The effects of audit firm rotations and retentions: an event study in Chile

We study markets’ reactions towards securities issued by firms that announce an external auditor’s retention instead of an external auditor’s rotation. We focus on differences in reactions to announcements when markets are stable versus when markets are convulsed. We carry out an event study of publicly traded Chilean companies (100% of the non-financial component of the main Chilean Stock Indexes) that announced a rotation or retention from 2004 to 2019. In the period 2009 to 2012, two major corporate scandals significantly affected Chilean financial markets. We find that, during the period without scandals, the market reacted more positively when a company announced a retention instead of a rotation of its auditor, however, during the period with scandals, the market reacted more positively when a company announced a rotation instead of a retention of its auditor. Our results suggest that, during the period without (with) scandals, the start-up costs and know how losses of an auditor’s change dominated (were dominated by) the improvements in auditor’s independence associated with this change. Additional results, obtained from tests performed with data subsamples, are consistent with our hypothesis and uncover differences between the announcements’ factual and perceived effects. We end by discussing the implications for firms and regulators.