Determinants of auditor choice: Review of the empirical literature

• DOI: http://doi.org/10.1111/ijau.12163
• Author: Md. Borhan Uddin Bhuiyan,Julia Wu,Xuan (Sean) Sun,Ahsan Habib
• Date: 01 July 2019
• Published date: 01 July 2019

ORIGINAL ARTICLE

Determinants of auditor choice: Review of the empirical

literature

Ahsan Habib

1

|Julia Wu

2

|Md. Borhan Uddin Bhuiyan

1

|Xuan (Sean) Sun

1

1

School of Accountancy, Massey University,

Auckland, New Zealand

2

Accounting and Information Systems, College

of Business and Law, University of Canterbury,

Christchurch, New Zealand

Correspondence

Ahsan Habib, School of Accountancy, Massey

University, Private Bag, 102904, Auckland,

New Zealand.

Email: a.habib@massey.ac.nz

We synthesize the empirical archival literature on the determinants of auditor choice

in an international setting, critique the findings, and offer suggestions for future

research. We categorize the determinants into (i) firm‐level ownership variables, (ii)

nonownership corporate governance determinants, (iii) economic determinants driven

by the risk of information asymmetry, and (iv) country‐level institutional determi-

nants, including legal protection of investors, political connections, and national

culture. Our comprehensive review not only enriches the academic literature, but also

provides material of considerable interest to investors, practitioners (auditors), and

regulators.

KEYWORDS

agency theory, auditor choice, corporate governance, industry specialist auditors, information

asymmetry

1|INTRODUCTION

The last three decades have witnessed a surge in research studies exam-

ining the determinants and implications of auditor choice. The increase

in auditor choice research has been interwoven with the reforms in cor-

porate governance regulation regimes and the recent developments in

the audit market (Carson, Simnett, Soo, & Wright, 2012; DeFond &

Zhang, 2014; Simnett, Carson, & Vanstraelen, 2016). First, regulatory

changes of unprecedented extent have fundamentallyaltered the provi-

sion and procurement of audit and assurance services, as well as the

corporate governance mechanism of their clients. The passage of the

Sarbanes–Oxley Act (SOX) (US House of Representatives, 2002) in

reaction to corporate scandals, such as Enron and WorldCom, has

shifted the responsibilities for auditor appointments from management

to the audit committee: a subcommittee of the board of directors. This

has influenced the auditing‐related corporate governance research

appreciably, as a sizeable audit committee literature has been published

since (Ghafran & O'Sullivan, 2013). Furthermore, the creation of the

PublicCompany Accounting Oversight Board in theUSA ended 25 years

of professional self‐regulation of the audit profession in that country.

Many national and/or transnational regulators have developed their

own corporate governance codes, guidelines, and/or best practice

regulations to align with the SOX provision on the appointment and

independence of external auditors.

1

Second, a series of mergers

between the big audit firms, and the dissolution of Arthur Andersen as

a result of Enron's collapse, have reduced the number of major audit

firms from eight to four. This has intensified audit market concentration

in various countries significantly. Whether such concentration has

affected firms' auditor choice decisions is still debated.

2

Finally, the

internationalization of accounting and auditing standard‐setting has

accelerated the globalization of auditing and assurance practices

and, thus, makes auditor and audit regulatory work easier and more

effective (Humphrey, Loft, & Samsonova‐Taddei, 2014). Considering

the historical development of the audit function, in particular the afore-

mentioned regulatory reforms coupled with the concentration and

globalization of the audit market,a firm's decision to appoint a particular

auditor over another is of great importance to regulators, practitioners,

and scholars.

Our literature review of auditor choice assesses, compares, and

critiques research results on the ex‐ante determinants of auditor

choice among different jurisdictions, to enable practitioners, standard

setters and regulators to (i) understand the reasons why certain audi-

tors are appointed over others, (ii) synthesize the diverse institutional

factors that affect the auditor choice by comparing and contrasting

the empirical findings from different countries, and (iii) reflect on the

implications for mandating various facets of auditor selection issues.

Received: 14 December 2018 Revised: 10 April 2019 Accepted: 23 April 2019

DOI: 10.1111/ijau.12163

308 © 2019 John Wiley & Sons Ltd Int J Audit. 2019;23:308–335.wileyonlinelibrary.com/journal/ijau

The available empirical literature on the determinants of auditor

choice is voluminous. We adapt the Brauer (2006), Haleblian, Devers,

McNamara, Carpenter, and Davison (2009), and Schweizer and

Nienhaus (2017) approaches to selecting papers for review, by identi-

fying, reviewing, and classifying relevant works. A total of 106

published studies have been identified and reviewed for the period

spanning 1982 to early 2019.

The paper proceeds as follows. Section 2 explains the selection

procedures for our literature review. Section 3 displays the theoretical

frameworks pertinent to auditor choice literature. Section 4 provides a

critical assessment of the determinants of auditor choice, with refer-

ence to the theoretical frameworks developed in Section 3. Finally,

Section 5 elaborates the implications of our review and concludes

the paper.

2|SAMPLE AND PROCEDURE

We adapt Brauer (2006), Haleblian et al. (2009), and Schweizer and

Nienhaus (2017) approaches to selecting papers for review, by identi-

fying, reviewing, and classifying relevant works. First, by defining a

review period from 1982 to early 2019, we ensured the inclusion of

all publications from 1982, when the seminal work by Chow (1982)

was published. Second, we performed an extensive search via ABI‐

INFORM, Business Source Complete (EBSCOhost), Emerald Insight,

Web of Science, Google Scholar, and internet sources to identify

potential studies published in accounting journals for inclusion in this

literature review. We restrict the journal library search to papers

published before the end of March 2019, with a keywords search

that included “audit*choice,”“auditor choice,”“audit* select,”“auditor

select*,”“auditor selection,”“audit quality,”“demand* audit,”“audit

size,”“auditor reputation,”“auditor type,”“specialist auditor choice,”

“specialist auditor selection,”“BIGN auditor choice,”and “BIGN audi-

tor selection.”We include auditor choice studies published in

nonaccounting and nonauditing journals, as well. To maintain the qual-

ity of this review, we include only those journals that are listed on the

Australian Business Deans Council and the Chartered Association of

Business Schools rankings. Our approach is to identify archival

research studies that are (1) aimed at investigating the ex‐ante auditor

choice (i.e., the auditor choice as the primary dependent variable) and

(2) reinforced by a robust peer review process and published in

reputable journals.

We exclude those papers that did not test auditor choice as the

primary research question but, instead, estimated auditor choice

regression to control for potential self‐selection problems. The appoint-

ment of auditors is a two‐party contractual arrangement. The auditor,

as the other party in the contract, also selects clients for particular

reasons; for instance, to protect their reputation and avoid potential

litigation risk (Khurana & Raman, 2004). Thus, “self‐selection bias”is

well recognized in the auditor choice literature. To avoid this concern,

the inverse Mills ratio (IMR) is calculated from the first‐stage auditor

choice model and then used as an additional independent variable in

the second‐stage regression model. For example, Krishnan (2005)

investigated the implications of auditor industry specialization on the

speed with which client firms recognize negative stock returns in

earnings. In order to address the impact of endogeneity of a client's

decision to hire an industry specialist auditor, on that client's earnings

conservatism, Krishnan (2005) first ran a logistic model of auditor

choice, calculated the IMR and, then, reestimated the earnings conser-

vatism model after including the IMR as an additional independent

variable. We exclude Krishnan's (2005) paper, because the auditor

choice model did not incorporate any theoretical framework detailed

in Section 3. Examples of some other studies excluded from our review

on this ground include MohammadRezaei and Mohd‐Saleh (2018) on

audit report lag and Muller and Riedl (2002) on the external monitoring

of property appraisal estimates.

Further, we have excluded studies on auditor change (e.g.,

DeFond, 1992; Francis & Wilson, 1988) and mandatory auditor rota-

tion (e.g., Lennox, Wu, & Zhang, 2014), since our survey encompasses

only the determinants of voluntary auditor choice. We have also

decided not to review working papers; this is primarily because the

papers have not been adequately vetted by the peer review process,

but also because identifying all the relevant working papers is difficult

and, finally, unpublished papers may be subsequently published.

Table 1 displays the journals and publication trends. As shown in

Table 1, 69% of the surveyed papers have been published in a reason-

ably small number of auditing, accounting, and corporate governance

journals. There is also a significant increase in number of publications

since 2001.

3|THEORETICAL PERSPECTIVES ON

AUDITOR CHOICE

Neoclassical economics theory posits that an audit service is a type of

economic good and, thus, shall be observed in a typical supply‐and‐

demand interplay in the audit service market. As a result of such market

interplay, it is expected that audit services are differentiated in many

aspects (Simunic & Stein, 1987). According to DeAngelo (1981), audit

quality is defined as the ability of an auditor to discover a misstatement,

as well as to report such misstatement. Francis (2004) and DeFond and

Zhang (2014) reviewed the extant literature on audit quality and con-

cluded that audit quality is associated with overall financial reporting

quality. Since our review focuses on the ex‐ante determinants of auditor

choice, we accept an assumption that auditors differ in terms of quality.

3

In this section, we summarize the theoretical frameworks that have

been employed to underpinning auditor choice research. Four such

frameworks are explained; namely, the agency theory; the information

asymmetry theory; the insurance theory; and, finally, the institutional

theory.

3.1 |Agency theory

Auditor choice studies that are drawn on agency theory usually use

corporate ownership structure as proxies for agency problems and

test for an association, if any, between ownership structure and

HABIB ET AL.309