Error announcements, auditor turnover, and earnings management – Evidence from Germany

Error announcements shall in principle unfold both a preventative and a sanctioning function via adverse publicity. While US research provides large and unambiguous evidence of sanctions which are based on capital market reactions, but also personal consequences of responsible managers and auditors, the few studies which investigated the German enforcement system do not yield comparable results, thereby questioning its efficacy. Building on this, we first investigate for the German enforcement setting whether error announcements lead to abnormal turnover of audit teams and audit firms than comparable non-error firms by using logistic regression. Second, we analyze whether audit team or audit firm turnover results in improved accounting quality. To do so, we proxy accounting quality with well-established earnings management models and explore the turnover’s impact on accounting quality with a difference-in-difference approach. Our results do not provide evidence of increased audit firm turnover due to error announcements, thereby contradicting studies from the US; the same holds for changes of the responsible audit teams. However, our results suggest that firms with changes of the audit firm or audit team exhibit an increase in accounting quality, which however takes place already in the time gap between error announcement and auditor change. Consequently, we interpret auditor changes serving as a signal of improved corporate governance, rather than indeed improving corporate governance.