Corporate social impact and auditor changes

• Published date: 01 April 2021
• Author: Shipeng Han,Zabihollah Rezaee,Ling Tuo,Jia Wu
• Date: 01 April 2021
• DOI: http://doi.org/10.1002/jcaf.22493

Received:  December Accepted:  February 

DOI: ./jcaf.

BLIND PEER REVIEW

Corporate social impact and auditor changes

Shipeng Han1Zabihollah Rezaee2Ling Tuo3Jia Wu4

Charlton College of Business, University

of Massachusetts Dartmouth, Dartmouth,

Massachusetts, USA

Fogelman College of Business &

Economics, University of Memphis,

Memphis, Tennessee, USA

Strome College of Business, Old

Dominion University, Norfolk, Virginia,

USA

Charlton College of Business, University

of Massachusetts Dartmouth, Dartmouth,

Massachusetts, USA

Correspondence

ShipengHan, University of Massachusetts

Dartmouth, Old Westport Road,

Dartmouth,MA -, USA.

Email:shan@umassd.edu

Thispaper does not contain any studies

withhuman participants performed by any

ofthe authors.

Abstract

Corporate social impact has great influence on companies’ financial and litiga-

tion risk. Especially, corporate social irresponsibility raises auditors’ concerns

about audit risk. Prior research finds that auditors charge higher audit fees to

companies engaging in social irresponsible activities. In this study, we investi-

gate the potential effects of corporate social impact on auditor–client relation-

ship. Our results suggest that the likelihood of auditor changes is greater for

the socially irresponsible companies and increases with severity.Additional tests

suggest that socially irresponsible companies are more likely to have disagree-

ments with their departing auditors and change to smaller auditors. Our findings

are robust under different measures and specifications. Our study contributes to

the literature by providing incremental evidence that auditors integrate clients’

social impact into their risk management and client selection. Our findings sug-

gest that corporate social impact has become another determinant of auditor–

client relationship and has profound effect on audit market competition.

KEYWORDS

corporate social impact, irresponsibility, auditor changes, downgrade, disagreement

1 INTRODUCTION

The impacts of auditor changes on financial reporting and

capital market have been attracting extensive attention

from investors and regulators.Although the relevant

information about auditor changes must be disclosed

mandatorily, the underlying reasons are ambiguous or

unclear (Glass Lewis & Company, ). Johnson and

Lys () contend that auditors changes are predictable

consequence of the changes in clients’ risk profiles.

The follow-up literature provides evidence that auditor

changes are driven by companies’ financial and litigation

risk and auditors’ perceived risk (Ghosh & Tang, ;

Johnstone & Bedard, ; Krishnan & Krishnan, ;

Shu, ). In addition to the fiduciary responsibility

General Electric recently announced to name a new auditor the

forthcoming fiscal year . Source: https://www.forbes.com/sites/

ezequielminaya////ge-names-new-auditor-for-the-first-time-in-

over-a-century/

to shareholders, social responsibility has become an

emerging and organic part of corporate planning and has

substantially changed business culture and model. Mean-

while, corporate social irresponsibility is subject to more

severe criticism and significantly increases companies’

financial and legal risk. Prior research finds that auditors

as the watchmen of capital market integrate social impact

information into their risk assessment and decision

making (Han et al., ; Koh & Tong, ). In this

paper, we investigate whether and how corporate social

impact as a nonfinancial factor influences client–auditor

relationship.

Our study is motivated by the following reasons. First,

auditor changes reflect the changes in auditor–client rela-

tionship and have great influence on audit quality (Mansi

et al., ). Understanding the emerging determinants of

auditor changes is beneficial and meaningful for investors

and regulators (Griffin & Lont, ; Whisenant et al.,

). Prior research documents extensive determinants

J Corp Account Finance. ;:–. ©  Wiley PeriodicalsLLC129wileyonlinelibrary.com/journal/jcaf

130 HAN  .

of auditor changes from either supply or demand side,

including companies’ financial performance, accounting

practice and auditors’ characteristics (Johnstone& Bedard,

; Johnson & Lys, ; Knechel et al., ;Landsman

et al., ; Mande & Son, ;Shu,). The advo-

cate of stakeholder capitalism has extended companies’

and auditors’ responsibilities to non-financial areas. Major

listed corporations in the U.S. have been publishing sus-

tainability reports.Meanwhile, big audit firms are also

actively involved in developing ESG reporting metrics.

The significant changes in the business world and ongo-

ing strategic transformation may has substantial influ-

ence on auditor–client relationship. Second, the growing

importance of corporate social responsibility in corporate

planning and auditors’ risk assessment may change the

competitive landscape among different auditors. We also

want to have an insight into the ongoing evolvement in

audit market by investigating non-financial determinants

of auditor changes. In this paper, we attemptto provide an

empirical answer in terms of the role of corporate social

impact.

The objective of a typical shareholder-focused company

is to maximize profits accruing to the owners (Shleifer &

Vishny, ). Other non-business activities (e.g., social

responsibility) that are not in the best interest of share-

holders are not considered either value added or justifi-

able. However, more rigid regulations and growing public

awareness on product quality, consumer safety, employee

rights, community responsibility, environmental protec-

tions have fundamentally changed the business environ-

ment and business leaders’ mindset. As what Marc Benioff,

Chairman and co-CEO of Salesforce notes:

“Capitalism, as we know, it is dead. We’regoing

to see a new kind of capitalism—and it won’t

be the Milton Friedman capitalism, that is just

about making money. The new capitalism is

that businesses are here to serve their sharehold-

ers, but also their stakeholders—employees,

customers, public schools, homeless and the

planet.”

Failure to tackle other stakeholders’ interests mayplace

enterprises in competitive disadvantages and endless legal

According to the report of Sustainable Investments Institute posted on

Harvard Law School Forum on Corporate Governance, % of the S&P

 issued a sustainability report by . Source: https://corpgov.law.

harvard.edu////state-of-integrated-and-sustainability-reporting-

/

https://www.accountingtoday.com/news/big-four-firms-release-esg-

reporting-metrics-with-world-economic-forum

https://www.cnn.com////business/marc-benioff-capitalism-

dead/index.html

sanctions. Modern business norms require business enti-

ties to contemplate their risks over a longer horizon and in

a wider range. Social responsibility demonstrates compa-

nies’ vision in risk management and efforts in moderating

the conflicts between shareholders and other stakeholders.

Companies’ social impact can affect their relation-

ship with auditors. On the one hand, corporate social

irresponsibility exposes companies to greater financial

and litigation risk. Companies have greater propensity to

apply more aggressive accounting policy. Evidence shows

that corporate social responsibility reflects management

integrity and source credibility (Beaulieu, )andis

associated with corporate governance and earnings man-

agement (Kim et al., ). Lange and Washburn ()

propose socially irresponsible companies tend to choose

unethical strategies at the expenses of the total system.

Therefore, socially irresponsible companies are more

likely to dismiss their auditors to avoid adverse opinion

and shop for opinion from less conservative auditors. On

the other hand, companies’ socially irresponsible activities

expose auditors to greater audit and business risk. There-

fore, risk-averse auditors, especially large auditors, tend to

shed the clients that have significant social irresponsibility

conducts to control their overall risk exposure. Corporate

social irresponsible conducts can lead to mismatch or

worsen the mismatch between companies and their

auditors. Therefore, we propose a positive relationship

between companies’ social irresponsible conducts and the

chance of auditor changes.

Different from prior studies that mainly use the total

scoreto proxy social impact (Brooks et al., ;Kim

et al., ), we focus only on companies’ social irresponsi-

bility because some prior studies suggest corporate social

responsibility and irresponsibility should be treated as sep-

arate yet related constructs (Lin-Hi & Müller, ; Strike

et al., ). Instead of fusing all positive and negative

indicators into a single variable, the sum of the negative

indicators is a cleaner measure of corporate social impact,

specifically corporate social irresponsibility, because the

media always unveil morenegative stories about corporate

social responsibility instead of positive stories about

corporate social responsibility. The MSCI ESG database

provides several non-exclusionary categories and each

denotes distinctive aspects of social impact. Simply using

arithmetical sum of all the distinctive categories may lose

important information. Instead, we define several social

irresponsibility measures pertaining to each relevant

category (e.g., environmental, social, and governance).

Another reason that we only study social irresponsibility

is auditors’ risk-averse nature and their asymmetric risk

The difference between the number of positive indicators (strengths)

and negative indicators (concerns).