Did Earnings Conservatism Increase for Former Andersen Clients?

Abstract

The unexpected fall of Arthur Andersen is an extraordinary event. Although Arthur Andersen was initially convicted in 2002, subsequently, the Supreme Court unanimously threw out the conviction. Was the Department of Justice hasty in shutting down Arthur Andersen? Could the managers and the new auditors of former Andersen clients have restored financial reporting credibility? This study examines whether earnings conservatism has increased for a sample of former Arthur Andersen clients that were forced to switch auditors in 2002. Relative to control samples consisting of audit clients of remaining brand-name auditors that did not switch auditors and those that switched within Big Four auditors, this study finds that earnings conservatism has increased for former Andersen clients that switched to a Big Four auditor. Furthermore, the level of conservatism for 2002 for former Andersen clients is even higher than those observed for a matched sample of non-Andersen clients that did not switch auditors. These findings suggest that in the post-Andersen world, Big Four auditors and managers use earnings conservatism as a risk management strategy.

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