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Stock Prices and Auditor Resignations

July 30, 2007

It is a truism on Wall Street that when an auditor resigns from a publicly traded company, the company is in trouble. According to new UC Davis research, the truism is true.

Stock prices of publicly traded companies dip about three percentage points right after the announcement of an auditor's resignation, a study by Paul Griffin, professor of management at the UC Davis Graduate School of Management, shows.

"Our study is apparently the first to document with appropriate statistical reliability that investors react negatively to auditor resignations," Griffin says.

Griffin and colleague David Lont, a lecturer in accountancy at the University of Otago in Dunedin, New Zealand, reviewed 2,524 auditor changes reported to the Securities and Exchange Commission by publicly traded companies between 2001 and 2005. The researchers also analyzed stock prices in the 100 days leading up to and following auditor change reports, looked into companies' involvement in federal securities litigation and pored over information from company financial statements.

Interestingly, the researchers found that auditor firings had little effect on stock prices -- suggesting investors are not alarmed by disagreements between a company and an auditor or by audit qualifications (accounting changes).

Auditor resignations were another story.

"Accounting firms typically do not resign as auditor from their lucrative clients without a good reason," Griffin says. "A resignation seems to foreshadow an underlying message about changes in fundamentals, particularly future profitability and growth."

Griffin recently presented his findings at the University of Otago and the Victoria University of Wellington in New Zealand. A copy of the study, "Do investors care about auditor dismissals and resignations?" is available online at: http://www.vuw.ac.nz/sacl/research/researchseminarseries/2007/pg_150307.pdf

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