Do Spanish Firms Change Auditor to Avoid a Qualified Audit Report?

• Author: Emiliano Ruiz‐Barbadillo,Nieves Gómez‐Aguilar
• Published date: 01 March 2003
• DOI: http://doi.org/10.1111/1099-1123.00004
• Date: 01 March 2003

SUMMARY

The study of the auditor changes in Spain is

extremely interesting because of the characteristics

of the Spanish audit market. Spanish legislation

does not impose any limits upon companies to

change auditors. Auditors have no possibilities

to defend themselves when companies decide to

resign the contract. In this context, the study of the

relationship between audit opinion and auditor

change can highlight the probability of a

company’s strategic behaviour to avoid receiving

a qualified audit opinion in the future. Thus,

we analyse the relationship between the auditor

change following a qualification and the

probability of obtaining a clean audit report in the

following year.

The quality of the auditing performed in the

company changes if the company changes its

auditor, because the quality of the new auditor’s

work is different from its predecessor. Using a

variety of surrogate measures to infer the relative

quality of the newly contracted audit firm, such as

the specialization, size, brand name, technology

and conservatism, we examine the effect of auditor

changes on audit quality.

If a company can perceive the level of quality

supplied by its auditor, it can look for a lower

quality auditor to increase the probability of

obtaining a clean report in the next year. Thus we

introduce the direction of the auditor change as a

strategic mechanism to improve the audit opinion.

We relate the previous auditor quality measures

with the probability of receiving an audit

qualification after the change. The results obtained

Do Spanish Firms Change Auditor to

Avoid a Qualified Audit Report?

Nieves Gómez-Aguilar and Emiliano Ruiz-Barbadillo*

University of Cádiz, Spain

In this paper we investigate whether Spanish firms employ

deliberate strategies in the choice of auditor to avoid audit

qualification. For a sample of 735 during the period 1991–96

we found no increase in the probability of changing auditor

following an audit qualification. We concluded that this would

be too obvious and detrimental to the firm’s interests. However,

135 firms do change auditor during the period examined. We

found that firms that have been qualified are significantly less

likely to move to higher quality auditors than are unqualified

firms, when that quality is measured by the specialisation of

the auditor, auditor brand name, auditor size and auditor

conservatism. For the 92 qualified firms changing auditor the

likelihood of a subsequent qualification is significantly related

to the quality of the auditor selected.

Key words: auditor change, audit opinion, audit report, audit

quality, auditor knowledge, auditor independence, Spanish

audit market, audit expectations gap, opinion shopping, opinion

improvement.

International Journal of Auditing

Int. J. Audit. 7: 37–53 (2003)

*Correspondence to: Emiliano Ruiz-Barbadillo, Dpto. Economía

de la Empresa. Facultad de Ciencias Económicas y

Empresariales, Glorieta Carlos Cano s/n. 11002, Cádiz, Spain.

Email: emiliano.ruiz@uca.es

ISSN 1090–6738

© Blackwell Publishing Ltd 2003. Published by Blackwell Publishing, 9600 Garsington Road,

Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

in the paper show that those firms which have been

qualified are significantly more likely to contract

lower quality auditors than are unqualified firms.

In addition, the likelihood of a subsequent

qualification when qualified firms change auditor

is significantly related to the quality of the new

auditor selected.

Given these results we analysed whether

external monitoring can limit this strategic

behaviour. We consider two types of external

control: the control that the National Stock

Exchange Commission (Comisión Nacional del

Mercado de Valores) has over the quoted

companies and the control of the Spanish National

Bank over the financial firms. In these cases, the

probability of obtaining a clean report after the

auditor change is lower for firms which are subject

to a more rigorous monitoring than the rest of the

companies.

We can, therefore, conclude that companies may

engage in strategic behaviour to avoid the receipt

of a qualified opinion in their audit reports. This

behaviour consists of replacing the incumbent

auditor by a lower-quality one. This behaviour is

limited by the perception that users of the audit

reports may have of the auditor change, because

companies will seek to reduce the effect that the

auditor switch may have by means of reducing

the audit quality in ways least likely to be

identified by third parties.

1. INTRODUCTION

This paper examines the use of the auditor switch

by Spanish companies to avoid a qualified audit

report. The effect of audit report on auditor

changes has received considerable attention in

audit research because these changes can be

motivated by management opportunism. There is

empirical evidence about the relationship between

audit opinion and auditor change in different

countries, but not for Spain. The Spanish context

is interesting because regulatory safeguards do not

exist to reduce manager influence over auditor

changes.

The 1988 Audit Law (Ley de Auditoría) made

audits compulsory for medium and large Spanish

companies. For many years before this, there had

been no significant market for auditing services in

Spain. From the end of nineteenth century, foreign

(particularly British) investors started to send

experts to Spain to audit the financial statements of

companies in which they held the majority of the

shares. These British auditors asked the Spanish

government to set up a body of officially

recognised experts to perform the functions being

undertaken by their British colleagues (Fernández

Peña, 1992, p. 45). These requests eventually led to

the formation in 1943 of the first professional body,

the Instituto de Auditores-Censores Jurados de

Cuentas de España (IACJCE) (García Benau &

Humphrey, 1992; Martínez García, 1992). This date

is traditionally taken as the birth of the Spanish

auditing profession, but it would be fair to say that

the profession had been born without a major

activity to develop. The Spanish audit function

was still generally seen as incongruous to the

liberal traditions dominant in Spanish business

circles, and an unnecessary interference in

corporate activity (Martínez García, 1992). Since

this time, one of the main objectives of the Spanish

audit profession has been the need to become

part of the relevant public institutions to secure

professional self-regulation for the auditing

function (García Benau et al., 1998).

Such processes of negotiation generated a

number of different regulations, such as the

Limited Companies Act of 1951 (Ley de Sociedades

Anónimas), Stock Exchange rules, and the reform

of the Code of Commerce in 1973, which all

sought to extend the requirements for companies

to submit to an annual external audit. However,

all these developments failed to secure the

institutionalisation of the Spanish audit profession.

Finally, the election of a socialist government

in 1983 and its commitment for Spain to enter

the European Union served to stimulate the

belief in the accounting community that auditing

was to become a growth industry, especially

given the plans laid down in the 8th Company

Directive.

The legal establishment of auditing in Spain

was accepted by society in general with much

enthusiasm, as auditing was considered to satisfy

an urgent need for the modernisation of the

national economy. The audit environment in the

late 1980s and early 1990s portrayed a high degree

of harmony. Legislation had established a

fundamental role for the audit function in

improving Spanish corporate governance and

the transparency of corporate financial reports.

Empirical research revealed differences in

expectations of the audit function between the

audit profession and a range of user groups, but

the gap was considerably less than in other

countries such as the UK (for a review, see García

38 N. Gómez-Aguilar and E. Ruiz-Barbadillo

© Blackwell Publishing Ltd 2003 Int. J. Audit. 7: 37–53 (2003)