Managing Risk: The Impact of Internal Control Deficiencies on Auditor Resignations and Fees

• In Event: Breakfast and Research Forum
  In Roundtable Session: Table 2: Auditors and Internal Control Weakness

Abstract

The purpose of this study is to provide insight into firms’ risk management strategies by empirically investigating the association between auditor resignations and audit fee premiums and the presence of an internal control material weakness, as indicated by an adverse opinion on internal controls over financial reporting (ICFR). Overall, adverse ICFR opinions are positively associated with auditor resignations. Following such resignations, companies tend to hire smaller audit firms. The subsequent auditor does, however, increase the audit fee. Our results are consistent with audit firms resigning from clients with adverse ICFR opinions in an effort to mitigate risk. Further, the subsequent auditor will mitigate risk by charging companies a risk fee premium. Interestingly, we find evidence that audit firms are less likely to resign from clients with adverse ICFR opinions in the period encompassing and following the recent economic recession than in the period prior to the recession. Firms continue to add a risk fee premium in difficult economic times; however, the premium is not as high as in the period prior to the recession. These results indicate that auditors will modify their engagement risk strategies; in particular they will act less conservatively when economic times are difficult.

Authors

• Penelope Lee Bagley, Appalachian State University

• Tracy Nelson Reed, Appalachian State University

• Jack W Dorminey, West Virginia University

• Dwayne N McSwain, Appalachian State University