accessible for an additional 134 companies;
and (4) financial data from CRSP was not available for 96 companies over the event window.
Thus, a final sample size of 713 companies was used for each of our statistical tests.
Table 1.
Sample selection criteria and descriptive statistics.

Year 2004 2005 '04 and '05

Population 1607 1594 3201
CRSP stock price data missing (Traded on OTC) 1063 1032 2095
Z-score data missing 87 76 163
Compustat financial data missing 97 37 134
CRSP financial data missing 46 50 96
Sample 314 399 713

Mean Median
Panel A—Average stock price reaction for the 713 companies
Cumulative abnormal returns (− 20,− 6) 1.10% 0.18%
Cumulative abnormal returns (− 5,− 2) − 0.17% − 0.37%
Cumulative abnormal returns (− 1,1) − 0.99% − 0.55%

Panel B—Client characteristics

SIZE (total assets in millions) 1504.00 112.10
Financial distress (Altman's z-score) 4.27 3.17
, ,
Denotes significantly different from zero in a two-tailed test at p < 0.10, 0.05, and
0.01, respectively.

10
Variable definition
Cumulative = the sum of the abnormal returns surrounding a company's initial 8-K
Abnormal Returns filing date; the abnormal return is the company's daily stock return minus
(CARs) the market model adjusted market return.

Full-size table

The dependent variable, the cumulative abnormal return (CAR), is the sum of the abnormal
returns surrounding a company's initial 8-K filing date. The abnormal return is the company's
daily stock return minus the market model adjusted market return. Per Table 1 (Panel A), the
mean and median stock price reaction during our sample period for CAR (− 1,+ 1) is − 0.99%
and − 0.55%, respectively.
Fig. 1, that plots average CARs (− 20,+ 3) surrounding all auditor realignment events in 2004
and 2005, supports our contention that a three-day announcement interval captures the primary
impact of Form 8-K (Item 4.01) disclosures. For example, CARs (− 20,− 6) indicate a modest
positive stock price reaction during this 15-day interval, while CARs (− 5,− 2) indicate a modest
negative stock price reaction during this four-day interval leading up to the event date. These
results are not significantly different from zero. However, CARs (− 1,+ 1) indicate a negative
stock market reaction that is supported by our t-test results (see Table 1, Panel A). Thus, not only
is the primary impact of 8-K (Item 4.01) disclosures concentrated around the three-day interval
(− 1,+ 1), but also there appears to be an absence of information leakage prior to the issuance of
auditor realignment disclosures. Thus, Table 6 reports only the three-day interval results.

Full-size image (21K)

Fig. 1. Daily average cumulative abnormal returns surrounding all auditor realignment events in
2004 and 2005.

We used multivariate regression to examine stock market reactions to auditor realignment

disclosures in 2004 and 20057; these 8-K disclosures were analyzed and sorted into the
following four categories: (1) reportable events, (2) other required disclosures, (3) voluntary
disclosures and (4) changes in predecessor/successor firm type. To ensure that each auditor

11
change disclosure was properly categorized, two of the authors examined each 8-K filing and
independently coded the data. The authors resolved any differences jointly by doing an
additional reading of the relevant 8-K filings.
We estimated the following multivariate regression equation to examine our research questions:

4.1. Control variables

Unlike prior studies, the above regression equation includes four variables to control for the
following: (1) SIZE or the logarithm of company total assets, (2) FINANCIAL_DISTRESS or
the probability of bankruptcy based on Altman's z-score, (3) YEAR_2004 to control for any
differences in results between 2004 and 2005,8 and (4) NO_REASON/REASON to control for
companies that disclose a “reason” for their realignment versus those that do not.
Our a priori belief is that larger public companies should experience greater market reactions to
auditor change announcements since there are more investment dollars at risk and thus more
financial analysts following these companies.9 We also expect companies that have a greater risk
of bankruptcy (e.g., Altman's z-score < 1.8) to generate significantly larger CARs in response to
auditor change disclosures than those companies with a lesser risk of bankruptcy since
disclosures by companies that are suspected of being in severe financial distress are likely to
have more impact on investors' decisions.
The mean and median values for the client characteristic control variables (SIZE and
FINANCIAL_DISTRESS) are included in Table 1 (Panel B).
5. Results
Table 2 provides a summary of the auditor realignment disclosures reported by all 3201
companies that changed auditors in 2004 and 2005, and the disclosures reported by the 713
companies included in our statistical sample. Of the 3201 companies that changed auditors,
40.2% provided “no reason” for their auditor change. In our statistical sample, the percentage of
companies providing “no reason” for their auditor change increased to 57.8%.
Table 2.
Summary of auditor change disclosures.

8K disclosures 2004 2005 '04 and '05 % of Sample % of

populat. populat. population companies companies
in populat. in sample
Reportable events:

12
8K disclosures 2004 2005 '04 and '05 % of Sample % of
populat. populat. population companies companies
in populat. in sample
CONTROLS 123 224 347 10.8 164 23.0
SCOPE 12 14 26 0.8 5 0.7
NON-RELIANCE 23 13 36 1.1 6 0.8
RESTATEMENT 40 81 121 3.8 44 6.2
Subtotal-Reportable 198 332 530 – 219 –
Other required disclosures:
RESIGNATION 605 553 1,158 36.2 225 31.6
DISAGREEMENT 28 24 52 1.6 20 2.8
GOING_CONCERN 569 596 1,165 36.4 32 4.5
Subtotal—Other 1202 1173 2375 – 277 –
Total 1400 1505 2905 – 496 –
Voluntary disclosures:
SERVICE 120 39 159 5.0 31 4.3
FEES 50 31 81 2.5 37 5.2
VERIFIABLE 240 175 415 13.0 33 4.6
Total voluntary 410 246 656 – 101 –
No reason given 642 645 1,287 40.2 412 57.8
a a a a a
Total number of 2452 2396 4848 151.5 1009 a141.5
disclosures/No
reasona
Total number of 1607 1594 3201 100.0 713 100.0
companies
Variable definitions
Reportable events
CONTROLS = internal controls are not adequate as evidenced by the reporting of
at least one material weakness in the Form 8-K filing (1 if reported,
0 otherwise).
SCOPE = expanded audit scope (or scope limitations) due to potentially
unreliable financial information reported in Form 8-K filing (1 if

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 Variable definitions
reported, 0 otherwise).
NON-RELIANCE = the logarithmic non-reliance on management's representations
reported in Form 8-K filings (1 if reported, 0 otherwise).
RESTATEMENT = financial restatement reported in Form 8-K filing (1 if reported, 0
otherwise).
Other required disclosures
RESIGNATION = auditor resignation or client dismissal reported in the Form 8-K
filing (1 if a resignation, 0 if a dismissal).
DISAGREEMENT = client–auditor disagreement over GAAP and/or internal control
issue reported in the Form 8-K filing (1 if reported, 0 otherwise).
GOING_CONCERN = going concern audit report modification in either of the two
preceding fiscal years as reported in the Form 8-K filing (1 if
reported, 0 otherwise).
Voluntary disclosures
SERVICE = client audit service concerns (e.g., auditor needs to be located
closer to the company, auditor independence concerns, etc.) reported
in the Form 8-K filing (1 if reported, 0 otherwise).
FEES = client and auditor fee-based disputes reported in the Form 8-K
filing (1 if reported, 0 otherwise).
VERIFIABLE = the voluntary disclosure of auditor consolidation resulting from a
merger, the need for a bigger auditor, etc. reported in the Form 8-K
filing (1 if reported, 0 otherwise).
Changes in firm type
Δ_TO_SMALLER_FIRM = change from a Big Four to a 2nd Tier firm or a change from a Big
Four to a local/regional firm or a change from a 2nd Tier to a
local/regional firm (1 if reported, 0 otherwise).
Δ_TO_LARGER_FIRM = change from a 2nd Tier to a Big Four firm or a change from a
local/regional to a Big Four firm or a change from a local/regional
firm to a 2nd Tier firm (1 if reported, 0 otherwise).

Full-size table

a
Several companies had multiple disclosures when they announced their auditor change.
Therefore, the auditor change disclosures are greater than the number of auditor changes.
14
This is due, in large part, to the dramatic decline in the percentage of companies that reported a
going concern audit report modification (GOING_CONCERN) in our statistical sample. A little
over a third (36.4%) of all 3201 companies that changed auditors during 2004 and 2005 had a
GOING_CONCERN disclosure, while the number in our statistical sample was only 4.5%. The
reason for the dramatic decline in GOING_CONCERN disclosures was that most
GOING_CONCERNS were issued to smaller companies traded on the OTC, instead of the
NYSE/AMEX/NASDAQ.
Whisenant et al. (2003) reports that only 9.3% of their statistical sample disclosed reportable
events (CONTROLS, SCOPE, NON-RELIANCE and RESTATEMENT) in the mid 1990s, while
Rama and Read (2006) reports that 15.5% and 23.6% of their statistical sample disclosed
reportable events in 2001 and 2003, respectively.10 In contrast, 30.7% of our statistical sample
disclosed reportable events (219 reportable events out of 713 companies). This dramatic growth
in reportable event disclosures over the past few years is due primarily to the increase in the
number of companies that reported internal control material weaknesses (CONTROLS).11 Much
of this increase in CONTROL disclosures appears to be caused by the implementation of SOX
404 for U.S. public companies with a market capitalization of at least $75 million. This is
supported by a significant increase in CONTROLS reported in 2005 (versus 2004) when these
larger public companies were required to issue their first-ever SOX 404 opinions (see Table 2).
The elimination of many smaller companies, that were traded on the OTC (and thus not required
to comply with SOX 404), caused the percentage of companies that reported CONTROLS to
increase dramatically from 10.8% (for all 3201 companies) to 23.0% (for the statistical sample).
Due to the exploratory nature of this study, detailed descriptive data are presented for three
explanatory variables (CONTROLS, SERVICE and changes in predecessor/successor firm type).
The descriptive data are followed by multivariate regression results.
5.1. Internal control material weaknesses
Table 3 provides interesting information about the types of CONTROLS, in both absolute and %
terms, reported by all 3201 companies that changed auditors in 2004 and 2005.12 The most
common types of CONTROLS reported are (in rank order): (1) weak control environment or
entity-level controls (e.g., inferior anti-fraud program, weak Board oversight and/or audit
committee that lacks financial expertise, no documented and communicated company-wide
accounting policies and procedures, etc.),13 (2) weak asset-related controls (e.g., contributing to
misstated current assets such as overstated cash receipts, understated accounts receivable
allowance, understated inventory obsolescence and overstated prepaids; overstated investments;
overstated intangibles due to understated goodwill impairments; and understated property, plant
and equipment due to unrecognized capital leases), and (3) weak revenue recognition-related

15
controls (e.g., contributing to understated sales discounts/sales returns and allowances and Staff
Accounting Bulletin No. 101 violations including no evidence of customer receipt of goods).14
Table 3.
Descriptive statistics for internal control material weaknesses.

Types of material weaknesses 2004 2005 '04 and '05 % of

(CONTROLS) population population population populat.
Control environment 45 109 154 16.9
Asset misstatements (Current, 27 75 102 11.2
P,P&E, Investment, Intangible)
Revenue recognition 34 57 91 10.0
Manual JEs and approval of 24 56 80 8.8
complex JEs
L-T debt and Equity equity cycles 25 38 63 6.9
Segregation of duties 28 30 58 6.4
Expenditure cycle 15 39 54 5.9
Deferred tax assets/Liabilities and 10 39 49 5.4
provision
Reconciliations 19 27 46 5.0
Timely and accurate F/S reporting 17 26 43 4.7
Inter-company, Consolidation 13 28 41 4.5
consolidation and JV accting
Lack of supporting documentation 15 22 37 4.1
General computer controls 17 22 39 4.0
Account misclassifications (e.g., 8 15 23 2.5
Asset vs. Exp)
Closing process 16 3 19 2.1
Other 6 4 10 1.1
Totals a319 b590 909 100.0
a
123 companies reported a total of 319 (or 2.6 per company) internal control “material
weaknesses” in 2004.
b
224 companies reported a total of 590 (or 2.6 per company) internal control “material
weaknesses” in 2005.

16
5.2. Service
In Table 4, we summarize the types of client service-related (SERVICE) disclosures within all
3201 companies who changed auditors. Interestingly, we found dramatic shifts in the types and
frequencies of SERVICE categories compared to Sankaraguruswamy and Whisenant (2004).15
Table 4.
Descriptive statistics for client service-related voluntary disclosures.

Types of SERVICE disclosures Our study Sankaraguruswamy and Whisenant

(2004)

n % n %
Auditor independence concerns 33 20.8 0 0.0

Auditor located closer to company 32 20.1 54 35.8

Prior experience with new auditor 31 19.5 24 15.9

Time for a change/new top mgmt 27 17.0 9 6.0
request
Greater industry/international 19 11.9 20 13.2
expertise
Better service desired 15 9.4 4 2.6
Mandatory partner rotation 2 1.3 0 0.0
Excellent proposal from successor 0 0.0 33 21.9
auditor
High staff turnover of predecessor 0 0.0 5 3.3
auditor
Totals 159 100.0 151 100.0
, ,
Denotes significantly different from zero in a two-tailed test at p < 0.10, 0.05, and
0.01, respectively.

In 2004 and 2005, the most frequent SERVICE disclosure is auditor independence concerns such
as a change resulting from a violation of the “one-year cooling off period” requirement that may
cause a financial expert to be suddenly terminated.16 In contrast, Sankaraguruswamy and
Whisenant (2004) do not report any auditor changes due to auditor independence concerns in the
mid 1990s. Thus, auditor independence has become a more contentious issue since the passage
of SOX.

17
We also found a significant increase in the time for a change category. This increase may be an
indication of client frustration over additional SOX-related internal control inquiry,
documentation and testing requirements in 2004 and 2005.
There is a significant decrease in the number of company decisions to dismiss their auditors and
hire successor auditors (who are) located closer to the company in 2004 and 2005 relative to the
mid 1990s. This type of disclosure may be viewed positively by investors since audit efficiency
and effectiveness may improve as audit teams no longer have to travel long distances to service
these clients.17 Future research may be needed to verify these conclusions.
5.3. Changes in firm type
In Table 5, we examine the impact of auditor realignments that resulted in changes in audit firm
type/category. Some changes to smaller successor firms are associated with negative CARs,
while some changes to larger successor firms are associated with positive CARs. For example,
changes from the Big 4 to the 2nd Tier and the 2nd Tier to local/regional firms are associated
with negative CARs, while changes from local/regional firms to the Big 4 are associated with
positive CARs.
Table 5.
Audit firm changes and average cumulative abnormal returns.

Predecessor firm Successor firm N Sample (− 1,+ 1)

Big Four 2nd Tier 209 − 1.05%
Big Four Local/Regional 207 − 0.68%
2nd Tier Local/Regional 54 − 3.98%

Change to smaller firm 470

2nd Tier Big Four 15 2.01%
Local/Regional Big Four 8 3.30%
Local/Regional 2nd Tier 8 − 1.31%

Change to larger firm 31

Big Four Big Four 138 − 0.56%
2nd Tier 2nd Tier 8 − 0.63%
Local/Regional Local/Regional 66 − 1.38%
No change in firm category 212
Total number of companies 713

18
 , ,
Denotes significantly different from zero in a two-tailed test a p < 0.10, 0.05, and
0.01, respectively.

Variable definitions
Big Four = Deloitte, E&Y, KPMG and PwC.
2nd Tier = BDO, Grant Thornton and RSM McGladrey.
Local/Regional = All other CPA firms not included in the above two categories.

Most of the companies in our statistical sample that changed auditors switched to a smaller firm
(n = 470) of which 416 changed from the Big 4 to a smaller firm. In contrast, only 66 companies
switched to a larger firm of which only 23 changed to the Big 4.
5.4. Multivariate impact of realignment disclosures on abnormal returns
In Table 6, we examine the relation between our control and explanatory variables and CARs
surrounding the 8-K filing date.18 As expected, the log of total assets (SIZE) and Altman's z-
score (FINANCIAL_DISTRESS) have a positive association with CARs (p < 0.05). In contrast,
the REASON/NO_REASON19 and YEAR_2004 control variables have a non-significant
association with CARs.
Table 6.
The association between cumulative abnormal returns (CARs) and reportable events, other
required disclosures and voluntary auditor realignment disclosures.

Dependent variable—CARs (− 1,+ 1)

Model 1 Model 2
Control variables
Intercept β0 − 0.018 − 0.016
SIZE β1 0.004 0.003
FINANCIAL DISTRESS β2 0.001 0.001
Year = 2004 β3 − 0.007 − 0.007
NO_REASON/REASON β4 0.003 0.002

Explanatory variables
Reportable events
CONTROLS β5 (−) − 0.001a − 0.001a
SCOPE β6 (−) − 0.013 − 0.017
NON-RELIANCE β7 (−) − 0.112 − 0.115

19
Dependent variable—CARs (− 1,+ 1)
Model 1 Model 2
RESTATEMENT β8 (−) − 0.009 − 0.009
Other required disclosures
RESIGNATION β9 (−) − 0.026 − 0.026
DISAGREEMENT β10 (−) 0.006 0.011
GOING_CONCERN β11 (−) 0.039 0.040
Voluntary disclosures
SERVICE β12 (+) − 0.009 − 0.011
FEES β13 (+) − 0.002 − 0.002
VERIFIABLE β14 (+) 0.006 0.006
Auditor type
Δ_TO_SMALLER_FIRM β15 (−) − 0.004
Δ_TO_LARGER_FIRM β16 (+) 0.021
Big 4 to 2nd Tier (−) − 0.003
Big 4 to Local/Regional (−) 0.001
2nd Tier to Local/Regional (−) − 0.028
2nd Tier to Big 4 (+) 0.023
Local/Regional to Big 4 (+) 0.048
Local/Regional to 2nd Tier (+) − 0.011
Adjusted R2 0.089 0.100
Model P value < .0001 < 0001
Number of observations 713 713
, ,
Denotes significantly different from zero in a two-tailed test at p < 0.10, 0.05, and
0.01, respectively.
Model 1:
CAR = βo + β1SIZE + β2FINANCIAL_DISTRESS + β3YEAR_2004 + β4NO_REASON/REASO
N + β5CONTROLS + β6SCOPE + β7NON-RELIANCE + β8RESTATEMENT +
β9RESIGNATION + β10DISAGREEMENT + β11GOING_CONCERN + β12SERVICE + β13FEES
+ β14VERIFIABLE + β15Δ_TO_SMALLER_FIRM + β16Δ_TO_LARGER_FIRM + ε.

Variable definitions
Cumulative Abnormal = the sum of the abnormal returns surrounding a company's

20
Variable definitions
Returns (CARs) initial 8-K filing date; the abnormal return is the company's daily
stock return minus the market model adjusted market return.
Control variables
SIZE = the logarithm of company total assets.
FINANCIAL_DISTRESS = the probability of bankruptcy per Altman's z-score (e.g., z-
scores less than 1.8, suggest substantial risk of bankruptcy, while
z-scores greater than 3.0 suggest limited risk of bankruptcy).
YEAR_2004 = to control for any differences in results between 2004 and 2005
(1 if 2004, 0 otherwise).
NO_REASON/REASON = to control for companies that disclose a “reason” for their
realignment versus those that do not (1 if no reason reported, 0 if
a reason reported).
Reportable events
CONTROLS = internal controls are not adequate as evidenced by the
reporting of at least one material weakness in the Form 8-K
filing (1 if reported, 0 otherwise).
SCOPE = expanded audit scope (or scope limitations) due to potentially
unreliable financial information reported in Form 8-K filing (1 if
reported, 0 otherwise).
NON-RELIANCE = non-reliance on management's representations reported in
Form 8-K filings (1 if reported, 0 otherwise).
RESTATEMENT = financial restatement reported in Form 8-K filing (1 if
reported, 0 otherwise).
Other required disclosures
RESIGNATION = auditor resignation or client dismissal reported in the Form 8-
K filing (1 if a resignation, 0 if a dismissal).
DISAGREEMENT = client–auditor disagreement over GAAP and/or internal control
issue reported in the Form 8-K filing (1 if reported, 0 otherwise).
GOING_CONCERN = going concern audit report modification in either of the two
preceding fiscal years as reported in the Form 8-K filing (1 if
reported, 0 otherwise).
Voluntary disclosures
SERVICE = client audit service concerns (e.g., auditor needs to be located
21
 Variable definitions
FEES
VERIFIABLE
Changes in firm type
Δ_TO_SMALLER_FIRM
Δ_TO_LARGER_FIRM
closer to the company, auditor independence concerns, etc.)
reported in the Form 8-K filing (1 if reported, 0 otherwise).
= client and auditor fee-based disputes reported in the Form 8-K
filing (1 if reported, 0 otherwise).
= the voluntary disclosure of an auditor consolidation resulting
from a merger, the need for a bigger auditor, etc. reported in the
Form 8-K filing (1 if reported, 0 otherwise).
= change from a Big Four to a 2nd Tier firm or a change from a
Big Four to a local/regional firm or a change from a 2nd Tier to a
local/regional firm (1 if reported, 0 otherwise).
= change from a 2nd Tier to a Big Four firm or a change from a
local/regional to a Big Four firm or a change from a
local/regional firm to a 2nd Tier firm (1 if reported, 0 otherwise).

Full-size table

a
The CONTROLS variable is statistically significant in 2004 (p < 0.05); it also is statistically
significant in 2005 when early adopters of SOX 404 (e.g., greater than $75 million in market
cap) are excluded (p < 0.05).
5.4.1. Impact of reportable events on abnormal returns
The only reportable event that is initially found to have negative information content is an
auditor's non-reliance on management's representations (NON_RELIANCE; p < 0.01).
We originally concluded that CONTROL disclosures generated a non-significant CAR; however,
after separately analyzing 2004 and 2005 data, we found that CONTROL disclosures do convey
negative information content in 2004 (p < 0.05), but not in 2005.
Since larger U.S. public companies (e.g., market capitalization of at least $75 million) had to
disclose SOX 404 internal control opinions for the first time in their 2005 10-Ks, we wondered if
the 2005 non-significant result was due to these previous disclosures. Thus, for these companies,
the subsequent disclosure in their 8-Ks would not convey new information content. To test this
hypothesis, we eliminated all companies with a market capitalization of at least $75 million from
our 2005 statistical sample (n = 79). We found that the remaining companies (n = 26) with 8-K
CONTROL disclosures were associated with negative CARs (p-value < 0.05).20

22
We then identified the earliest CONTROL disclosure dates for the 79 companies in 2005 that had
a market capitalization of at least $75 million. We then analyzed the market's reaction to these
CONTROL disclosures and found negative CARs (p < 0.10).
Results indicate a non-significant relation between audit scope (SCOPE) and CARs. In contrast,
NON-RELIANCE is significant at the 0.01 level with the expected negative sign (see Table 6);
however, similar to SCOPE (n = 5), there are a small number of NON_RELIANCE disclosures
(n = 6). Further analysis of the six companies with NON-RELIANCE disclosures uncovered that
three had earnings restatements, three had NASDAQ/AMEX de-listings and one had a de-listing
warning within 12 to 18 months of the NON-RELIANCE 8-K disclosure date. Further analysis
also revealed that four out of the six NON_RELIANCE disclosures generated negative CARs,
while three out of the five SCOPE disclosures generated negative CARs; however, the
NON_RELIANCE negative CARs were of greater magnitude than the SCOPE negative
CARs.21 Thus, investors appear to react more negatively to NON_RELIANCE disclosures
because they imply that the financial statements may contain one or more material misstatements
and thus can no longer be trusted.
We find that earnings restatement (RESTATEMENT) disclosures generate non-significant CARs.
As previously discussed, this appears to result from the 8-K requirement to disclose all
RESTATEMENTS in the current and/or prior fiscal year. Thus, the market impact of
RESTATEMENTS is likely to be significantly diminished by the lag between their original
disclosure and their subsequent 8-K disclosure. Thus, their subsequent disclosure in the 8-K does
not provide new information content to investors.
5.4.2. Impact of other required disclosures on abnormal returns
The multivariate regression results in Table 6 indicate that there is negative information content
within the auditor resignation (RESIGNATION) variable (p < 0.01), while there is positive
information content within the going concern report modification (GOING_CONCERN)
variable (p < 0.01). However, there is no information content within the client–auditor
disagreements over GAAP and/or internal control material weaknesses (DISAGREEMENT)
variable.
Originally, we were surprised that investors reacted positively to a company disclosing that it had
previously received a GOING_CONCERN (p < 0.01).22 However, interviews with several Big 4
firm partners indicated that they were not surprised by this result. The partners stated that
investors normally react very negatively to the initial 10-K going concern disclosure because
they assume the worst case scenario. In their experience, investors view a subsequent auditor
change as an opportunity for a troubled company to be exposed to a fresh set of eyes that may
provide value added recommendations that can help turn around the company.

23
We also had some concern that this unexpected result may be due to significant multicollinearity
between the FINANCIAL_DISTRESS and GOING_CONCERN variables. However, the
nominal Pearson coefficient between these two variables dispelled this concern (− 0.11). Future
research may be needed to verify this study's results.
We then identified the initial disclosure dates for the 32 companies in our statistical sample that
reported a GOING_CONCERN (see Table 2) and found that, on average, 535 days had passed
between the initial disclosure date and the 8-K disclosure date.23 We then analyzed the market's
reaction to the initial GOING_CONCERN disclosure and found negative CARs (p < 0.01).
Results indicate that DISAGREEMENTS do not convey negative information to investors. The
small number of DISAGREEMENTS, however, is somewhat surprising given that external
auditors appear more willing to “stand up” to top management on less material issues than in the
1990s, in part, out of fear of becoming the next Andersen.
5.4.3. Impact of voluntary disclosures on abnormal returns
The multivariate regression results indicate that the non-verifiable voluntary disclosures
(SERVICE and FEES) and the VERIFIABLE disclosures are not associated with positive CARs
(see Table 6).
5.4.4. Impact of firm type on abnormal returns
We find that market reactions to auditor realignments vary significantly with changes in firm
type, especially a Δ_TO_LARGER_FIRM per Model 1, Table 6 (p < 0.10). The positive
information content associated with a Δ_TO_LARGER_FIRM appears to be driven primarily by
changes from local/regional firms to the Big 4 per Model 2, Table 6 (p < 0.05).
In general, a Δ_TO_SMALLER_FIRM does not convey negative information content to
investors. Similar to Table 5, the one exception is the change from the 2nd Tier to a
local/regional firm.24 In this case, the change does generate negative CARs in Model 2, Table 6
(p < 0.01).
6. Implications, limitations and directions for future research
6.1. Implications
This study's results provide several contributions to the existing literature. In general, this study
extends prior research by examining all required and voluntary Form 8-K (Item 4.01) auditor
realignment disclosures to assess whether they convey information content to investors in a post
SOX-era.
6.1.1. Reportable events
In contrast to Whisenant et al.'s (2003) non-significant result, we believe that this is the first
study to report that CONTROL disclosures convey negative information to investors. This
finding appears to provide some cost justification for the implementation of SOX 404
requirements and enhances the transparency of corporate reporting.

24
Although not justifying causality, CONTROL disclosures also exhibit a positive correlation with
RESTATEMENTS (Pearson coefficient of 0.30 and p < 0.01).25 This relationship is supported
by Reilly (2006) who contends that greater SOX 404 internal control documentation and testing
triggered an unprecedented level of restatements in 2004 and 2005 compared to the 2000 to 2003
time period. More specifically, all public companies, not just those with auditor realignments,
reported 1195 restatements in 2005 and 613 restatements in 2004 during a period of economic
prosperity (Reilly, 2006) versus an average of only 289 restatements from 2000 to 2003 during a
period of economic recession and market upheaval (Huron, 2005). This finding appears to
provide some additional justification for the costs associated with implementing SOX 404.
As previously discussed, Whisenant et al. (2003) found negative information content when they
combined the three remaining reportable event disclosures into a single explanatory variable
(SCOPE, NON_RELIANCE and RESTATEMENTS). However, we were interested in
uncoupling these three reportable events and examining their unique information content. Our
model results indicate that NON-RELIANCE is the only one of these three remaining reportable
event disclosures that has a negative CAR. Thus, infrequent, but egregious NON-RELIANCE
disclosures may have been the primary driver behind Whisenant et al.'s (2003) combined
reportable events significant variable.
6.1.2. Other required disclosures
Unlike prior studies, we find that DISAGREEMENTS do not convey negative information to
investors. In a post-SOX era, more proactive and independent boards of directors including the
requirement that audit committees have two financial experts26 and top management's financial
statement “certification” requirement27 (and the related risk that a subsequent earnings
restatement may trigger their dismissal and/or personal liability)28 may have reduced the
number and severity of GAAP disputes in 2004 and 2005.
The non-significant association between DISAGREEMENTS and CARs also appears to result,
in part, from an increase in disputes over whether control weaknesses rose to the level of a
CONTROL. Specifically, nearly one-quarter of the statistical sample's DISAGREEMENTS
relate to CONTROL disputes. This more prevalent dispute in 2004 and 2005 may be viewed by
investors more positively than DISAGREEMENTS over material revenue recognition and
expense incurrence issues.
6.1.3. Voluntary disclosures
In contrast to Sankaraguruswamy and Whisenant's (2004) positive results, we find that non-
verifiable voluntary disclosures (SERVICE and FEES) do not convey positive information to
investors.29 We believe that this conflicting result may be due, in part, to the dramatic shift in
the types and frequencies of SERVICE categories in a post-SOX era (see Table 4). For example,
auditor independence issues (e.g., a realignment so that different firms provide audit and tax

25
services) may be viewed as increasing costs without increasing audit effectiveness and thus may
actually convey negative information to investors.
Investors also may have changed their perception of an external audit's importance as a result of
recent accounting scandals and thus may no longer value cost savings resulting from FEES over
possible reductions in audit effectiveness.30
Similar to prior studies, we find that VERIFIABLE disclosures (such as consolidating auditors
following a merger and the need (for) a bigger audit firm) do not convey information content to
investors. Even though the types of VERIFIABLE disclosures have changed in 2004 and 2005
relative to the 1980s and mid 1990s (e.g., smaller audit firms announcing that they are not
registering with the PCAOB), the non-significant results appear to be still due to their previous
announcement in other media.
6.1.4. Firm type
Unlike prior studies, we find that market reactions to auditor changes vary with changes in firm
type, especially a Δ_TO_LARGER_FIRM. We believe that this is the first study to report this
relationship and thus provide some support for the product differentiation hypothesis (Dopuch &
Simunic, 1982).
6.2. Limitations
As is true of all research, this study has limitations that may affect the results obtained or the
applicability of the results. One potential limitation is that we do not control for all other events
that are not reported in 8-K filings that may also impact CARs. We believe that this limitation,
however, is minimized through the use of a shortened event window (− 1,+ 1). This shortened
event window is due, in part, to the accelerated timeframe for reporting 8-K related events
beginning in 2004.31
Another limitation is potential bias within our statistical results since a large percentage of
auditor realignments provide no stated reason for the change. Because auditor switches are a
costly event (e.g., substantial audit fees may be lost by the firm and substantial upfront costs are
incurred by client personnel to educate a new firm on company policies and procedures, etc.),
this decision is not taken lightly by either party. Thus, we contend that a legitimate reason(s)
should exist for every auditor change. As a result, similar to Glass Lewis & Co., Grant Thornton
and the U.S. Treasury, we urge the SEC to require all U.S. public companies to provide a
reason(s) for every auditor change ([Glass Lewis and Co., 2007] and [U.S. Treasury, 2008]). The
Advisory Committee on the Auditing Profession contends that explicitly stating the reason(s) for
an auditor realignment will assist investors in determining financial reporting quality and in
making investment decisions (U.S. Treasury, 2008).
6.3. Future research

26
Implications of this study's results for future research are as follows: (1) whether CONTROLS
will still provide information content after Auditing Standard (AS) No. 5′s top down, risk-based
SOX 404 approach is adopted by SEC registrant companies (PCAOB, 2007); (2) whether this
study's positive association between GOING_CONCERN and CARs and this study's non-
significant association between DISAGREEMENTS and CARs is supported by future research;
(3) whether many client dismissals are, in reality, auditor resignations; discussions with several
accounting firm partners resulted in admissions that they planned to resign from some audit
engagements, but allowed the clients to report them as 8-K dismissals.
7. Conclusions
The purpose of this study was to investigate whether required and voluntary Form 8-K (Item
4.01) auditor realignment disclosures in 2004 and 2005 convey information content to investors
in a post SOX era. Although prior research has examined similar disclosures in the 1980s and
mid 1990s, we were interested in determining whether recent accounting scandals, the demise of
Andersen and the passage of SOX in 2002 have significantly affected investors' perceptions of
the relative importance of these disclosures. Unlike prior research, our results indicate that
internal control material weakness and non-reliance on management representation disclosures
convey negative information content, while audit scope limitation, earnings restatement and
client–auditor disagreement disclosures do not convey information content in a post SOX era.
Also, unlike prior research, voluntary disclosures such as fee disputes do not convey information
content. Similar to prior research, auditor resignation disclosures convey information content.
Other required disclosures such as when an auditor realignment occurs after a company has
received a going concern opinion and when a company switches to a larger audit firm (e.g., from
a local/regional firm to a Big 4 firm) are associated with positive CARs. We believe that this is
the first study to analyze the impact of 8-K going concern disclosures on CARs, and we believe
that this is the first 8-K disclosure study whose results provide some support for the product
differentiation hypothesis.
Acknowledgements
The authors gratefully acknowledge the assistance of Glass Lewis & Co., LLC and its Managing
Director of Research (and former SEC Chief Accountant), Lynn E. Turner, for his insights. The
paper also benefited from comments from Stephen Bryan, John Campbell and workshop
participants at Wake Forest University.
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Corresponding author.

1 Sarbanes–Oxley Act, Section 302: Corporate responsibility for financial reports, H.R. 3763,
June 2002.
2 Besides going concern disclosures, disclaimers of opinion also are likely to be viewed
negatively by investors; however, because disclaimers of opinion are rare, they are not
emphasized in this study.
3 Similar to Whisenant et al. (2003), our univariate relationship between CARs and the three
remaining reportable event disclosures (audit scope concerns, non-reliance on management's
representations and earnings restatements) when combined into a single explanatory variable
were statistically significant (p-value < 0.05); however, when this variable is incorporated into
our more expansive multivariate regression model, it is not statistically significant.
4 Beasley, Carcello and Hermanson (1997) found that 83.0% of material fraudulent financial
reporting addressed in SEC Accounting and Auditing Enforcement Releases (AAERs) from 1987

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to 1997 were perpetrated by top management (e.g., the CEO and/or the CFO).
5 We use similar voluntary disclosure classifications as Sankaraguruswamy and Whisenant
(2004).
6 Boone and Raman (2001) report a significant association between updates to a Big 6 firm from
a non-Big 6 firm and downgrades to a non-Big 6 firm from a Big 6 firm and cumulative
abnormal trading activity (CATA) five days after the 8-K auditor change announcement date.
The CATA are significant for trading initiated by individual investors, but not for trading
initiated by institutional investors. The authors, however, did not test for a significant association
between upgrades and downgrades and CARs.
7 Non-reliance on management's representations is considered so important that it is not only
disclosed in Item 4.01, but also it is disclosed within a separate Item 4.02, effective 2004 (SEC,
2004).
8 We considered a fifth variable to control for the disclosure of multiple realignment reasons;
however, only 54 out of 713 statistical sample companies disclosed multiple reasons and this
variable was significantly correlated (variance inflation factor or VIF > 10) with two explanatory
variables (CONTROLS and RESTATEMENTS); also, since this variable had little effect on the
overall model, we excluded it from our final analyses.
9 We also considered the number of sell-side analysts covering a given stock to ascertain if this
was a better proxy for a company’s information environment relative to company SIZE.
However, since median total assets within our statistical sample were only $112 million (Table 1,
Panel B), we concluded that the majority of our sample companies would not be covered by
analysts who normally do not follow companies with less than $2–3 billion in total assets.
10 Rama and Read (2006) exclude 2002 data because of the unusually large number of auditor
changes associated with the death of Andersen.
11 While Whisenant et al. (2003) reports an average of 21 CONTROLS per year within their
statistical sample in the mid 1990s, our study reports an average of 82 CONTROLS per year in
2004 and 2005 within our statistical sample.
12 The relative percentages within the 3201 companies (per Table 3) are comparable to those
within the statistical sample.
13 A weak control environment or entity-level controls is a serious concern since a strong tone at
the top is considered by some to be the most effective means for preventing and/or detecting
management fraud (Oversight, 2005). Auditing Standard (AS) No. 5 (PCAOB, 2007) emphasizes
more prominently the importance of evaluating the control environment or entity level controls
as a basis for assessing fraud risk relative to superseded AS No. 2 (PCAOB, 2004). Thus, as
auditors evaluate entity level controls more rigorously in compliance with AS No. 5, companies
are more likely to devote more time and attention to this critical issue.

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14 Revenue recognition-related CONTROLS are of serious concern since Statement on Auditing
Standards (SAS) No. 99 contends that auditors should conclude that revenue recognition is high
risk for fraudulent reporting on every audit (AICPA, 2001). Weak controls over revenue
recognition create greater opportunities for management to manipulate this account to overstate
reported earnings. As a result of the disclosure of weak revenue recognition controls, in
accordance with SOX 404, controls should be strengthened over this material balance and reduce
the risk that management can successfully manipulate this account in the future.
15 Comparable SERVICE categories and frequencies are noted within all 3,201 companies and
the statistical sample.
16 Sarbanes–Oxley Act, Section 206: Conflicts of interest, H.R. 3763, June 2002.
17 The frequency of better service desired disclosures increased significantly in our study
(relative to Sankaraguruswamy and Whisenant (2004); however, this result likely contributes to a
positive association between SERVICE and CARs, thus partially offsetting some of the
frequency differences within other SERVICE categories that likely contribute to a negative
associate between SERVICE and CARs.
18 Our multivariate model adjusted R-squares of 8% to 10% are significantly higher than prior
studies whose adjusted R-squares are between 1% and 4%. This appears to be due, in part, to our
expanded use of control variables and expanded number of explanatory variables; for example,
Whisenant et al. (2003) does not use any control variables and only analyzes required disclosures
within their models; Sankaraguruswamy and Whisenant (2004) includes several control
variables, but only analyzes voluntary disclosures within their models.
19 Although the association between the REASON/NO_REASON control variable and CARs
was non-significant within the multivariable regression models (Table 6), the univariate results
are significant. Specifically, both the companies that disclosed a REASON (p-value < 0.01) and
the companies that disclosed NO_REASON (p-value < 0.10) experienced significant negative
CARs; however, companies that disclosed a REASON generated significantly larger CARs than
companies that disclosed NO_REASON (p-value < 0.10).
20 Companies with a market cap of less than $75 million will release their first-ever
management internal control report for fiscal years ending after December 15, 2007 and will
release their first-ever auditor internal control opinion for fiscal years ending after December 15,
2008 (SEC, 2007).
21 In ascending order, the 5 CARs for the SCOPE variable are as follows: 0.002, 0.001, − 0.005,
− 0.046, and − 0.190; in ascending order, the 6 CARs for the NON_RELIANCE variable are as
follows: 0.007, 0.001, − 0.027, − 0.125, − 0.190, and − 0.515. To test whether the − 0.515 CAR
is a potential outlier, we calculated Cook's Distance (D) Measure; specifically, Cook's D
measures whether the − 0.515 CAR is significantly influencing the regression coefficient for not

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only the NON_RELIANCE variable, but also all other explanatory variables. Cook's D for this
observation was only 0.622 or the 13th percentile per F-distribution tables; in other words, we
have only 13% confidence that the − 0.515 CAR is significantly influencing the explanatory
variable's regression coefficient(s). In contrast, a Cook's D of 0.958 represents a 50% confidence
level, while a Cook's D of 1.661 represents a 95% confident level.
22 Besides GOING_CONCERN audit report modifications, three disclaimers of opinion
resulting from SCOPE concerns (two related to a significantly expanded audit scope and one
related to a scope limitation) are identified within the 3201 companies that changed auditors;
however, none of these OTC traded companies are included in the statistical sample.
23 The median number of days between the initial GOING_CONCERN disclosure and the 8-K
disclosure date is 382.
24 Unlike Table 5's univariate results, our regression model results do not support a significant
relation between CARs and changes from the Big 4 to the 2nd Tier.
25 Sixty-four (64) % of the companies who reported a RESTATEMENT in their 2004 and/or
2005 Form 8-Ks also reported an internal control material weakness (CONTROLS);
interestingly, in 2004, only 49% of companies who reported a RESTATEMENT also disclosed a
CONTROL; in 2005, 73% of companies who reported a RESTATEMENT also disclosed a
CONTROL as first-ever SOX 404 opinions were required for larger public companies.
26 Sarbanes–Oxley Act, Section 301: Public company audit committees and section 407:
Disclosure of audit committee financial expert, H.R. 3763, June 2002.
27 Sarbanes–Oxley Act, Section 302: Corporate responsibility for financial reports, H.R. 3763,
June 2002.
28 For example, over the past 18 months, nearly 200 companies have disclosed federal or
internal stock option “backdating” investigations resulting in nearly 70 senior executives, Board
member and in-house legal counsel departures. Several senior executives also have been charged
with criminal misconduct, and three senior executives have been found guilty of multiple fraud
charges.
29 Non-significant results are found whether SERVICE and FEES are analyzed as separate
explanatory variables or as a combined explanatory variable.
30 Comparable non-significant results are found when the combined FEE variable is divided into
client initiated fee disputes and auditor initiated fee disputes; also, similar to prior studies, FEES
are significantly associated with changes to smaller audit firms (p < 0.01).
31 Effective August 2004, the SEC (2004) implemented a four business day deadline for filing 8-
K related events with no extension provision.

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