Academic Spotlight: Auditor Ratification’s Impact on Audit Quality

Research shows that shareholder dissatisfaction improves audit quality.

In June of 2020, Paul Tanyi, Gregory Martin, Dasaratha Rama, and K. Raghunandan published research in Accounting Horizons that measured shareholder votes against the ratification of an audit firm in the proxy statement. Their research reveals that an increase in shareholder dissatisfaction leads to better audit quality.1

Specifically, Tanyi et. al.’s article, Shareholder Dissatisfaction and Subsequent Audit Outcomes, found that companies with greater shareholder dissatisfaction saw an increase of $137 thousand, on average, in audit fees, compared to an average increase of $83 thousand for companies with less shareholder dissatisfaction. The dissatisfaction also resulted in longer reporting lags, lower abnormal accruals, and fewer accounting misstatements.

Higher audit fees and longer reporting lags are generally due to audit firms performing additional work. In theory, this should result in better quality audits. Additionally, lower abnormal accruals and fewer accounting misstatements indicate that this extra auditor effort results in higher quality financial information.

Tanyi et. al’s conclusion is fascinating because, traditionally, the auditor ratification process has had little effect on client- audit firm relationships. In a previous blog, we show the rarity of significant votes against an audit firm. Less than 1 in 20 votes sees more than 5% of shareholders voting against the ratification of their auditor for the following year. Additionally, until last year, a majority of shareholders had not voted against an audit firm since 2014. In short, significant shareholder votes against an audit firm are uncommon.

Frequency Distribution of % Votes Against Auditor Ratification
Note: This table reflects 2019 data.

Furthermore, ratifications are non-binding. A significant vote against auditor ratification does not require a company to change firms, and, as identified by our previous blog, many choose to stay with their auditor. Out of the ten companies with the highest percentage of votes against auditor ratification since 2015, only one changed their audit firm.

Even the top vote against auditor ratification in 2020 – where more than 50% of shareholders voted against the audit firm – didn’t result in an audit firm change. SPAR Group, Inc. [SGRP] saw 54% of shareholders vote against the audit firm, while just 8% voted for the audit firm – this was an increase from 31% against and 41% for in the previous year. Despite this increase, SPAR Group remained with BDO USA LLP, having first engaged them for FY 2013.

Despite some evidence, auditor ratification votes have little effect on the continuation of the client-audit firm relationship. Meanwhile, the findings of this paper show that shareholder dissatisfaction may have an effect on audit quality. However, more research that explores how improved audit quality might affect shareholders’ satisfaction with their auditors would be beneficial.

1. Paul Tanyi (University of North Carolina at Charlotte), Gregory Martin (University of North Carolina at Charlotte), Dasaratha Rama (Florida International University) and K. Raghunandan (Florida International University).

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