This study uses an agency theory framework to analyze firms' incentives to hire external auditing. It postulates that a major reason for firms to hire this service is to help control the conflict of interests among firm managers, shareholders, and bond-holders. Firm characteristics which affect the severity of this conflict or the marginal cost of external auditing are expected to influence a firm's demand for this service. Based on this analysis, leverage, firm size, and number of accounting-based debt covenants are predicted to increase the probability that a firm will voluntarily hire external auditing. The firm manager's ownership share is predicted to have the opposite effect. Univariate and multivariate tests were conducted on a sample of 165 NYSE and OTC firms from the year 1926. The results generally supported the hypothesized effects of leverage and accounting-based debt covenants, and moderately supported the predicted role of firm size. Manager ownership effects could not be tested due to data problems.

This study focuses on the influence of qualified opinions on auditor switches. Results from a random sample of SEC-registrants support the contention that firms switch auditors more frequently after receiving qualified opinions. However, it was not found that firms that have received qualified opinions switch systematically to audit firms with a history of rendering proportionally fewer qualified opinions. Also, limited results suggest that qualified firms which switch auditors do not tend subsequently to receive more clean opinions.