bagherpour et al - 2014 - government and managerial influence on auditor switching under partial privatization

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Government and managerial inﬂuence on auditor
switching under partial privatization
Mohammad A. Bagherpour
a
, Gary S. Monroe
b
, Greg Shailer
c,d,
⇑
a
School of Administrative and Economic Science, Ferdowsi University of Mashhad, Mashhad, Iran
b
School of Accounting, and Centre for Accounting & Assurance Research, The University of New South Wales, Sydney,
NSW 2052, Australia
c
Research School of Accounting and Business Information Systems, The Australian National University, Hanna Neumann Building 21,
Canberra, ACT 0200, Australia
d
Australian National Centre for Audit & Assurance Research, The Australian National University, Hanna Neumann Building 21,
Canberra, ACT 0200, Australia
abstract
We investigate how auditor switching is affected by government
inﬂuence, misalignment between type of auditor (government vs.
private) and type of controlling shareholder (government vs. pri-
vate), and misalignment between an incumbent auditor and
imputed preferences of managers in a market characterized by
continued substantial government ownership in listed entities.
We exploit a natural policy and regulatory experiment in Iran that
allows us to investigate what happens when previously govern-
ment-owned entities are partially privatized as listed entities
where, in many cases, the government retains signiﬁcant owner-

ship interests. At the same time, there were signiﬁcant changes
in the audit market, resulting in large increases in the number of
private sector auditors competing for previously state-adminis-
tered audits. We ﬁnd the likelihood of auditor switches is strongly
associated with measures of misalignment between type of auditor
and type of controlling shareholder and auditor–managerial mis-
alignment, but these associations are constrained by signiﬁcant
government inﬂuence. Exposing the constraining effect of signiﬁ-
cant government inﬂuence on auditor switching is an important
contribution to our understanding of privatizations, government
shareholder inﬂuence and auditor choice. These results have impli-
cations for policy development in other emerging and transition
/>0278-4254/Ó 2014 Published by Elsevier Inc.
⇑
Corresponding author at: Research School of Accounting and Business Information Systems, The Australian National
University, Hanna Neumann Building 21, Canberra, ACT 0200, Australia. Tel.: +61 2 6125 4333.
E-mail address: (G. Shailer).
J. Account. Public Policy xxx (2014) xxx–xxx
Contents lists available at ScienceDirect
J. Account. Public Policy
journal homepage: www.elsevier.com/locate/jaccpubpol
Please cite this article in press as: Bagherpour, M.A., et al. Government and managerial inﬂuence on auditor
switching under partial privatization. J. Account. Public Policy (2014), />j.jaccpubpol.2014.04.004
economies where privatization remains largely partial, and compe-
tition among private sector auditors is still emergent.
Ó 2014 Published by Elsevier Inc.
1. Introduction
The link between political economy and auditor choice is an important policy question in emerging
and transition markets where privatization has been a signiﬁcant phenomenon (Guedhami et al.,
2009). Privatizing corporate ownership raises the risks of serious agency conﬂicts between minority

investors and politically connected managers or continuing government ownership, with signiﬁcant
implications for auditor choice (Chan et al., 2007; Wang et al., 2008; Guedhami et al., 2009). The risk
of expropriation of minority shareholders by large shareholders is higher in emerging markets than in
developed markets (Claessens et al., 2000; Claessens and Fan, 2002) and this may be reﬂected in ﬁnan-
cial reporting decisions. Therefore, the role of auditors in reducing conﬂicts of interest in ﬁnancial
reporting decisions is potentially more important in emerging markets than in developed markets.
Consequently, factors that affect auditor changes, and may impair auditor independence and ulti-
mately, audit quality, can have signiﬁcant policy relevance in emerging and transition markets.
Where there is signiﬁcant government inﬂuence through retained ownership in partially privatized
companies, managers may prefer auditors who are more aligned with government interests. The
widespread phenomena of privatizations and economic liberalization in several emerging markets
have been accompanied by rapid growth in audit suppliers as governments have licensed more private
sector audit ﬁrms. While there has been some research on auditor choice following privatizations,
emphasizing auditor size differences (e.g., Chan et al., 2007; Wang et al., 2008; Guedhami et al.,
2009), there is little examination of what happens when previously state-administered audits are
relocated to a market governed by competition and demand (Mennicken, 2010). We contribute to
the public policy literature concerned with auditing by addressing this issue.
We complement and extend the existing literature by investigating the effects of signiﬁcant gov-
ernment inﬂuence on incentives for auditor switching in an immature audit market in which auditor
competition is increasing, alongside an emerging equity market. We focus on incentives arising from
misalignments between type of auditor (government vs. private) and type of controlling shareholder
(government vs. private), and between auditor and imputed preferences of managers. Hereafter, we
refer to these two types of misalignment as ‘‘auditor–controlling shareholder misalignment’’ and
‘‘auditor–managerial misalignment’’. We do this in a market characterized by continued substantial
government ownership in listed entities and rapid growth in the number of competing audit ﬁrms
separated from government control. In particular, we examine whether government inﬂuence prevails
over the switching incentives arising from auditor–controlling shareholder misalignment and audi-
tor–managerial misalignment.
We examine auditor–controlling shareholder misalignment from a perspective that is different to
the prevailing emphasis on ‘‘Big N’’ vs. ‘‘non-Big N’’ as the auditor choice, relative to client interests.

1
We consider whether auditor switches are driven by government control of listed corporations and audit
ﬁrm ownership (i.e., government or private sector auditors). We examine auditor–managerial misalign-
ment in more traditional terms by focusing on conditions that have the potential to create conﬂict
between auditors and client management; these include changes in management, discretionary accrual
preferences and audit qualiﬁcations.
Our study exploits a natural experiment concerning auditor switching that was generated by policy
and regulatory changes in Iran. The policy changes involve: (1) the incremental partial privatization of
government corporations; (2) removal of the government auditor’s monopoly over the audit of
1
Chan et al. (2007) ﬁnd that a decrease in government shareholdings leads to an increased demand for higher-quality audits in
China. In a comparison of auditor choice by privatized ﬁrms across 32 countries, Guedhami et al. (2009) reveal that privatized ﬁrms
are less likely to appoint a Big Four auditor.
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switching under partial privatization. J. Account. Public Policy (2014), />j.jaccpubpol.2014.04.004
government-controlled listed companies, which increased the ability of management to switch audi-
tors; and (3) changes in the licensing of auditors, which resulted in a signiﬁcant increase in the num-
ber of private sector auditors competing for clients. We argue that agency costs and signaling
incentives for Iranian listed companies are likely to have increased due to the rapid increase in the
supply of private sector audit services, changes in the managerial labor and capital markets, and
equity market growth with the accompanying emergent importance of private investors. We link this
to alignment incentives for auditor switching, which are conditioned by continuing government inﬂu-
ence in many of the privatized companies.
Substantial transfers of stock in Iranian companies from the government to the private sector
increased shareholder diffusion and information asymmetry. Changes in ownership from government
to private investors affect shareholders’ incentives and the mandates given to managers. The objec-
tives of government-controlled companies include implementing government policies (such as pro-
viding employment and providing cheaper goods and services) as well as earning proﬁts. The
government policy position regarding the privatization of Iranian companies indicates that they no

longer have this range or complexity of objectives and are therefore free to concentrate on proﬁt-seek-
ing (Komijani, 2003). However, when government retains signiﬁcant inﬂuence through ownership of
shares, the complexity of management decision-making motives may affect auditor choice decisions.
Interest in depoliticizing privatized ﬁrms or signaling to potential investors may encourage switching
to private sector auditors, while government interests may encourage the retention of government-
controlled auditors.
The extant research on auditor switching is largely focused on markets characterized by relatively
stable overall numbers of accounting ﬁrms competing for audits, but with increases in concentration
and implied reductions in competition in the large client sector that is dominated by big international
accounting ﬁrms (e.g., Gilling and Stanton, 1978; Pong, 1999; Wolk et al., 2001). The Iranian audit
market is substantially different from this characterization. In Iran, the removal of the government
auditor’s monopoly and changes in licensing led to rapid growth in competition for the supply of audit
services, as evidenced by a 100% growth in the number of audit ﬁrms engaged by companies listed on
the Tehran Stock Exchange (TSE) from 2000 to 2003 with a continuing exclusion of international audit
ﬁrms.
2
Other characteristics of the emerging Iranian audit market that enhance its value as a natural
experiment and distinguish our study from previous emerging market studies include: the exclu-
sion of the international audit ﬁrms or their afﬁliates from the Iranian audit market; and the
absence of civil litigation risk for auditors. Studies of changes in auditor competition in the extant
literature emphasize reduced supplier competition associated with increases in market domination
by the Big N audit ﬁrms (e.g., Gilling and Stanton, 1978; Healy and Lys, 1986; Pong, 1999; Wolk
et al., 2001; Sullivan, 2002; Chaney et al., 2003; Chen et al., 2007; Kohlbeck et al., 2008; Asthana
et al., 2009). This supply-side focus is complemented by studies of companies’ auditor switching
decisions in relation to auditor specialization and the imputed declining supplier competition as
the number of Big N ﬁrms declined (e.g., Johnson and Lys, 1990; Gigler and Penno, 1995; GAO,
2003; Wolosky, 2003; Bloom and Schirm, 2005). Citron and Manalis (2001) study auditor choice
in a market characterized by increasing competition, following Greece’s liberalization of its audit
market in 1992, which ended the state-controlled monopoly of statutory audits. However, their
study links the demand for the newly entered Big Six international ﬁrms with substantial foreign

ownership – neither of which is relevant to the Iranian setting. With the exception of Citron and
Manalis (2001), our study is the only known examination of auditor switching in the context of
increased auditor competition.
3
Given the exclusion of international audit ﬁrms, the Iranian audit
market is less conditioned by auditor reputation effects compared to settings underlying much of
the prior literature. Furthermore, the absence of civil litigation risk for Iranian auditors eliminates
the insurance hypothesis (see Wallace, 1987) as an explanation for auditor switching. To the extent
2
The 100% increase in audit ﬁrms is based on our data (including companies with missing ﬁnancial data), which covers 88% of
the companies listed on the TSE.
3
Chaney et al. (2003) analytically consider switching under aggressive auditor competition attributed to auditor’s direct
solicitation of potential clients.
M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
3
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switching under partial privatization. J. Account. Public Policy (2014), />j.jaccpubpol.2014.04.004
that we neutralize the supply-side effects of risk on auditor choice, we obtain a more powerful test of
the demand-side relation between auditor choice and client-related characteristics (see Clarkson and
Simunic, 1994).
We ﬁnd the likelihood of auditor switches is strongly associated with our measures of auditor–con-
trolling shareholder misalignment and auditor–managerial misalignment, but these associations are
constrained when the government retains signiﬁcant ownership in privatized companies. Our results
suggest that the retention of signiﬁcant government inﬂuence through shareholdings may affect a
ﬁrm’s accounting choices by inﬂuencing its auditor. Exposing the constraining effect of signiﬁcant gov-
ernment inﬂuence on auditor switching is an important contribution to our understanding of privati-
zations, government shareholder inﬂuence and auditor choice. Our ﬁndings on the relation between
government inﬂuence, auditor supply and the demand for private sector auditors in a transition econ-
omy support arguments concerning the importance of the development of accounting institutions for

the efﬁcient allocation of resources and economic growth (Rajan and Zingales, 1998; Wurgler, 2000;
Wang et al., 2008). Thus, our results have implications for policy development in emerging markets
where privatization remains largely partial, with immature competition among private sector
auditors.
In the following section, we provide background information on the institutional environment in
Iran. In Section 3, we develop our hypotheses. In subsequent sections, we describe our research
method, present our results and discuss those results.
2. Institutional environment
Following Iran’s Islamic Revolution in 1979, all banks and insurance companies and many
heavy industry companies were fully nationalized. Many other companies were not fully nation-
alized, but were transferred to government control when private sector owners abandoned or for-
feited their interests in companies and through the government-owned banks acting on debt
defaults. Although the TSE was established in 1967, these changes largely eliminated share trad-
ing. In 1989, to stimulate economic recovery, the Iranian government implemented a privatization
policy to transfer ownership of government companies to the private sector through a series of
ﬁve-year plans (Davani, 2003; TSE, 2003). The ﬁrst ﬁve-year plan (1989–1993) required the gov-
ernment to transfer ownership of nationalized and state industrial units (excluding strategic
industries) to private sector shareholders (Abadi, 1995). The second ﬁve-year plan (1995–1999)
was a continuation of the ﬁrst plan (Amirahmadi, 1996). Under the Economic, Social and Cultural
Development Plan for 2000–2004, the number of TSE-listed companies grew from 296 in 1999 to
386 in 2003. This growth came from the listing of government-controlled companies as part of
the government’s privatization policy and the listing of new private sector companies. Substantial
transfers of stock in Iranian companies from the government to the private sector increased
shareholder diffusion and the potential for information asymmetry; however, a small number
of transactions appear to have been pseudo-privatizations, with government agencies still holding
more than 95% of the total issued shares.
The privatization process has been gradual, with the government retaining signiﬁcant ownership
interests in many of the companies. The retention of signiﬁcant government inﬂuence enables state
ministries to directly or indirectly appoint directors (FallahDoost, 2009, as cited in
Mohammadrezaei et al., 2012) and CEOs (Mohammadrezaei et al., 2012). In Iran, appointments

(and dismissals) of board members (and sometimes CEOs and CFOs) to government-controlled entities
are often inﬂuenced by political, military or security wings and are usually based on political motives,
and appointees are often politicians or bureaucrats with political connections (Mohammadrezaei
et al., 2012).
Accompanying the nationalization of companies after 1979, audit functions were transferred to
government auditors, culminating in the establishment of the Iranian Auditing Organization (IAO)
in 1987. This gave the IAO a monopoly over the audit of the nationalized companies and the par-
tially privatized companies; however, there were a small number of non-government-controlled,
TSE-listed companies audited by private sector auditors certiﬁed by the Economic Ministry. The
4 M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
Please cite this article in press as: Bagherpour, M.A., et al. Government and managerial inﬂuence on auditor
switching under partial privatization. J. Account. Public Policy (2014), />j.jaccpubpol.2014.04.004
IAO experienced difﬁculties in auditing the variety of government-controlled entities and was not
suited to auditing the increasing number of proﬁt-seeking companies post-1989. To address this
issue, regulatory changes were introduced in 1993 that allowed certiﬁed public accountants to
practice. However, this regulation was ineffective because the designated certifying agency, the Ira-
nian Association of Certiﬁed Public Accountants (IACPA), was not established until 2001. As a con-
sequence, the IAO dominated the audit market for TSE-listed companies until 2001. Since the
establishment of the IACPA in 2001, government auditors are certiﬁed members and auditors of
TSE-listed companies must be members of the IACPA (Davani, 2003). A TSE-listed company can
now choose either a private sector auditor or a government auditor, regardless of whether the
company is government-controlled.
4
In 2001, the IACPA licensed 402 private sector auditors. Of these, 309 auditors were sole prac-
titioners, mostly providing services to small non-listed clients, and 93 were in partnerships. By the
end of 2003, there were 156 sole practitioners and the number in partnerships had increased to
395. The number of licensed auditors employed by the IAO was relatively ﬂat, changing from
207 in 2001 to 237 in 2003, but the modest growth suggests the private sector growth was not
merely a transfer of auditors from government employment to private practice. We observe a cor-
responding change in market shares between government and private sector auditors, based on the

number of clients in our sample; the private sector auditors’ market share rose from 33% in 2001
to 62% in 2003.
Although the statutory requirements for an audit identify shareholders as the intended recipients
of reports, the law does not establish a recognizable duty of care or direct liability to shareholders and
Iranian law does not provide for civil action against auditors to recover damages. The primary legal
exposure for auditors in Iran is prosecution under criminal provisions in the Iranian Trade Law;
however, we are not aware of any such prosecutions to date.
Iranian audit ﬁrms are not afﬁliated with major international audit ﬁrms (they are prohibited by
law) and there are no obvious domestic substitutes as market leaders. The market shares of Iranian
audit ﬁrms were dynamic during our study period, with many audit ﬁrm entries, restructurings and
mergers. Using client revenues or the number of clients as measures of auditor size, no ﬁrm was con-
sistently ranked in the Big N across our sample period.
Although data limitations preclude direct assessment of the economic signiﬁcance of audits in Iran,
several domestic studies indicate that ﬁnancial statement users regard the independent audit as
important (Salehi et al., 2009; Moradi et al., 2011a,b). Consistent with experiences in other jurisdic-
tions, these studies also indicate that the traditional audit expectations gaps and issues regarding
self-interested agents are prevalent in Iran.
3. Auditor switching and alignment
We argue that the institutional changes described above created incentives for companies to
switch auditors to achieve preferred auditor–controlling shareholder alignment or auditor–manage-
rial alignment, and changes in the audit market provided increasing opportunities to switch, but
did not necessarily abate government inﬂuence in the decisions of partially privatized companies.
Exploiting the dynamics of the Iranian market, we develop hypotheses concerning government inﬂu-
ence, auditor–controlling shareholder misalignment and auditor–managerial misalignment. Auditor–
client alignment and managerial interests have received prior attention in the audit choice/switching
literature. The literature identiﬁes a variety of potential incentives for audit switching. We revisit
these switching incentives to assess whether they apply in our novel setting and for our new measure
of auditor–controlling shareholder misalignment, and to evaluate the extent to which government
inﬂuence prevails over private incentives for switching induced by auditor–managerial misalignment.
However, several of these incentives (litigation risk, audit fees and auditor size) do not apply to the

Iranian context or cannot be tested with available data.
4
Iranian Trade Law requires listed companies to appoint a licensed auditor, who is approved by shareholders at the annual
general meeting.
M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
5
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The absence of civil litigation risk for Iranian auditors eliminates the insurance hypothesis for audi-
tor selection (see Wallace, 1987), but it has other implications for auditor switching. The absence of
litigation risk may increase the propensity for Iranian corporations to switch auditors to gain other
advantages, because the costs of switching are lower. Kallunki et al. (2007) argue that the importance
of reliable auditing services and the resources a client has to devote to familiarizing the new auditor
with the client are lower in countries where the severity of the legal environment is lower, compared
to countries where it is higher. Consequently, switching costs are lower in countries with less strict
legal environments. The absence of litigation risk for managers and auditors in Iran implies lower
switching costs for clients and auditors, which should increase the willingness of auditors to compete
for clients and the likelihood of switching. Therefore, we expect the Iranian market to exhibit a larger
number of switches due to managers seeking improved auditor–controlling shareholder alignment or
auditor–managerial alignment. This expectation is conﬁrmed by our data set. We had a sample-based
switching rate of 9.8% during 1999–2003, with a maximum annual rate of 18.7% in 2003 (as discussed
in Section 5).
5
Prior studies indicate that audit fees can motivate switching decisions. While audit fee data are not
generally available for Iranian corporations, we obtained voluntarily disclosed audit fees for 74 listed
corporations for 2003. The average audit fee as a percentage of sales for these 74 corporations was
0.31%; and their average audit fee as a percentage of assets was 0.15%.
6
On this basis, while Iranian
audit fees appear less material than fees in developed markets (Gul et al. (2009) report average audit fees

as a percentage of assets for non-lowballing US ﬁrms for 2003–2004 of 0.34%), they appear non-trivial for
Iranian corporations. Therefore, audit fees may be a signiﬁcant switching incentive, but we cannot test
this effect. While this is a potential limitation of our study, the alignment switching incentives we exam-
ine are not likely to be correlated with audit fees; we argue that the unavailability of audit fee data biases
our study against ﬁnding signiﬁcant alignment switching factors.
Research in mature audit markets has long used auditor size (Big N or market share) as an indicator
of audit quality (following DeAngelo, 1981; Francis, 2004). While switching to signal audit quality to
investors may be an incentive, we cannot proxy this traditional aspect of auditor quality in the Iranian
market. Major international audit ﬁrms are excluded from the Iranian market and, using client reve-
nues or the number of clients as measures of auditor size, no ﬁrm is consistently ranked in the Big N
across our sample period because of the audit ﬁrm entries, growth and mergers. If a positive reputa-
tion is built over a long period (Fombrun and Shanley, 1990), then ﬁrm name reputational effects are
likely to be weak in a market with only ﬁve years of development. Bedard et al. (2010) indicate that,
despite considerable research interest, there is little understanding of investors’ and managers’ per-
ceptions of audit quality in mature markets and it is beyond the scope of this study to resolve how
investors or managers assess audit quality in Iran. The absence of international or large, established
Iranian audit ﬁrms implies reputational or quality aspects do not rely on simple brand name effects,
with auditor switching being motivated by other criteria.
The following sections discuss other incentives identiﬁed in the extant literature that may be
applicable to the Iranian context, as well as incentives that we argue are speciﬁc to the Iranian
market.
3.1. Government inﬂuence
In a competitive market, companies or management tend to select or retain auditors that best meet
their needs (Burton and Roberts, 1967; Shockley, 1981; Addams and Davis, 1994; Beattie and Fearnley,
1998), resulting in a market characterized by a high level of auditor–client alignment. Auditor
5
Our maximum switching rate is around double the switching rates reported for the Chinese market for a similar period. Chan
et al. (2006) report a sample-based switching rate of 9% in China during 1996–2002 (with a maximum annual rate of 11% in 2000
and 2001). Despite the substantial legal, cultural and economic differences between the Iranian and Chinese markets, we suggest
this comparison indicates a particularly rapid increase in the propensity for switching in the Iranian market.

6
While not sufﬁcient for modeling, these cases are reasonably consistent with the average size of ﬁrms in our sample, as
described in Section 5. The mean natural log of revenues for the 74 ﬁrms for which we obtained 2003 fee data is 11.49, compared to
11.62 for our full sample; the standard deviations are 1.12 and 1.29 respectively.
6 M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
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switching under partial privatization. J. Account. Public Policy (2014), />j.jaccpubpol.2014.04.004
switching is more likely to occur when an auditor and client are not well aligned. Changes in either
client or auditor characteristics may result in a misalignment, which can be corrected by switching
auditors (Landsman et al., 2009).
The government-owned audit ﬁrm initially audited corporations that became listed as a
consequence of Iran’s privatization policy. There are multiple arguments as to why (partially)
privatized corporations might retain or switch auditors. We argue that the incentives for priv-
atized ﬁrms to switch auditors are conditioned by the extent of continuing government
inﬂuence.
Privatizations in emerging markets have prompted concerns regarding potential agency conﬂicts
between minority investors and politically connected managers or continuing government owner-
ship. Government inﬂuence through ownership may render corporations more likely to pursue
social or political goals such as infrastructure development, employment or other social agendas.
In particular, government owners may have strong motives to obscure ﬁrm performance informa-
tion (Bushman et al., 2004), which may be facilitated by stock exchanges that are illiquid and opa-
que during privatization programs (Megginson and Netter, 2001; Guedhami et al., 2009). There is
evidence that government ownership affects board member selection (Fan et al., 2007) and corpo-
rate structure (Fan et al., 2012). Although government-controlled listed corporations do not have to
be audited by the government-owned audit ﬁrm, managers of government-inﬂuenced companies
may generally prefer the government auditor because of its experience with such entities or for
political reasons. Where there is signiﬁcant government inﬂuence through retained ownership,
managers are more likely to choose auditors that are more aligned with government interests
(Wang et al., 2008; Guedhami et al., 2009) and it has been suggested that governments can inﬂu-
ence government auditors (Wang et al., 2008). Political or social objectives may divert govern-

ment-controlled ﬁrms from pursuing proﬁts (e.g., Eckel and Vining, 1985; Shleifer and Vishny,
1994), making acquiescent managers less likely to switch to auditors more suited to private inves-
tor interests. Consistent with these arguments, Chan et al. (2007) report increased demand for
higher-quality audits following decreased government share ownership in China. Therefore, our
government inﬂuence hypothesis is:
H1. The likelihood of an auditor switch is negatively associated with signiﬁcant government
inﬂuence.
With respect to determining signiﬁcant government inﬂuence, we focus on the percentage of
shares retained by the government. Consistent with the International Financial Accounting
Standard 28 (IASB, 2011) on equity accounting, we use government ownership of 20% or more
of the shares as indicative of signiﬁcant government inﬂuence. This follows previous inﬂuential
studies (e.g., La Porta et al., 1999; Claessens et al., 2000, 2002). However, as argued by
Chapelle and Szafarz (2005), the threshold of 20% is an empirical rule of thumb that has no spe-
ciﬁc formal justiﬁcation. Therefore, we examine other thresholds in our robustness tests. There
may be non-shareholding sources of government inﬂuence, such as government contracts,
manager–government relationships and board members’ political connections, but we do not have
access to such data.
3.2. Auditor–controlling shareholder misalignment
In the absence of signiﬁcant government inﬂuence, privatization relieves an Iranian company of
responsibility for implementing government policy (Komijani, 2003) and Iranian government-con-
trolled companies were known to be mismanaged and poor performers (EghtesadeIran, 2002). If gov-
ernment control or the pursuit of government objectives is costly to private sector shareholders,
managers of privatized companies have incentives to signal increased emphasis on investors’ interests
and reduced government involvement by switching to a private sector auditor. Private sector auditors
may have also developed different expertise in regulatory compliance and be perceived as having
more afﬁnity with the interests of investors, brokers and investment bankers. Therefore, we expect
private auditors’ experience and reputation to better match the needs of a privatized company.
M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
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Consequently, where there is auditor–controlling shareholder misalignment, there is more incentive
to switch auditors for alignment purposes. We consider that an auditor–controlling shareholder
misalignment occurs when a government-controlled company has a private sector auditor and where
a private sector company has a government auditor.
7
Therefore, our auditor–controlling shareholder mis-
alignment hypothesis is:
H2. The likelihood of an auditor switch is positively associated with auditor–controlling shareholder
misalignment.
3.3. The effect of managerial interests on auditor choice
Managers’ preferences may motivate auditor selection and switching behavior. Incoming managers
may choose to switch auditors if they have a preferred relationship with a particular auditor
(Williams, 1988; Seabright et al., 1992; Addams and Davis, 1994; Beattie and Fearnley, 1998;
Hudaib and Cooke, 2005). Existing managers may also switch auditors if they are seeking accommo-
dation of their choices and applications of accounting policies (Schwartz and Menon, 1985). Therefore,
our auditor–managerial misalignment hypothesis is:
H3. The likelihood of an auditor switch is positively associated with auditor–managerial misalign-
ment.
We test this hypothesis by examining three indicators of potential misalignment of auditors and
managerial preferences: changes in management, accounting choice preferences and disagreements
between auditors and managers indicated by qualiﬁed opinions.
To test the proposition of incoming managers preferring particular auditors, we focus on
changes in CEO and Chair of the Board. We consider both CEO and Chair changes because we
have no evidence of the relative power of each of these ofﬁces in Iranian companies. We observe
very high rates of change in CEOs (22%) and Chairs (25%) in our pooled sample of TSE-listed
companies; the pooled rate of simultaneous change in CEO and Chair is 11%.
8
These high rates
of change suggest there might not be sufﬁcient stability in the managerial labor market or mana-

gerial entrenchment for managers to inﬂuence auditor choice. However, consistent with studies
indicating that management changes are one of the main reasons for auditor switches (Burton
and Roberts, 1967; Carpenter and Strawser, 1971; Beattie and Fearnley, 1995, 1998; Woo and
Koh, 2001; Hudaib and Cooke, 2005), we expect the likelihood of an auditor switch is higher fol-
lowing a change in client management.
9
With respect to managers seeking auditors who are more accommodating of their accounting
choices, we examine evidence of accounting choice and auditor opinions that indicate auditor–
manager disagreement over the choice and application of accounting policies. If managers prefer
auditors who are more accommodating with respect to their choice and application of accounting
policies (Schwartz and Menon, 1985), then we expect accounting choices to be linked to auditor
switches, irrespective of management changes. We contend that auditors are not indifferent to
accounting choices, and will prefer conservative accounting practices if this exposes them to less
risk of punitive actions. This contention is consistent with US evidence that auditors are more
likely to be sued when there are earnings overstatements compared to when there are earnings
understatements (St. Pierre and Anderson, 1984). While Iranian auditors do not face civil litiga-
7
A controlling shareholder is deﬁned as one who holds 50% or more of the issued shares. In our additional testing, we also test
auditor–controlling shareholder misalignment when a government-controlled company has a private sector auditor.
8
While the same person could be CEO and Chair during the period of our study, we ﬁnd no instances of this in our sample. The
simultaneous changes in both Chair and CEO in our sample also appear unrelated to privatization or other ownership changes.
9
The results of earlier studies of the association between management changes and auditor switches are inconsistent. Some
studies do not ﬁnd any signiﬁcant association (e.g., Chow and Rice, 1982; Schwartz and Menon, 1985; Williams, 1988), while
others ﬁnd signiﬁcant associations (e.g., Burton and Roberts, 1967; Carpenter and Strawser, 1971; Beattie and Fearnley, 1995,
1998).
8 M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
Please cite this article in press as: Bagherpour, M.A., et al. Government and managerial inﬂuence on auditor
switching under partial privatization. J. Account. Public Policy (2014), />j.jaccpubpol.2014.04.004

tion risk, they can be jailed for issuing unqualiﬁed opinions on misleading ﬁnancial reports
(Iranian Trade Laws Article 267) or have their license suspended or cancelled by the IACPA. If
prosecutions or other adverse outcomes are more likely when there are earnings overstatements
rather than earnings understatements, then Iranian auditors have incentives to prefer conserva-
tive accounting methods and choices. If an incumbent auditor’s accounting preferences lead to
income decreasing accounting choices, then there is a greater likelihood of an auditor switch,
because it is more likely to be inconsistent with managers’ preferences (Defond and
Subramanyam, 1998). This argument does not assume that managers are motivated to manipulate
earnings – it argues that, if managers believe the incumbent auditor’s accounting choice prefer-
ences are more conservative than those expected from the average auditor, then management has
an incentive to switch auditors in the hope of ﬁnding a more reasonable successor (Defond and
Subramanyam, 1998, p. 36). It follows that an auditor switch is more likely for a company with
large negative discretionary accruals than for other companies. Therefore, we expect the likeli-
hood of an auditor switch increases following large negative discretionary accruals, as indicated
by the lower quartile of discretionary accruals.
Qualiﬁed and adverse audit opinions reﬂect either disagreements with management or inherent
uncertainties. Qualiﬁed audit opinions may be viewed as negative signals of managements’ steward-
ship of the company (Williams, 1988) and have been linked to adverse effects on company value and
management compensation (Chow and Rice, 1982). Some prior studies report an increased likelihood
of auditor changes following a qualiﬁed audit opinion (e.g., Chow and Rice, 1982; Teoh, 1992; Lennox,
2000; Hudaib and Cooke, 2005). Others report a negative association (Woo and Koh, 2001) or no asso-
ciation (e.g., Schwartz and Menon, 1985; Haskins and Williams, 1990). Earlier studies mostly do not
distinguish between qualiﬁed audit opinions resulting from disagreements with management and
qualiﬁed opinions resulting from environmental conditions such as inherent uncertainties or scope
limitations not imposed by the client. However, Hudaib and Cooke (2005) ﬁnd that the severity of
an audit opinion, in relation to disagreements, is positively associated with auditor switching. We con-
tend that management has more incentive to bring about an auditor switch if the audit opinion
reﬂects adversely on management. In Iran, qualiﬁed and adverse audit opinions are issued for scope
limitations, inherent uncertainties and violations of GAAP (disagreements with management over
the choice and application of accounting policies). We contend that qualiﬁed and adverse opinions

that reﬂect directly on management (i.e., client-imposed scope limitations and violations of GAAP)
are more likely to result in management seeking a change of auditor, compared to qualiﬁed opinions
issued because of environmental conditions (i.e., inherent uncertainties or scope limitations not
imposed by the client). Therefore, we expect the likelihood of an auditor switch is higher if a client
receives a qualiﬁed audit opinion resulting from violations of GAAP or client-imposed limitations of
scope.
4. Empirical model
We specify the following logistic regression as our main model to test the hypothesized effects on
auditor switching propensities. To test the impact of signiﬁcant government inﬂuence (H1), we use the
indicator variable Government inﬂuence. In relation to the auditor–controlling shareholder misalign-
ment hypothesis (H2), we test auditor–controlling shareholder misalignment with the variable
Misaligned. We use the variables
D
Management, NegativeDA and QualDisagree to test the auditor–
managerial misalignment hypothesis (H3). The control variables in the model are described in
Section 4.1.
Auditor switch
t
¼ b
0
þ b
1
Go
v
ernment influence þ b
2
Misaligned
tÀ1
þ b
3

D
Management
tÀ1
þ b
4
QualDisagree
tÀ1
þ b
5
Negati
v
eDA
tÀ1
þ b
6
Go
v
ernment ownership þ b
7
QualOther
tÀ1
þ b
8
Positi
v
eDA
tÀ1
þ b
9
Size

tÀ1
þ b
10
SalesGrowth
tÀ1
þ b
11
Loss
tÀ1
þ b
12
Le
v
erage
tÀ1
þ b
13
ROA
tÀ1
þ b
14
Competition years þ
R
b
i
Industry
i
ð1Þ
M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
9

Please cite this article in press as: Bagherpour, M.A., et al. Government and managerial inﬂuence on auditor
switching under partial privatization. J. Account. Public Policy (2014), />j.jaccpubpol.2014.04.004
where:
Dependent variable:
Auditor switch
1 If a corporation had a change of auditor in the current year, 0 otherwise. We
identify switches from the audit ﬁrm names on the published audit reports in
the relevant corporation’s annual report obtained from the TSE library
Test variables:
Government
inﬂuence
1 If government owns 20% or more of the issued shares and 0 otherwise. We
use 20% to be consistent with the threshold used in equity accounting
standards to determine signiﬁcant inﬂuence. We test other thresholds in our
robustness tests
Misaligned
1 If a corporation is private sector controlled and had a government auditor
in the previous year, 0 otherwise. Types of auditor and corporations were
identiﬁed from the published annual reports obtained from the TSE library
D
Management 1 If there was a change in both the Chair of the Board and the Chief Executive
Ofﬁcer in the previous year, 0 otherwise. The Chair and the CEO are identiﬁed
from notes in the annual report obtained from the TSE library
QualDisagree
1 If the audit opinion for the previous year was qualiﬁed because of a
violation of GAAP or a client-imposed scope limitation, 0 otherwise. We
identify the type of audit opinion from the auditor’s report in the annual
report obtained from the TSE library
NegativeDA
1 If discretionary accruals for the previous year, estimated using the Dechow

and Dichev (2002) approach, was in the bottom quartile (income decreasing),
and 0 otherwise. We exclude the middle quartiles to reduce noise and control
for the top quartile using PositiveDA
Control variables:
Government
ownership
Percentage of issued shares held by government agencies
QualOther 1 If the audit opinion for the previous year was qualiﬁed for reasons other
than violations of GAAP or client-imposed scope limitations, 0 otherwise. We
identify the type of audit opinion from the auditor’s report in the annual
report obtained from the TSE library
PositiveDA
1 If discretionary accruals for the previous year, estimated using the Dechow
and Dichev (2002) approach, was in the top quartile (income increasing), and
0 otherwise
Size
Natural logarithm of total revenue for the previous year, as disclosed in the
ﬁnancial statements in the annual reports obtained from the TSE library
SalesGrowth
1 If sales growth during the previous year was greater than or equal to 30%,
using sales as disclosed in the ﬁnancial statements in the annual reports
obtained from the TSE library. Other thresholds are also tested
Loss
1 If a loss was reported in the previous year and 0 otherwise, as disclosed in
the ﬁnancial statements in the annual reports obtained from the TSE library
Leverage
Long-term debt divided by total assets at the end of the previous year, as
disclosed in the ﬁnancial statements in the annual report obtained from the
TSE library
ROA

Previous year net proﬁt divided by total assets
Competition
years
1 For cases occurring during the years of increased competition in the audit
market following the introduction of the IACPA in 2001 (i.e., 2002–2003), 0
otherwise
Industry
(0,1) Classiﬁcation variables for industries based on the industry
classiﬁcations published by the TSE
10 M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
Please cite this article in press as: Bagherpour, M.A., et al. Government and managerial inﬂuence on auditor
switching under partial privatization. J. Account. Public Policy (2 014), />j.jaccpubpol.2014.04.004
4.1. Control variables for other switching effects
We include the continuous variable Government ownership as a control variable, because prior
research has found this to be signiﬁcant in relation to auditor switching (Guedhami et al., 2009)
and to control for any government ownership inﬂuence incremental to our signiﬁcant inﬂuence
threshold measure.
We include the variable QualOther to control for the possibility that audit qualiﬁcations, for reasons
other than violations of GAAP and client-imposed scope limitations, impact on auditor switching. We
include the variable PositiveDA to control for two reasons. Income increasing discretionary accruals
may reﬂect the preferences of management and have been approved by the auditor, reducing the like-
lihood of switching. However, if switching is management’s response to auditors limiting the capacity
of managers to engage in earnings management, irrespective of direction, then the results should be
the same for both income-increasing and income-decreasing discretionary accruals.
We control for Size and SalesGrowth, because client size and growth are known to be important
determinants of auditor choice in developed markets (Francis and Wilson, 1988) and some emerging
markets (Chan et al., 2007; Wang et al., 2008; Guedhami et al., 2009).
10
Large clients are more likely to
have selected a large auditor, so a market with few competing large auditors offers little opportunity for

switching. An auditor switch is much more likely when sales growth is relatively large. Low to moderate
sales growth is less likely to trigger an audit switch, because it is less likely to change the size of the cli-
ent to the level where client size-auditor size becomes misaligned. Therefore, in relation to client growth,
we expect auditor switches are more likely to arise as a threshold effect rather than a linear relation.
11
Prior studies suggest that auditor opinions and switching are inﬂuenced by proﬁtability and ﬁnan-
cial distress (Schwartz and Menon, 1985; Geiger et al., 1998; Carey et al., 2008), which we control for
using Loss, Leverage and ROA (Chan et al., 2007; Wang et al., 2008; Guedhami et al., 2009). Consistent
with prior studies on auditor switching, we include industry control variables based on the industry
classiﬁcations used by the TSE. We control for the following: equipment; oil and petrochemical;
investment; medical and pharmaceutical; alimentary and drinking; basic metals; packaging; rubber
and plastic; electrical machinery; minerals; textile; and automotive. Other industry groups have too
few cases for separate controls.
12
In our discussion of the institutional environment in Section 2, we indicate that the number of
licensed auditors in private practice increased substantially following the establishment of the IACPA
(also see Table 1 in Section 5). Increased competition for audit clients increases the opportunities for
Table 1
Sample by auditor changes.
Year Companies
(n)
Signiﬁcant
government
inﬂuence (%)
Number of
private sector
audit ﬁrms
Auditor changes Direction of auditor change
Frequency % Public to
private

Private to
private
Private to
public
1999 106 52 18 7 6.6 1 4 2
2000 134 52 17 9 6.7 2 7 0
2001 151 51 18 2 1.3 1 1 0
2002 149 43 28 21 14.1 16 5 0
2003 117 39 37 23 19.7 20 3 0
Firm-years 657 47 62 9.4 40 20 2
10
Expertise or specialization may also be an important factor in auditor selection. However, some industries attracting
specialization in developed markets are not prevalent in Iran; for example, there are no listed ﬁnancial institutions. Also, auditor
expertise requires both strategic investment of resources and sufﬁcient time for knowledge acquisition and reputation building.
We contend that the emergent ﬁrms in an immature market are highly constrained in this regard, and so Iranian audit ﬁrms had
little opportunity to develop specializations in the two years post-2001 included in our study. Therefore, we do not construct an
industry specialization hypothesis for auditor alignment switching, although we control for industry effects in our ﬁnal model.
11
In further tests, we test and report a range of thresholds for sales growth.
12
While capital-raising might inﬂuence switching decisions in developed markets (Healy and Lys, 1986; Woo and Koh, 2001),
data deﬁciencies prevent us controlling for this possible effect.
M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
11
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switching under partial privatization. J. Account. Public Policy (2014), />j.jaccpubpol.2014.04.004
companies to change auditors (Beattie and Fearnley, 1998) in order to select an auditor that better
matches the company’s or manager’s needs. We control for this effect with the Competition years indi-
cator variable, and also control for individual year ﬁxed effects, reducing the likelihood of our test vari-
ables proxying for omitted variables.

5. Sample statistics
Our population is all companies listed on the TSE during 1999–2003, which is two years preceding
and two years following the establishment of the IACPA in 2001. The numbers of listed companies in
each of the ﬁve years were 296, 311, 323, 338 and 386, yielding a potential population of 1654 ﬁrm-
years. For our sample, the average government ownership declined from 31% (1999–2001) to 24%
(2002–2003). Data were manually collected from the hardcopy ﬁnancial statements held in the TSE
library. We excluded 15 companies where private shareholdings totaled less than 5% to avoid the
potential bias of what were effectively pseudo-privatizations, where private interests are unlikely
to inﬂuence managers. Incomplete ﬁles and missing data resulted in our ﬁnal sample of 657 ﬁrm-year
observations.
13
The increased competition in the supply of audit services following the establishment of the IACPA
in 2001 is illustrated in Table 1, which indicates that the number of audit ﬁrms in our sample was ﬂat
at 17–18 through 1999–2001, but this increased to 28 in 2002 and 37 in 2003.
14
The post-2001 growth
coincides with the majority (71%) of the 62 auditor changes during our sample period. These are pre-
sented by year and direction in Table 1. Companies that have a change in audit ﬁrm as a result of an audit
ﬁrm merger are not coded as switches. Most switches (65%) were from the government auditor to a pri-
vate sector auditor. Only two switches were from a private sector auditor to the government auditor,
which occurred in 1999, prior to the establishment of the IACPA. The predominance of switches in the
later years is consistent with switches being facilitated by the changes in government policy that
increased auditor competition. The variation in switching across the years also conﬁrms the desirability
of controlling for individual year ﬁxed effects.
Descriptive statistics and frequencies for the other variables for each year are presented in Table 2.
There is a near even split between companies with signiﬁcant government inﬂuence; 47% of our sam-
ple have government ownership P20%. The percentage of companies in our sample with signiﬁcant
government inﬂuence declined from 52% in 1999 to 39% in 2003, which is consistent with the govern-
ment’s privatization policies. This variable is also used for split sample descriptions in Table 2. The
switching rate for the pooled sample is 9%, but the switching rate is signiﬁcantly lower (p = 0.005)

for the sub-sample with signiﬁcant government inﬂuence, compared to the sub-sample with no sig-
niﬁcant government inﬂuence (6% vs. 12%). Average government ownership in the pooled sample is
28%; with 54% and 4% for the signiﬁcant and no signiﬁcant government inﬂuence sub-samples respec-
tively (signiﬁcantly different at p < 0.001).
13
Many of the available TSE ﬁles were incomplete. We did not detect any bias with respect to missing data, other than a greater
proportion of missing cases for the ﬁrst and last year of the series. Our sample represents 36–51% of cases for each year. Based on
chi-square tests of differences in frequencies of valid and missing data for each variable grouped by auditor switch versus no
switch, we do not ﬁnd any signiﬁcant difference for included variables. We did ﬁnd substantial bias with respect to capital-raising
(changes in equity or debt), for which there was a large amount of missing data, so we have not included capital-raising in our
models. Our reported models are estimated using list-wise deletion of cases with missing data. However, as an additional missing
data test we also estimate the main model using all possible cases, where missing values are replaced by mean values of nearby
points, and we obtain substantially similar results. These tests suggest the deletion of cases with missing data does not bias our
results. We also re-estimate our models with change in equity and change in debt as additional variables but these were unreliable
and unstable, and are not tabulated. Most corporate debt in Iran comes from government-owned banks and it is not obvious how
this might relate to incentives for switching incentives. This may be an interesting future study should the necessary data become
available.
14
The number and structure of private sector audit ﬁrms during our period of study is very dynamic. Firm identities vary
considerably from year to year; our sample contains over 50 private sector audit ﬁrms and many have only a small number of
clients in any year. Total yearly client numbers for private sector audit ﬁrms range from 0 to 15, and this is highly fragmented if
tabulated by client type or other demographics. Our ﬁnal sample has 657 cases from a population of 1654 ﬁrm-years; while we
have no basis for assuming any sample bias in this regard, we cannot be sufﬁciently conﬁdent that the sample proﬁle indicates the
market shares of individual audit ﬁrms each year. We are not able to identify any patterns in sample distributions by audit ﬁrm
that allows us to identify clear market leaders.
12 M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
Please cite this article in press as: Bagherpour, M.A., et al. Government and managerial inﬂuence on auditor
switching under partial privatization. J. Account. Public Policy (2 014), />j.jaccpubpol.2014.04.004
Among our switching incentive measures, there are signiﬁcant differences between the split sam-
ples for Misaligned (p < 0.001) and QualDisagree (p = 0.089). Unusually, most companies received a

qualiﬁed audit opinion, and most of these are QualDisagree; these mostly arise because the auditor dis-
agreed with management’s interpretations of tax laws and so was not satisﬁed with the adequacy of
management’s provision for tax payable. The remaining switching incentive indicators (SalesGrowth,
D
Management, NegativeDA) have reasonably consistent proportions across the sub-samples.
Pearson and Spearman correlation coefﬁcients were estimated between all test and control
variables. The only notable correlations involving test variables are between the mutually exclusive
QualDisagree and QualOther (correlation is À0.63, p < 0.001) and Government ownership and Misaligned
(correlation is À0.37, p < 0.001); therefore, we do not report the matrices here.
6. Results
As discussed below, all three hypotheses are supported by the results for the pooled sample
reported in Panel A of Table 3.
15
Our main variable of interest, Government inﬂuence, is negative and signiﬁcant, indicating that
the existence of signiﬁcant government inﬂuence reduces the likelihood of an auditor switch,
supporting H1.
Table 2
Descriptive statistics.
Pooled sample (n = 657) No signiﬁcant government
inﬂuence (n = 345)
Signiﬁcant government
inﬂuence (n = 312)
Mean/
Proportion
Std.
deviation
Mean/
Proportion
Std.
deviation

Mean/
Proportion
Std.
deviation
Auditor switch (0,1) 0.09 0.12 0.06
Government inﬂuence
(0,1)
0.47 – –
Misaligned (0,1) 0.40 0.48 0.32
D
Management (0,1) 0.11 0.10 0.12
QualDisagree (0,1) 0.79 0.82 0.77
NegativeDA (0,1) 0.25 0.26 0.24
Government ownership 0.28 0.30 0.04 0.06 0.54 0.23
QualOther (0,1) 0.09 0.10 0.09
PositiveDA (0,1) 0.25 0.23 0.27
Size 11.37 1.20 11.23 1.08 11.50 1.30
SalesGrowth (0,1) 0.29 0.29 0.29
Loss (0,1) 0.16 0.15 0.17
Leverage 0.11 0.13 0.12 0.11 0.13
ROA 0.11 0.17 0.10 0.16 0.11 0.18
Competition years (0,1) 0.40 0.45 0.35
Auditor switch = 1 if a corporation had a change of auditor in the current year, 0 otherwise. Government inﬂuence = 1 if the
government owns 20% or more of the issued shares and 0 otherwise. Misaligned = 1 if a corporation is private sector controlled
and had a government auditor in the previous year, 0 otherwise.
D
Management = 1 if there was a change in both the Chair of
the Board and the Chief Executive Ofﬁcer in the previous year, 0 otherwise. QualDisagree = 1 if the audit opinion for the
previous year was qualiﬁed because of a violation of GAAP or a client-imposed scope limitation, 0 otherwise. NegativeDA = 1 if
discretionary accruals for the previous year, estimated using the Dechow and Dichev (2002) approach, was in the bottom

quartile (income decreasing), and 0 otherwise. Government ownership is the percentage of issued shares held by government
agencies. QualOther = 1 if the audit opinion for the previous year was qualiﬁed for reasons other than violations of GAAP or
client-imposed scope limitations, 0 otherwise. PositiveDA = 1 if income increasing discretionary accruals for the previous year,
estimated using the Dechow and Dichev (2002) approach, was in the top quartile, and 0 otherwise. Size = natural logarithm of
total revenue for the previous year. SalesGrowth = 1 if sales growth in the previous year P 30%. Leverage = long-term debt
divided by total assets at the end of the previous year. Loss = 1 if a loss was reported in the previous year and 0 otherwise.
Leverage = long-term debt divided by total assets at the end of the previous year. ROA = previous year net proﬁt divided by total
assets. Competition years = 1 if year is 2002 or 2003, 0 otherwise.
15
All regressions control for year and industry ﬁxed effects and p-values are determined using robust standard errors clustered
on ﬁrm.
M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
13
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switching under partial privatization. J. Account. Public Policy (2014), />j.jaccpubpol.2014.04.004
Misaligned is positive and highly signiﬁcant, which means private sector controlled companies with
a government auditor are more likely to switch auditors, supporting H2. This is also consistent with
prior studies that use other measures of misalignment (Burton and Roberts, 1967; Shockley, 1981;
Addams and Davis, 1994; Beattie and Fearnley, 1998; Landsman et al., 2009).
H3 is supported by the coefﬁcients for the three test variables,
D
Management, NegativeDA and
QualDisagree. Consistent with the expectation, based on prior studies, that a change in management
increases the likelihood of auditor switching,
D
Management is positive and signiﬁcant. NegativeDA
is signiﬁcant and positive, which is consistent with DeFond and Subramanyam (1998) and our
Table 3
Logistic regressions of auditor switches.
Variable Predicted

sign
Panel A Panel B (split sample)
Pooled sample No signiﬁcant government
inﬂuence
Signiﬁcant government
inﬂuence
Coefﬁcient p-Value one-
tail (two-tail)
Coefﬁcient p-Value one-
tail (two-tail)
Coefﬁcient p-Value one-
tail (two-tail)
Government interests
Government
inﬂuence
ÀÀ1.098 0.047 – –
Switching incentives
Misaligned + 1.135 0.003 1.180 0.008 0.530 0.291
D
Management + 0.610 0.057 0.912 0.029 0.479 0.299
QualDisagree + 1.637 0.003 1.641 0.035 2.321 0.013
NegativeDA + 0.553 0.059 0.862 0.024 À0.096 0.437
Controls:
Government
ownership
? 1.436 (0.277) 1.436 (0.647) À0.102 (0.961)
QualOther ? 0.688 (0.412) 1.150 (0.316) À1.372 (0.673)
PositiveDA ÀÀ0.220 0.287 0.324 0.234 À1.125 0.047
Size ÀÀ0.250 0.009 À0.304 0.054 À0.280 0.061
SalesGrowth + 0.285 0.200 0.552 0.068 À0.405 0.269

Loss ? 0.718 (0.135) 0.418 (0.509) 1.788 (0.113)
Leverage ? 0.247 (0.816) 0.029 (0.983) À0.139 (0.941)
ROA ? 2.527 (0.118) 1.114 (0.535) 8.256 (0.095)
Competition
years
+ 1.841 0.002 1.609 (0.055) 3.062 (0.011)
Constant À3.112 (0.012) À3.058 (0.122) À4.878 (0.099)
n 657 345 312
Wald chi
2
94.63 (<0.001) 88.7 (<0.001) 70.55 (<0.001)
Pseudo R
2
0.21 0.19 0.38
Log pseudo
likelihood
À162.80 À105.05 À44.61
All regressions control for year and industry ﬁxed effects and p-values are determined using robust standard errors clustered on
ﬁrm. The dependent variable is Auditor switch = 1 if a corporation had a change of auditor in the current year, 0 otherwise.
Government inﬂuence = 1 if the government owns 20% or more of the issued shares and 0 otherwise. Misaligned = 1 if a
corporation is private sector controlled and has a government auditor in the previous year, 0 otherwise. SalesGrowth = 1 if sales
growth in the previous year P 30%.
D
Management = 1 if there was a change in both the Chair of the Board and the Chief
Executive Ofﬁcer in the previous year, 0 otherwise. QualDisagree = 1 if the audit opinion for the previous year was qualiﬁed
because of a violation of GAAP or a client-imposed scope limitation, 0 otherwise. NegativeDA = 1 if discretionary accruals for the
previous year, estimated using the Dechow and Dichev (2002) approach, was in the bottom quartile (income decreasing), and 0
otherwise. Government ownership is the percentage of issued shares held by government agencies. QualOther = 1 if the audit
opinion for the previous year was qualiﬁed for reasons other than violations of GAAP or client-imposed scope limitations, 0
otherwise. PositiveDA = 1 if income increasing discretionary accruals for the previous year, estimated using the Dechow and

Dichev (2002) approach, was in the top quartile, and 0 otherwise. Size = natural logarithm of total revenue for the previous year.
Leverage = long-term debt divided by total assets at the end of the previous year. Loss = 1 if a loss was reported in the previous
year and 0 otherwise. Leverage = long-term debt divided by total assets at the end of the previous year. ROA = previous year net
proﬁt divided by total assets. Competition years = 1 if year is 2002 or 2003, 0 otherwise. Regressions also estimated controlling
for individual year and industry ﬁxed effects, with robust standard errors clustered by ﬁrm.
14 M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
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switching under partial privatization. J. Account. Public Policy (2 014), />j.jaccpubpol.2014.04.004
argument that managers are more likely to drop auditors who impose conservative accounting
choices. QualDisagree is signiﬁcant and positive, consistent with prior studies (Chow and Rice, 1982;
Teoh, 1992; Lennox, 2000; Hudaib and Cooke, 2005) that ﬁnd a positive signiﬁcant association
between audit qualiﬁcation and auditor switching.
Our control variables Government ownership, QualOther, PositiveDA, SalesGrowth, Loss, Leverage and
ROA are not signiﬁcant. Size is signiﬁcant and negative, consistent with the proposition that larger
audit clients are more constrained in switching auditors. Competition years is signiﬁcant and positive,
conﬁrming that the increased number of audit ﬁrms, after the establishment of the IACPA in 2001,
increased the opportunity for and likelihood of auditor switching. The increased number of auditors
in the marketplace implies different levels of audit quality and competitive advantage, which provides
TSE-listed companies with a wider choice of auditors.
6.1. Further test of the impact of government inﬂuence
Our hypothesis development in Section 3 implies that managerial and private interests may be sec-
ondary to, or effective only in the absence of, signiﬁcant government inﬂuence in relation to auditor
switching. To assess whether this is the case, we re-estimate our model using split samples based on
Government inﬂuence, as reported in Panel B of Table 3. For the sub-sample with no signiﬁcant govern-
ment inﬂuence (Government inﬂuence = 0), the results for each of the test variables for H2 (Misaligned)
and H3 (
D
Management, NegativeDA and QualDisagree) remain signiﬁcant and in the predicted direc-
tion. For the sub-sample with signiﬁcant government inﬂuence (Government inﬂuence = 1), only Qual-
Disagree remains signiﬁcant. We interpret this as evidence that signiﬁcant government inﬂuence

arising from ownership of shares generally dominates managerial incentives for switching.
6.2. Sensitivity tests
In this section, we consider whether our results are robust to regression variable speciﬁcations and
correlated omitted variables. We pay particular attention to government ownership and alignment,
but also consider difference in sales growth. For efﬁciency, we do not tabulate the results of all the
further tests. The reported results for our main tests remain robust to these sensitivity tests.
As this study of auditor switching is substantially motivated by the partial privatization and contin-
uing government inﬂuence, we also separately consider the following: (1) different measures of sig-
niﬁcant government inﬂuence; (2) the impact of changes in government control; (3) omitting our
control variable for the level of government ownership (Government ownership); and (4) misalignment
of auditor and client in cases of government-controlled companies.
We varied our measure of signiﬁcant government inﬂuence from 10% through to 50% government
ownership, in place of the 20% indicator used as our main test variable. The reported results for our
test variables persist at levels above 20%, but not below.
For changes in government control, we re-estimated all our regressions with an additional indica-
tor variable for cases where government ownership became less than 50% in the previous year. This
variable does not load for the ‘no signiﬁcant government inﬂuence’ sub-sample and was not signiﬁ-
cant in the other regressions; results for our test variables remain substantially the same as our
reported results.
There is a risk of structural multicollinearity, because we control for government ownership levels
while testing signiﬁcant government inﬂuence. Therefore, we re-estimate the regressions without
Government ownership and obtain results consistent with our reported results, and no changes in
our ﬁndings concerning our test variables.
Our model tests the importance of auditor–controlling shareholder misalignment, based on a pri-
vate sector controlled company having a government auditor. We also re-estimate our pooled sample
regression including an additional misalignment variable that is equal to 1 if a corporation is govern-
ment-controlled and has a private sector auditor in the previous year, and 0 otherwise. This type of
misalignment comprises only 4% of our sample and this variable does not load for the ‘no signiﬁcant
government inﬂuence’ sub-sample and is not signiﬁcant in the other regressions; results for our test
variables remain substantially the same as our reported results.

M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
15
Please cite this article in press as: Bagherpour, M.A., et al. Government and managerial inﬂuence on auditor
switching under partial privatization. J. Account. Public Policy (2014), />j.jaccpubpol.2014.04.004
In all of our regressions, we control for sales growth of 30+% as a potential determinant of switching
behavior. This was signiﬁcant only for the ‘no signiﬁcant government inﬂuence’ sub-sample, consis-
tent with it being an auditor–client realignment motive that is suppressed when there is signiﬁcant
government inﬂuence. We also tested growth thresholds of 20% and 40%. SalesGrowth of 20+% is not
signiﬁcant in any of the pooled or split sample regressions, while at 40+%, it is signiﬁcant for the
pooled sample (b = 0.56, p = 0.067, one-tail) and for the ‘no signiﬁcant government inﬂuence’ sub-
sample (b = 1.23, p = 0.003, one-tail). For the ‘signiﬁcant government inﬂuence’ sub-sample, the coef-
ﬁcient is not signiﬁcant at conventional levels (b = À1.52, p = 0.106, two-tail). We also re-estimated
our regressions using a continuous measure of sales growth, but this was not signiﬁcant. In all tests,
the results for our test variables are substantially the same as our reported results. The signiﬁcant
results for sales growth at 30% and 40% support our contention that sufﬁciently large growth can cre-
ate auditor–controlling shareholder misalignment, thus increasing the likelihood of a switch in the
absence of signiﬁcant government inﬂuence.
7. Discussion and conclusions
We contribute to the auditing literature by examining the link between state ownership and audi-
tor choice for privatized companies in an emerging market. We provide an important addition to the
evidence concerning the importance of government share ownership to auditor choice and comple-
ment other studies of the political economy of partial privatization and auditor choice. We also offer
new insight into emergent audit markets and the implications of auditor competition for auditor–con-
trolling shareholder alignment and the implications of auditor switching. We analyze the impact of
government inﬂuence on companies’ auditor choices during a period of privatization of share owner-
ship and increasing competition in the emergent private audit market in Iran. This extends the auditor
choice research that focuses mainly on agency cost issues in the US and similar jurisdictions, and com-
plements earlier studies on the effects of institutions on accounting and auditor choice. Our results
indicate that auditor switching by companies listed on the TSE is consistent with predicted misalign-
ment incentives, facilitated by increased competition, but generally constrained by the presence of

signiﬁcant government inﬂuence. These contributions to our understanding of partial privatization
effects and the functioning of an emergent audit market have implications for policy development
in emerging and transition economies.
Consistent with recent studies of government share ownership (Chan et al., 2007; Wang et al.,
2008; Guedhami et al., 2009), our results suggest that government retention of signiﬁcant inﬂuence
through shareholdings may affect a ﬁrm’s accounting choices by inﬂuencing its auditor. Our ﬁndings
on the relation between government inﬂuence, auditor supply and the demand for private sector audi-
tors in a transition economy support arguments concerning the importance of policy development in
relation to accounting institutions for the efﬁcient allocation of resources and economic growth (Rajan
and Zingales, 1998; Wurgler, 2000; Wang et al., 2008).
With respect to auditor–controlling shareholder misalignment, we ﬁnd that private sector con-
trolled companies with a government auditor are more likely to switch auditors. Concerning audi-
tor–managerial misalignment, we ﬁnd that management changes, large income reducing
discretionary accruals and qualiﬁed reports caused by auditor–management disagreements increase
the likelihood of an auditor switch. However, we ﬁnd this switching behavior is constrained by signif-
icant government inﬂuence.
While exposing the constraining effect of signiﬁcant government inﬂuence on auditor switching is
an important contribution to our understanding of privatizations, government shareholder inﬂuence
and auditor choice, it remains ambiguous as to whether this constraining effect is positive or negative
from a public policy perspective. While constraints on self-serving manager behavior might be advan-
tageous, the agency risks for minority shareholders, arising from the inﬂuence of dominant sharehold-
ers, may frustrate expected gains from this policy option (Shleifer and Vishny, 1994). Constraints on
the availability and use of auditors sufﬁciently independent from government interests may affect
the opacity and liquidity of equity markets under partially privatized regimes. This may have serious
consequences for participation in, and the efﬁciency of, these markets. However, this must be bal-
16 M.A. Bagherpour et al. /J. Account. Public Policy xxx (2014) xxx–xxx
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switching under partial privatization. J. Account. Public Policy (2 014), />j.jaccpubpol.2014.04.004
anced against the beneﬁts of constraints on managers pursuing their own interests in switching or
selecting auditors. Future research might address the extent to which this constraint on auditor

switching constrains other forms of managerial self-interest or enhances/curtails the ﬁnancial report-
ing transparency and liquidity of equity markets.
Our ﬁndings have implications for regulators (in emerging or transition economies with immature
audit markets). Most developing markets are characterized by privatization of government-controlled
entities, growing capital needs, and increasing competition in capital markets and the market for audit
services; therefore, our results seem particularly relevant to emerging markets where the regulators
anticipate increased competition in the supply of audit services. Prior research is focused mainly on
conditions of decreasing competition in the audit market, while we examine a dynamic audit market
with increasing competition. Having established that, at least in the Iranian context, increasing com-
petition in the supply of audit services increases the likelihood of auditor switching motivated by both
corporate and managerial interests, we suggest there is a need for future research examining the con-
sequences of such switching for the quality or value of the audit function. Further studies of other
dynamic markets that exhibit increasing numbers of competing private sector auditors, such as East-
ern European countries and China, will further enrich our understanding of competition and align-
ment. More generally, institutional and structural changes in emerging markets will continue to
provide valuable opportunities to better understand shareholder inﬂuence or the dynamics of audit
markets that are harder to test in mature markets.
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