PCAOB Auditing Standard No. 5, Audit Risk and Auditor Dismissal and Audit Risk

In 2007, the Public Company Accounting Oversight Board (PCAOB) issued Auditing Standard No. 5 (ASS) as a response to criticism that AS2 (auditing standard effective after 2004) was too prescriptive and costly for smaller firms whose risk profile did not support the unnecessary audit procedures. ASS was effective for all fiscal years ending after November 14, 2007. In addition, ASS mandated audits be more risk-focused and tailored to the specifics of the client firm's business operations. This study incorporates audit risk to investigate ASS's impact on the likelihood of auditor dismissals relative to AS2. The study attempts to test whether riskier audits are more strongly associated with auditor dismissals in the ASS regime compared to the AS2 regime. Results show auditor dismissals are more likely for higher risk firms in the ASS regime compared to AS2. Additional tests show the main effect is more pronounced for dismissals where the dismissed auditor is Big 4 (Ernst & Young, PwC, Deloitte, KPMG) and the successor auditor is non-Big 4. This paper provides evidence that risk may play a larger role in auditor dismissals in the ASS era compared to AS2. This evidence is important to the free enterprise system because of the accountability that external auditors provide. This accountability is relied upon by financial information users in their decision-making. This paper examines client risk's impact on auditor dismissals which impacts the auditor's role in a free enterprise market.