178 The Accounting Review, July 1997

Client-Auditor Realignment and Restrictions

on Auditor Solicitation Author(s): Paul K.
Chaney, Debra C. Jeter, Pamela Erickson Shaw
Source: The Accounting Review, Vol. 72, No. 3,
(Jul., 1997), pp. 433-453
Published by: American Accounting Association

Client-Auditor Realignment and Restrictions on Auditor Solicitation

Paul K. Chaney
Debra C. Jeter
Vanderbilt
University
Pamela Erickson Shaw
Investor Management
Corporation

ABSTRACT: We compare clients' realignment decisions in markets

permitting direct uninvited solicitation (allowed markets) and markets
prohibiting such practices (banned markets), providing insight into the
effects of increased competition on client-auditor alignment. We argue
that solicitation influences realignment decisions if clients do not invite
nonincumbents to submit proposals, and if net economies are available (i.
e., the cost savings from switching auditors exceeds any transactions costs
incurred in realignment). By examining realignments among Big 8
auditors during the period 1980 through 1988, and by controlling for other
variables associ- ated with auditor switching, we are able to focus on the
effects of solicitation in a setting of homogeneous audit quality and
diversity in state boards' direct solicitation rules. We find that realignment
occurs more frequently in the allowed market than in the banned market.
Thus, in markets where auditors are allowed to approach prospective
clients with proposals, clients become better informed and the outcome
may be reduced inefficiencies.

Key Words: Auditing, Auditor switching, Auditor alignment, Solicitation.

Data Availability: Data are available in public sources identified in the
study.

This paper addresses the effect of uninvited solicitation on the market

for audit services. Many states lifted their bans on direct uninvited
solicitation (hereafter direct solicitation) by auditors throughout the
1980s. Proponents of these changes argued that direct solicitation
benefited clients as audit firms capable of providing services at
 179 The Accounting Review, July 1997
lower costs were. We would like to acknowledge the helpful comments of
Rashad Abdel-khalik, Cindy Alexander, Michael Bamber, Roger Blair,
Germain Boer, J. S. Butler, Jere Francis, Chris Hogan. Prem Jain. Craig Lewis,
Ron Masulis, Dan Simunic, workshop participants at Vanderbilt University
and the University of Florida, and two anonymous reviewers. Financial
assistance of the Dean's Fund for Faculty Research of the Owen
Graduate School of Management is gratefully acknowledged. permitted to
inform prospective clients of available economies. Opponents claimed
that direct solicitation led to cut-throat competition and lowered audit
quality. Recent attention by the press suggests that the mid-1990s is
another period of intense competition, as audit firms of all sizes strive
to offset the effects of profit and revenue declines or slow growth
during the early 1990s. The disappearance of state laws prohibiting
direct solicitation is cited as playing a role in the "hungry" pursuit of
clients (Wall Street ]ournal1995, 1). Although solicitation is still
viewed by many in a negative light, this paper presents evidence
consistent with the arguments of proponents of this form of increased
competition.

Chaney et al. (1995) consider the claims that direct solicitation

injures the competitive position of smaller auditors and provide evidence
inconsistent with these claims. They show that the growth of Big 8
auditors during the 1980s was not associated with direct solicitation
activities as switches from non-Big 8 to Big 8 auditors occurred just
as often in states banning direct solicitation as in those allowing it. In
this paper, we provide evidence that clients are more likely to switch
from one Big 8 auditor to another when direct solicitation is allowed.
We suggest that clients are more likely to suffer from misalignment
inefficiencies when direct solicitation is banned, because solicitation
lowers the client's cost of identifying inefficiencies and therefore
increases the likelihood of switching.

We present empirical evidence bearing on the extent of misalignment in

banned markets. In particular, we examine the association between the
client's decision to swi tch audi tors (or to retai n the incumbent) and the
rules governing solicitation in the client's primary place of operations.
We restrict our empirical tests to clients of the Big 8.1 The firms in our
sample either retain their Big 8 auditor or switch to another Big 8
auditor. We presume that audit quality is constant across the Big 8 and
focus on cost efficiencies (inefficiencies) as a determinant of client-
auditor alignment. However, we recognize that an auditor's advantage
in a particular setting could as easily be described in terms of audit or
service quality as in terms of cost savings." Because prior research fails
to demonstrate a significant relation between specific Big 8 auditors
 180 The Accounting Review, July 1997
and litigation activity levels (Palmrose 1988) and fails to find quality
differences among major auditors (Imhoff 1988), we chose to focus our
discussion on cost savings rather than audit quality. We examine
client realignment decisions during the period 1980 through 1988
because of the diversity in state boards' direct solicitation rules
during this period.'

The remainder of the paper is organized as follows. Section II

describes the economic development, and section III discusses the
hypothesis and empirical model. Section IV summarizes the sample
selection and data collection, the results are presented in section V, and
section VI is a summary of the major findings of the study. The institutional
background is provided in an appendix.

II. INVITATION AND REALIGNMENT

DECISIONS
Advocates of direct solicitation claim that the increased flow of
information in the allowed market provides benefits to clients." Prior
research has addressed some of the criticisms of solicitation and
provided evidence refuting criticisms that solicitation impairs: (1) the
competi- tive position of smaller auditors relative to Big 8 auditors (Chaney
et al.1995) and (2) audit quality.

1 The term "Big 8" (as opposed to "Big 6") is used throughout the
remainder of the paper because our sample observations were drawn
from periods preceding the merger of Deloitte, Haskins and Sells
and Touche Ross into the firm Deloitte
& Touche, and the merger of Ernst and Whinney and Arthur Young
into the firm Ernst & Young.
2 The auditee' s desire for higher audit quality (or lack thereof) is a
complex issue, as clients prefer a standard opinion but also wish to
avoid liability losses; see Simunic (1980) for a model that recognizes
the interdependence of auditee and auditor economic interests.
3 For a complete description of specific states allowing and banning
solicitation in each year, see Jeter and Shaw (1995).
For additional facts regarding specific court cases, see Chaney et al.
(1995).
4 For example, the Antitrust Division of the Justice Department has
argued that the alignment between clients and audit firms in allowed
markets reflects more fully the available information regarding fees and
services as compared to banned markets.
181 The Accounting Review, July 1997
Chaney, Jeter and Shaw-Client-Auditor Realignment and Restrictions on
Auditor Solicitation 435

as measured by the auditor's decision to issue nonstandard opinions

(Jeter and Shaw 1995). Jeter and Shaw (1995) model auditors' issuance
of nonstandard audit reports in banned and allowed markets and find
that auditors in the allowed market are more likely than those in the
banned market to issue a nonstandard report when one is warranted.
In this paper we provide additional insight into the effects of
solicitation by comparing
realignment decisions in states allowing direct solicitation to
realignment decisions in states banning direct solicitation. We assume
that the client has imperfect information regarding the relative
efficiency of the incumbent and nonincumbent auditors. The client
obtains information about possible auditor misalignment, i.e., available
audit firm economies, in one of two mutually exclusive ways: (1) the client
invites nonincumbent proposals, or (2) nonincumbents engage in direct
solicitation. The following sections discuss the conditions required
for misalignment: availability of net economies and the invitation
condition.

A vailable Net Economies

As seen in figure 1, the client realigns only when net economies are
available and the client obtains the information necessary to recognize
their availability. Net economies are defined as the cost savings from
switching auditors less any transaction costs incurred in realignment.
Audit economies occur when the incumbent's avoidable costs of
providing the audit (including any opportunity costs) exceeds that of
one or more nonincumbents.
Cross-sectional differences in audit firms' client-specific
avoidable costs may reflect
clientele differences (product mix) or differences in audit technologies
(see, Deis and Giroux
1992; Eichenseher 1984; Danos and Eichenseher 1982; Gigler and Penno
1995). Johnson and Lys (1990) argue that audit firms with similar
production technologies will attract similar clients. Over time, the low-
cost auditor for a particular client may shift because of changes in
client characteristics and/or changes in auditor technologies,
specializations, etc. (Gigler and Penno
1995). Differences in audit technologies do not imply a general
superiority or greater efficiency for any audit firm but may well suggest
that certain technologies are better suited (and thus less costly) to a
Chaney, Jeter and Shaw--Client-Auditor Realignment and Restrictions on Auditor Solicitation 182
particular client at a particular point in time.f Johnson and Lys (1990)
document evidence of an association between exogenous changes in
client characteristics and realignment wi th low-cost audit firms, where the
relati ve size of predecessor and successor audit firms proxies for relative
audit costs.

The Invitation Condition

If the client invites proposals from nonincumbent auditors, the client
will obtain information and make a decision to realign or to not realign.
Thus, the potential benefits of direct solicitation rest on the assumption
that clients do not always invite because invitation is costly. As shown in
the italicized branches of figure 1, if the client does not initiate the
invitation process, the solicitation rules can have a direct bearing on the
realignment (switching) outcome. The client's initial decision to invite
(or to not invite) proposals depends on the client's expectations about
nonincumbent fees, and realignment and invitation costs. The client will
invite if the incumbent's audit fee is greater than the client's expected total
costs of realignment; otherwise the client will not invite. If a client in a
banned market chooses not to invite and net economies are available, the
client will retain the incumbent auditor and suffer efficiency losses from
being aligned with an auditor who is not the low-cost auditor.

5 If the assumption of constant audit quality across the Big 8 is relaxed.

auditor switches could be explained in terms of higher audit or service
quality instead of cost savings.

If at least one lower-cost nonincumbent approaches the client in an

allowed market, the client may invite bids from several auditors. Thus,
solicitation may actually serve to initiate invitations which otherwise
would not occur. Given that both clients and auditors change over
time, continuous invitation would be necessary to assure alignment of
each client with its lowest-cost auditor. Direct solicitation reduces the
expected costs of invitation by reducing the likelihood of completely
fruitless invitations. Once the firm has been approached by an auditor
offering a lower fee, the client can invite other bids with certainty that at
least one auditor can do the job for less.
In summary 'I misalignments can occur in banned markets because
(1) clients do not issue open or specific invitations for audit firm
proposals and (2) available audit economies exist such that the client
would realign if the client had information regarding the relati ve
efficiency of the incumbent and a less costly nonincumbent. The
ability to discern empirically a difference between banned and allowed
183 The Accounting Review, July 1997
markets depends on the frequency with which these two conditions are
satisfied. Evidence of greater realignment activity in the allowed
market than in the banned market is consistent with the existence of
economic benefits (losses) for clients in allowed (banned) states.

III. HYPOTHESIS AND EMPIRICAL

MODEL
This study tests the null hypothesis that realignment decisions do not
differ between markets banning direct solicitation and markets allowing
direct solicitation. Our dependent variable, client realignment, is
measured as an indicator variable set equal to 1 if a realignment occurs
and
o if the client retains the incumbent auditor. Our independent variable of
primary interest is the
direct solicitation rule in the client's primary place of operations. This
variable is set equal to I if direct solicitation is allowed in the client's
principal place of business activity in the current period and 0 otherwise.
Our test procedures control for other variables that are expected
to be associated with
realignment. Johnson and Lys (1990) document an association
between realignment decisions and measures of client growth, changes
in client operations and changes in clients' financing activities.
Drawing upon their findings, we expect realignment activity to be related
to (a) changes in auditee characteristics, (b) characteristics of the
incumbent auditor, and (c) costs associated with realignment. Hence,
we include variables to control for these potential effects in our
regression.

Client Change
Internal growth or change is expected to increase the probability
that a client will change auditors, even if that client was correctly
aligned with its low-cost auditor before such growth or change. Changes
in client operations can erode the incumbent auditor's competitive
advantage that stems from the incumbent being familiar with the client's
operations and reporting systems. If the client experiences rapid
growth, consequent increases in complexity of operations and
financing are likely to disrupt the cost advantage of the incumbent,
and another auditor could become the low-cost provider. A client
experiencing severe contraction is also a potential candidate for
realignment, as a nonincumbent could be better suited for the client's
new scale of operations. Similarly, a change in profitability could
indicate that a change in auditor is desirable. For example, a poor return
on assets is expected to serve as a leading indicator of contraction
Chaney, Jeter and Shaw--Client-Auditor Realignment and Restrictions on Auditor Solicitation 184
(Johnson and Lys 1990) while an increasing return on assets serves to
indicate future expansion. Clients planning major security offerings often
realign to take advantage of an auditor viewed as having expertise
and/or reputation deemed beneficial in obtaining the external
financing. We expect a positi ve relation between realignment and each
of the following variables that reflect changing auditee characteristics,
measured as absolute values:
(1) asset growth after the realignment decision (if the change in
operations is anticipated by the client, then client-initiated realignments
will be more strongly related to growth measured after the decision than
to growth measured before the decision date );6
(2) the change in return on assets from the pre-realignment
decision period to the post- realignment period;
(3) the change in new financing from the pre-realignment
decision period to the post- realignment period.

Incumbent Auditor Characteristics

When an auditor specializes in particular industries or has special
expertise or technologies suitable for the prospective client, that auditor is
likely to possess a competitive advantage over other auditors (Eichen
seher 1984; Danos and Eichenseher 1982; Johnson and Lys 1990). We
include the incumbent auditor's market share within the client's industry
as a proxy for incumbent auditor characteristics indicative of
specialization skills. This variable is measured as the percentage of
total sales in the client's industry which was audited by the incumbent
auditor in the year preceding the year of the realignment decision. We
predict a negative relation between this variable and realignment
activity. Alternative measures of auditor concentration are also
computed and are summarized in the results section.
Realignment Costs
Net economies from realignment are inversely related to the
transactions costs incurred in realignment. Start-up costs incurred by a
nonincumbent auditor and realignment costs incurred by the client
(subsequent to the realignment decision) are likely to be associated with
the audit risk and complexity of the client's balance sheet accounts and
the quantity of client transactions. As proxies for transactions costs, we
include two variables associated with the complexity of the client's
operations (client size, measured as the log of net sale, and an indicator
variable set equal to 1 if the client is involved in foreign operations) and
two variables associated with the risk to the auditor (receivable
intensiveness, measured as accounts receivable divided by inventories;
and inventory intensiveness, measured as inventories divided by net
sales)." Firms with high levels of recei vable or in ventory intensi veness
185 The Accounting Review, July 1997
are expected to incur increased real ignment costs, as these measures
indicate a degree of uncertainty about asset collectibility. Such
uncertainty indicates greater audit risk (Simon and Francis 1988; Bell and
Tabor 1991) and potentially greater start-up costs upon realignment. We
predict a negative relation between these transaction cost proxies and
realignment activity.

Realignment Model
The realignment model is (firm-specific subscripts have been
omitted for convenience):
R = ao + aIDS + a2GrowA + a3dRA +
a4dNFin + a.Mktshr
+ a6Size + a.Recint + aglnvint + a9For + e
(1)
where:

R = a variable that equals 1 if a realignment occurs and 0 if

the firm retains the incumbent;
DS a variable that equals 1 if direct solicitation is allowed
in the firm's principal
place of business activity in the current period and 0
otherwise;

6 We alternatively included a variable for asset growth before the

realignment decision in our logistic regression, but the coefficient was
insignificant and is not reported. Other variables were essentially
unaffected.
7 These measures of intensiveness are the same as used in Bell and
Tabor (1991).
Chaney, Jeter and Shaw--Client-Auditor Realignment and Restrictions on Auditor Solicitation 186

GrowA the log of the absolute value of the continuously

compounded annual rate of growth in total assets over the
four years after the current year;
LlRA the log of the absolute value of the change in the return
on assets where the
change is measured as the difference in average return on
assets for the fi ve years preceding the current year and
average return on assets for the four years following the
current year;
~Fin = the log of the absolute value of the change in new
financing where the change
is measured as the difference in average new financing
(divided by total assets)
for the four years following the current year and the five
years preceding the
current
year;
187 The Accounting Review, July 1997

Mktshr the proportion of industry sales (two-digit SIC code

= level) audited by the incumbent auditor in the previous
year;
Size the log of net sales, measured in 1982 dollars;
= the receivable intensi veness of the firm, measured as the
Recint ratio of recei vables to inventory;
= the inventory intensi veness of the firm, measured as the ratio
of inventory to net
Invint sales; and
= a variable that equals 1 if the firm engages in foreign
operations; 0 otherwise.
For
=

Logistic regression analysis of the model presented in equation (1)

is used to test a null hypothesis that the likelihood of realignment does
not differ between clients operating in banned and allowed markets. The
significance of the direct solicitation (DS) coefficient is a direct test of the
null hypothesis. A positi ve association with the likelihood of realignment
is expected for the solicitation variable (DS) and each of the change
variables (asset growth (GrowA ), the change in return on assets (i.1RA)
and the change in new financing (i.1NFin)). A negative association with
the likelihood of realignment is expected for the auditor's market share
variable (as a measure of the incumbent's degree of specialization in the
client's industry) and for the transactions costs
variables (Size, Recint, Invint, For).

IV. SAMPLE SELECTION AND DATA

COLLECTION
We estimate the logistic regression using a pooled time-series cross-
sectional sample of Big
8 audit firm clients drawn from banned and allowed markets. We requested
information on direct solicitation rules from each of the 50 state boards.
We asked for copies of the Code of Ethics provisions regarding direct
solicitation and advertising in effect in 1975 as well as copies of
amendments to these provisions in periods subsequent to 1975.
Twenty-five states responded with usable information covering all years
1975 through April 1989. Other states responded with partial information,
and the remainder of the information was obtained from 1984 and
1989 editions of Commerce Clearing House's Accountancy Law Reports
(1984, 1989). For those states and years for which we had information,
Chaney, Jeter and Shaw--Client-Auditor Realignment and Restrictions on Auditor Solicitation 188

table 1 summarizes the number of states in which solicitation was

banned and the number of states in which solicitation was allowed by year
(1980 through 1988).8 See the appendix for additional information on
the insti tutional background of direct solicitation in the U.S.
The sample of firms was selected from the Compustat Annual
Industrial Tape for the years
1980 through 1988. Observations were assigned to banned and
allowed markets using the

8 We followed up with repeated questionnaires and phone calls, but

the phone calls were uninformative. We attempted to locate a source to
fill in the missing information from any services which might be
available, including Commerce Clearing House, Prentice Hall, the
AICPA and the National Association of State Boards of Accountancy.
We were not successful at locating such a source. Thus, we rely
primarily upon the information provided in the questionnaires.
 TABLE
1
Summary of State Direct
Solicitation Rules
Number of States Allowed and Banned:
1980-1988

Policy 1980 1981 1982 1983 1984 1985 1986 1987 1988
Allowed 6 6 9 10 19 21 23 31 3
Banned" 19 17 17 14 14 12 10 9 8
Oral 1 2 2 3 3 4
Banned"
"Number of states in which all forms of direct solicitation were
prohibited.
bNumber of states in which oral direct solicitations were prohibited and
written direct solicitation was allowed.

National Bureau of Standards' Federal Information Processing

Standards (FIPS) state code, a code that designates the principal
location of a company's operations." Companies operating in states
during years for which direct solicitation rule information was unavailable
were excluded, as were corporations with principal locations in foreign
countries.
With the exception of the direct solicitation variable, measures for all
variables were obtained using Compustat annual data. Realignments
were identified using Compustat's auditor codes. Each Big 8 audit firm
is uniquely identified by Compustat. Two consecutive years of audit
firm information were required to identify realignment. The realignment
year for a client switching within the Big 8 market was defined as the year
in which the auditor code changed from one Big
8 code to another Big 8 code. 10
The final sample includes 12,442 observations after the following
deletions: (1) companies operating in states prohibiting only oral direct
solicitation (mainly Florida), (2) companies operating in states in years
where the rule changed from prohibiting direct solicitation to allowing
direct solicitation, and (3) companies with missing dependent or
independent variable information. I I
 V.RESUL
TS
Table 2 presents the numbers of sample observations by market and
by year for the sample and tests for differences in the percentage of clients
realigning in the banned and allowed markets. As increasing numbers of
states relaxed their market restrictions (see table I), the number of
observations in the allowed category increased over the nine-year
period. During 1980 through
1982, more clients operated in banned markets than in allowed markets.
In 1984, the number of clients operating in allowed markets slightly
exceeded those operating in banned markets. By
1986, about twice as many clients operated in allowed markets as in
banned markets.

9 This location is defined to include the company's headquarters. To

verify the Compustat classifications, we manually examined a sample
offirms' locations (headquarters) and found the Compustat
classifications to be highly reliable. lOIn cases where the company's
fiscal period was not a calendar year, we eliminated any fiscal period
which extended
into the year of the change in policy for the firm's state.
11 In reconciling our initial sample of firms with our final sample, a
summary of the numbers of firms at each stage is as follows: 31,877
Big 8 clients on Compustat with information as to state and auditor
(between 1980 and 1988)~ minus
7,935 firms with unavailable direct solicitation policy information;
minus 465 firms in states changing from banned to
allowed in a given year; minus 1,856 clients in states where oral
solicitation was banned but written allowed; minus 118 other; minus
9,061 firms with missing Compustat variable information needed in
our analysis yields a final sample of
12,442 observations.
 TABLE
2
Comparison of Realignment Activities in the Banned and
Allowed Markets

Banned Market
Allowed Market

Total Num Tot

Num ber al
Firms
Year ber
12 Percentag
1.84 651 11 Percentag
1.93 569
1980
1981 9 1.44 625 14 2.58 542
1982 7 1.11 629 11 2.04 539
1983 6 1.03 585 10 1.74 575
902
1984 1 1.73 579 25 2.77
1985 1 1.87 535 28 3.07 912
1986 11 2.20 499 27 2.98 906
1,159
1987 13 2.95 440 42 3.62
1988 11 2.43 453 47 3.50 1,342
2.89 7,446
Total 89 1.78 4,996 215
Test of Proportions
Pearson Chi- 15.344
Probability (Chi- 0.000
square)

Realignment activity increased during the 1980s in both markets.

As seen in table 2, the realignment acti vity in the allowed market
expressed as a percentage of total clients exceeds that in the banned
market in every year. The Pearson Chi-square (15.34) is significant at
the 0.001 level, indicating significantly more switches in the allowed
market than in the banned market.
Table 3 presents summary descriptive statistics for variables used in
the logistic regression. Descripti ve statistics and tests of mean and median
differences are presented for realigning and non-realigning groups and
for clients operating in banned and allowed markets. Panel A of table
3 compares the variables in the realignment and non-realignment groups.
Over 70% of the clients that switched auditors were in the allowed market,
while 59.6% of the non-realigning clients were in the allowed market. The
mean and median values for changes in growth, earnings and financing are
larger for the realigning group than for the group of clients retaining
their audit firms, confirming the expectation that clients undergoing
change are more likely to switch auditors. There is no significant
difference in the incumbent auditor's market share for the realigning and
non-realigning groups. Consistent with previous research, clients
switching auditors tend to be smaller than clients retaining their existing
auditor, but there are no significant differences in inventory and
receivables intensiveness for the two groups. Finally, panel A of table 3
indicates that clients switching auditors are less likely to be involved in
foreign operations than the clients who do not switch auditors.
Panel B of table 3 compares the variables in the banned and allowed
markets. The change variables are not consistent across markets; the
change in return on assets is smaller in the allowed
 TABLE
3

Comparison of Variables for Non-Realigning and

Realigning Clients and for Banned Market and
Allowed Market Clients

Panel A: Variables by Client Realignment Status

Non- Realig Te
Realigning ning st
Sample Size 12,138 30
Variables Mea Median Mea Median Means Media
DS ns
0.59 s ns
0.70 s 15.344* ns
Realignment 0.00 1.00
GrowN 0.08 0.103 0.12 0.143 - -
~Ab 0.03 0.036 0.05 0.060 - -
dNFin h 0.04 0.050 0.06 0.078 - -4.761
Mktshr (Sales) 0.14 0.099 0.14 0.104 0.771 0.954
Mktshr 0.1 0.097 0.13 0.097 0.747 0.249
Size" 127.4 112.618 48.0 41.372 8.790* 7.891
Invint 0.1 0.146 0.16 0.147 0.585 0.009
Recint 2.1 0.991 2.66 0.983 -0.124 -0.227
For 0.3 0.18 19.855*
03 4 *
Panel B: Variables by State Solicitation Status

Bann Allo Test

ed wed Statist
Sample Size 4,9 7,446 "
Variables Mea Median Means Median Means Media
ns s 1.000 s ns
DS 0.0
Realignment 0.Q 0.029 15.344**
GrowAb 0.0' 0.101 0.089 0.107 -2.351 * -1.938
~Ab 0.0 0.037 0.032 0.036 0.949 1.206
dNFin b 0.0 0.046 0.044 0.054 -4.196** -
Mktshr (Sales) 0.1 0.095 0.145 0.102 -1.853 -
Mktshr 0.1 0.093 0.143 0.099 -2.840** -
Size" 131.5 124.213 119.83 101.210 2.519* 4.162
Invint 0.1 0.138 0.173 0.151 -4.466** -
Recint 2.2 1.027 2.090 0.969 2.236* 3.869
For 0.3 0.299 0.075
01 (Continued on next page)
Chaney, Jeter and Shaw-Client-Auditor Realignment and Restrictions on Auditor Solicitation 187

TABLE 3
(Continued)

** Significant at the 0.01 level.

* Significant at the 0.05 level.
A t-test is used to test for differences in means and the Wilcoxon rank
sum test is used to test for differences in medians.
For dummy variables a Chi-square test is used.
b These variables are presented in non-log form in this table, although
defined as log-transformed variables throughout
the remainder of the paper.
OS = a dummy variable that equals 1 if direct
solicitation is allowed in the firm's principal place of
business activity in the current period and 0 otherwise;
Chaney, Jeter and Shaw-Client-Auditor Realignment and Restrictions on Auditor Solicitation 188

Realignme a dummy variable that equals 1 if a realignment occurs

nt (R) and 0 if the firm retains the incumbent; the log of the
GrowA absolute value of the continuously compounded annual
rate of growth in total assets over the four years after the
~RA current year;
the log of the absolute value of the change in the return
on assets where the change is measured
~NFin as the difference i'n average return on assets for the
five years preceding the current year and average return
Mktshr on assets for the four years following the current year;
(Sales) the log of the absolute value of the change in new financing
Mktshr where the change is measured as the
(Assets) difference in average new financing (divided by total
Size assets) for the four years following the current year and
Recint the five years preceding the current year;
Invint the proportion of industry sales <two-digit SIC code level)
For audited by the incumbent auditor in the
previous year;
the proportion of industry assets (two-digit SIC code
level) audited by the incumbent auditor in the previous
year;
the log of the net sales, measured in 1982 dollars;
the receivable intensiveness of the firm, measured as the
ratio of receivables to inventory;
the inventory intensiveness of the firm, measured as the
ratio of inventory to net sales;
a dummy variable that equals 1 if the firm engages in
foreign operations. 0 otherwise.

market while the change in growth and the change in new financing
are smaller in the banned market. The incumbent auditor's market share
is larger in the allowed market than in the banned market. Clients are
slightly larger and more receivables-intensive in the banned market,
while clients in the allowed markets are more inventory intensive.'?
Differences across banned and allowed markets in variables expected
to influence realignment activity indicate the need for multi variate
analysis. Consequently, we turn to the results of the logistic regression.
Results of the logistic regression are reported in table 4. The
significance of the direct solicitation variable (DS) is a direct test of the
Chaney, Jeter and Shaw-Client-Auditor Realignment and Restrictions on Auditor Solicitation 189

null hypothesis after controlling for other factors related to realignment

decisions. As predicted, the coefficient for the direct solicitation variable
is positi ve and significant at 0.00. This documentation of the existence of
realignment differences is consistent with the argument that misalignment
efficiency losses may be present in banned
markets. As expected, the coefficients of the change variables Grow A
and ~RA are positi ve and
significant at the 0.01 level, while the change in new financing ~NFin is
positive and significant at 0.07.13
Three of the four variables proxying for realignment costs have
negative coefficients as predicted; size and inventory intensi veness are
significant at 0.00 and 0.05 respecti vely, while the variable for involvement
in foreign operations is significant at 0.06 and receivable intensiveness
is not statistically significant. The logistic regression was also estimated
with alternati ve size and complexity measures based on total assets, the
sum of total assets and liabilities, and the sum of revenues and expenses.
The results were similar to those reported in table 4. We also estimated

12The correlation matrix among independent variables (not reported)

indicates some statistically significant correlations, but no correlation
exceeded 0.36 in absolute value. Estimated signs and significance of
the coefficients are generally insensitive to the inclusion or exclusion
of the other independent variables.
l3We also estimated the model using non-logged data except for the
size variable, and the results were qualitatively unchanged.
 444 The Accounting Review, July 1997

the logistic regression with the intensiveness variables measured as

receivables divided by total assets and inventory divided by total assets,
as well as receivables divided by net sales. Results were consistent with
those reported.
Contrary to our prediction, the coefficient on the incumbent's
market share variable is positive (although not significant). A positive
coefficient would suggest that clients whose incumbent auditors have
a larger share of the industry are more likely to switch. Alternative
measures of auditor concentration were substituted for the market share
variable, including the percentage of total assets in the client's industry
which were audited by the incumbent auditor in the preceding year, and
an indicator variable set equal to 1 if the incumbent auditor is the leader
or second in the industry. Results are consistent with those for the reported
market share variable. In each case, the coefficient on the market share
variable was insignificant but its sign was opposite than that predicted.
This suggests that measures of incumbent market share do not capture
all the relevant characteristics considered in the optimal alignment of
client and auditor; for example, clients may be involved in multiple
industries, or individual differences among clients unrelated to industry
may make one auditor more appropriate than another. Also, we note that
the use of two-digit SIC codes to measure market share may fail to capture
meaningfully the incumbent's degree of specialization.

TABLE
4
Logistic Regression
Results
Effect of Direct Solicitation on
Realignment Decisions

Predic Parameter Stand

ted Estimate ard Probab
Variable
Intercept - 0.241 ility0.00
DS + 0.47 0.128 0.00
GrowA + 0.13 0.055 0.01
~A + 0.15 0.049 0.00
ilNFin + 0.06 0.043 0.07
5
 Mktshr (sales) 0.32 0.416 0.44
Size - 0.037 0.00
Recint 0.00 0.014 0.26
Invint - 0.448 0.05
For - 0.159 0.06
0.24
Sample Size 12,442
.19
Model R
Model Chi- 121.82
Model 0.00
Concordant 66.9%
Pairs
Variables are defined in table 3.
Chaney, Jeter and Shaw-Client-Auditor Realignment and Restrictions on Auditor Solicitation 189

The measure of concordant pairs reported in table 4 is an estimate

used in assessing the predictive abilty of the model; the higher the
concordant number of pairs, the better the predicti ve ability of the model.
Input observations with different responses (in this case realignment or
no realignment) are paired. The pair is said to be concordant if the
predicted values from the logistic regression match the actual
realignment decisions; that is, if the larger response has a lower
predicted event probability than the smaller response, where an event
response is defined as the response whose ordered value is 1.
In summary, our results reveal that client changes in growth, rate of
return, and external
financing are positively associated with client realignment. These
findings are consistent with previous research (Johnson and Lys
1990) and indicate that clients undergoing changing operations are
more likely to have available economies from realignment. Three of our
control variables for transactions costs (size, inventory intensiveness
and involvement in foreign operations) are negatively associated with
client realignment, while the other one (receivable intensiveness) is
insignificant. This negative association is consistent with our
predictions, as transactions costs reduce the net economies from
realignment. Most importantly, given the objective of this paper, our
results indicate that there is more realignment activity in allowed than in
banned markets. We interpret this finding as indicating that bans on direct
solicitation represent
a friction that inhibits the efficient alignment of auditors and clients.
Two issues merit further attention. First, alternative specifications of
the sample or empirical model are considered. Second, these results are
compared and contrasted to earlier research finding no difference in
realignment activity between banned and allowed markets for switches
from non-Big 8 to Big 8 auditors. The following sections address these
concerns.

Alternative Sampling or Empirical Specifications

The purpose of this section is to test the robustness of the results
presented in table 4 to alternati ve specifications. We consider alternate
samples, a test limited to states which changed solicitation policy during
our test period, an extension into the 1990s to control state-specific
factors, inclusion of interactive variables, and industry effects.
As mentioned previously, the results presented in table 4 excluded
observations from the state of Florida because this state's solicitation
policies were unique (e.g., banned oral solicitation only). However, the
unique policies in Florida are viewed by some as particularly restrictive
190 The Accounting Review, July 1997
in terms of using regulation to reduce competition. For example, in
Florida a client could only negotiate with one auditor at a time (rather
than a group of competing auditors) and had to completely cut off
negotiations with the first auditor before commencing negotiations
with another auditor. Thus, we present the results in table 5, panel
A, of our regression with observations from Florida included
(classified as a banned state). The results are essentially unchanged,
except that the variable for involvement in foreign operations is no longer
significant.
As a further test of the robustness of the logistic regression to
alternative sample selection
criteria, we estimate the regression excluding observations not only
from Florida, but also from two other important states, Texas and
California. Texas was one of the last states to lift its ban on solicitation
(and banned solicitation throughout our entire test period). In contrast,
California allowed solicitation throughout our entire period. As large
numbers of firms were located in these two states, neither of which
changed its solicitation policy during our test period, we wanted to
determine if these states had a strong and unrepresentative influence on
the results reported in table 4. These results, presented in table 5, panel B,
are essentially unchanged from those reported in table 4. The only
differences in this specification are that the variable for inventory
intensiveness is not significantly different from zero while the foreign
involvement variable is significantly negative with a p-value of 0.03.
In summary, the inclusion or exclusion of these
Chaney, Jeter and Shaw-Client-Auditor Realignment and Restrictions on Auditor Solicitation 191

TABL
ES
Logistic Regression Results Under Alternative
Sampling Specifications

R=ao + a1DS + a2GrowA + a3L1RA + a4LlNFin + asMkshr + a6Size +

a.Recint + a.Lnvint + a.For + e
Panel A: With Florida Added

Predicted Parameter
Variable Sign Estimate
Probability

Intercept -2.022 0.00

DS + 0.368 0.00
GrowA + 0.099 0.03
8RA + 0.144 0.00
8NFin + 0.082 0.01
Mktshr (sales) 0.246 0.27
Size -0.201 0.00
Invint -0.661 0.05
Recint 0.004 0.33
For -0.036 0.40

Sample Size 12,890

Model R Statistic .19
Model Significance .00
Concordant Pairs 67.0%

Panel B: Without Florida, Texas, California

Predicted Parameter
Variable Sign Estimate
Probability

Intercept -2.099 0.00

DS + 0.571 0.00
192 The Accounting Review, July 1997
GrowA + 0.239 0.00
8RA + 0.148 0.01
8NFin + 0.117 0.02
Mktshr (sales) -0.244 0.34
Size -0.120 0.01
Invint -0.634 0.13
Recint 0.009 0.32
For -0.406 0.03

Sample Size 8,503

Model R Statistic 0.21
Model Significance 0.00
Concordant Pairs 68.6%

Variable definitions are the same as in table 3.

In table 4, observations from Florida were excluded but observations
from Texas and California were included.
Chaney, Jeter and Shaw--Client-Auditor Realignment and Restrictions
on Auditor Solicitation 447

TABLE
6
Auditor Switches Before and After the Year of the Change in
Solicitation Policy

Mean Percentage of
Firms Switching
Before Change After Change
T-test Prob.

Within three years of policy 1.55% 3.08% -1.490 0.0

Within five years of policy 1.34 3.2 -2.280 0.0
Within seven years of 1.19 3.4 -2.923 0.0
policy change 1 02

states in the analysis does not alter the basic finding that switches
occur more frequently in allowed states than in banned states among
Big 8 auditors.
Next, we limit our sample to those states for which we have
information related to the year of the change in solicitation policy and
compare the realignment rates before and after the year of the change.
Table 6 presents the mean rates for three-, five- and seven-year periods
before and after the year of the change in solicitation policy. In each
comparison, there were more switches after the change than before
(significantly more for the five- and seven-year comparisons). The
interpretation of these findings must be tempered by the realization
that realignment rates increased during the 1980s in both banned and
allowed markets, as indicated in table 2. However, the increase was more
dramatic in those states which changed solicitation policy. The increase
was over three times greater in the states which changed solicitation
policy as compared to states which did not change their policy over the
same time period. For samples of firms in states which did not change
solicitation policy, the mean switching rate increased by about 40-45
percent (from 1.46% for five "before" years to 2.07% for five "after"
years for the "banned throughout" sample; and from 2.36% to 3.44% for
the "allowed throughout" sample). In contrast, the increase was 141 % for
the change sample (from 1.34% before the change to 3.23% after). 14
We conduct another test aimed at controlling state-specific factors
that may intluence the tendency of firms to switch auditors. Recognizing
the possibility that the environments of states that banned and allowed
solicitation during our test period might differ in ways unrelated to
solicitation policy, we compared switching rates between the two sets of
states in a time period when all states allowed solicitation. As indicated
in the appendix, all states lifted the ban on solicitation by the early
1990s. Therefore, we computed the percentage of switches in the years
1992 and 1993, but we categorized the observations from each state
based on the state's former (1983) status as allowed or banned. If we still
found differences in those years, it would suggest that a force other than
solicitation was at work. In 1992, switches in the market labeled as
allowed in 1983 were slightly higher than in markets labeled as banned in
1983. However, the difference was not significant, based on the Pearson
Chi-square. In 1993 the pattern reversed, with slightly more switches that
year in the group labeled as previously banned than in the previously
allowed group; again the difference was not significant. We repeated the
comparison using 1984 categories (instead of 1983), with similar results.
15

14We further considered the effect of time by adding indicator variables

for time periods (years) to our logistic regression specified in equation
(1); the sign and significance of the direct solicitation variable were
not altered.
15To expand this test into a multivariate setting, we selected the years
1991-92, classified states based on their 1983-84 allowedlbanned
status, and measured the control variables from equation
(1) over two years instead of four where necessary (since we did not
have data for four years after 1992). Again we found no difference in
realignment activity between the markets previously labeled as banned
and allowed. The coefficient on DS was -0.005, with a p-value of
0.78. This provides some assurance that the difference in realignment
activity shown in table 4 is not due to variables omitted from our
analysis.
192 The Accounting Review, July 1997

To consider the possibility that a disproportionate number of switches

occur in the first years after a state begins to allow solicitation, we
estimated the logistic regression with an additional indicator variable
coded 1 if the current year is within three years!" of the change and 0
otherwise. The DS variable was significant (positive), but the
additional indicator variable was not significant. Thus, we conclude
that there are not a disproportionate number of switches in the first few
years after the change, compared to later years. One possible explanation
is that auditors do not take full advantage of the opportunity to solicit
clients right away after the change in policy.
We also estimated our logistic regression with the addition of interacti
ve variables to control for potential interaction between direct solicitation
policy and each of our categories of control variables: "change" variables,
realignment or transactions costs variables, and incumbent auditor
characteristics. Given that solicitation is most likely to make a difference
in circumstances where: (1) a given client does not invite (the probability
of invitation is low), and (2) net economies are available, predictions are
not clearcut for interactive variables. The variables designed to pick up
potential interactive effects between client change or transactions costs
and solicitation policy were not statistically significant. As clients with
high change levels and/or low transactions costs may be more likely to
benefit from switching, but also more likely to invite, these countervailing
forces may be operating and offset each other. More importantly, the
inclusion of the interactive variables did not alter the sign or significance
of the variables of interest.
Another approach to predicting interacti ve effects is to identify client
characteristics likely to be targeted by nonincumbent auditors in the
allowed market, as solicitation policy is most likely to make a difference
when nonincumbent auditors target a gi ven client as a prospect for their
direct solicitation efforts in the allowed market. For example, auditors
may target clients which are not currently aligned with the "specialists"
for their industry .17 Also, auditors are more likely to target growing clients
than shrinking clients, if growth is perceived as indicating future account
size and health. The variables aimed at picking up interactive effects
between solicitation and client characteristics likely to be targeted by
nonincumbent auditors were not significant at conventional levels. Again
the coefficient on DS was not affected by the inclusion of the interactive
terms.
In the event that switches occurred with greater frequency within
certain industries, we also control for potential industry effects. Forexample,
ifindustry classification captures additional factors that reflect the
complexity or costliness of switching, then we might see fewer switches
in some industries than others. We repeated regression equation (l) with
Chaney, Jeter and Shaw-Client-Auditor Realignment and Restrictions on Auditor Solicitation 193
the addition of indicator variables for industry classification. For
purposes of this test, we divided industries into 17 two-digit SIC code
groups. Three of the groups had significantly more or fewer switches than
our comparison group, the services industry, after controlling for other
factors associated with auditor switching.!" The coefficient for the direct
solicitation variable remained positive and significant at 0.00 1, pro- viding
additional support for the argument that misalignment efficiency losses are
present in banned markets. Industry classification may pick up some of the
effects related to available economies from switching. The conclusions are
robust regarding the effect of solicitation on switching.

16We tried other cutoffs, such as w'ithin one or two years of the change,
but the variable was not significant. Thus. we find no evidence of
relatively more frequent switches in the early years after the policy
change than in later periods.
17Por many industries there may not be a single "specialist," and
industry share may be fairly equally divided among several auditors.
We use the term "specialist" loosely to indicate those auditors with
the heaviest concentrations of clients, client assets or client sales in a
particular industry.
181nparticular, we find evidence of significantly more switches in
wholesalers (SIC codes 5000-5299) at the 0.0 I level;
and transportation and public utilities (SIC codes 4000-4999) at the
0.10 level; and significantly fewer switches in instruments and
miscellaneous manufacturing (SIC codes 3800-3999) at the 0.05
level, all in comparison to services (SIC codes 7000 up). We examined
a distribution of each SIC code by banned and allowed market and
found that most industries (including the four mentioned above) were
represented very close to our overall proportions (40 percent in the
banned market and 60 percent in the allowed market).
194 The Accounting Review, July 1997

Comparison of Big 8 to Big 8 vs. Non-Big 8 to Big 8

The finding that auditor switches within the Big 8 are greater in the
allowed market than the banned market contrasts with research showing
that switches from non-Big 8 to Big 8 auditors are no more likely in the
allowed market than in the banned market (Chaney et al. 1995). One
explanation for these contrasting findings is the possibility that Big 8
auditors engage more actively in soliciting clients audited by other Big
8 auditors than those audited by non-Big 8 auditors, or that solicitation
efforts by large auditors are more successful among clients already
audited by a Big 8 auditor. It is also likely that the motivation for
realignment decisions within the Big 8 is different than the motivation for
changing to a Big 8 from a non-Big 8 auditor. Prior research (Johnson
and Lys 1990; Francis and Simon 1987; Palmrose 1986, 1988) suggests
that clients realign from non-Big 8 to Big 8 auditors to be associated with
the larger auditors' brand names or to take advantage of economies of
scale. Such switches are more likely to be initiated by the client (rather
than by a nonincumbent auditor) than switches among Big 8 auditors.
Further, several studies (Balvers et al. 1988; Palmrose 1988; DeAngelo
1981) suggest quality distinctions between non-Big 8 and Big 8 auditors.
Certainly switches from non-Big 8 to Big 8 Auditors occur more frequently
(averaging six to seven percent per year) than switches among Big 8
auditors. 19
However the prior evidence suggests that switches from non-Big 8 to
Big 8 are not influenced significantly by a state's solicitation policies.
Table 7, panel A presents descriptive data related to the size of firms
included in this study
in comparison to the size of firms in the earlier study. Not surprisingly,
both the mean and median values of firms in the Big 8 to Big 8 study are
significantly larger than in the non-Big 8 to Big 8 study. The comparison
of median firm size is particularly striking. For example, in the banned
market the median size of the firms in the earlier study was $8.78 million,
while the median firm size in the banned market is $124.21 million for the
current study. Similarly, the median firm size in the allowed market in the
earlier study was $9.14 million, while the current study's median size is
$101.19 million.
To consider the effects of solicitation on large versus small firms in
our Big 8 sample, we estimate our logistic regression with the addition
of an interactive variable DS*Sz, where Sz is an indicator variable set
equal to 1 if a firm is in the bottom size quartile, 0 otherwise. (Firms in
the bottom quartile are comparable in size to those in the non-Big 8 to
Big 8 sample.) The results of this regression are presented in table 7, panel
B. The coefficient on direct solicitation is 0.542 (p-value < 0.01). The
Chaney, Jeter and Shaw-Client-Auditor Realignment and Restrictions on Auditor Solicitation 195
coefficient on the interactive variable DS*Sz is -0.421 (p-value < 0.05),
suggesting that for firms in the bottom quartile, the effect of solicitation
on realignment decisions
is significantly less than for firms in the top three quartiles. Further, the
effect of solicitation for firms in the bottom quartile, represented by the
sum of the DS and DS*Sz coefficients, is not significantly different
from zero.
This evidence suggests that the more frequent realignment activity
in the allowed market observed in the current study is related primarily to
firms in the upper three quartiles based on firm size. Thus, it appears that
solicitation is most likely to make a difference in switching decisions
among larger firms. We interpret this tentatively as suggesting that
auditors are more likely to direct their solicitation efforts toward larger
clients. This seems reasonable, as larger clients generally involve
higher audit fees and potentially greater profits to the auditors.

VI. SUMMARY AND CONCLUSIONS

The primary objecti ve of this research is to compare clients'
realignment decisions in markets permitting direct solicitation (allowed
markets) and markets prohibiting such practices (banned

19See Chaney et al. (1995, table 7).

196 The Accounting Review, July 1997

TABLE
7
Size Effects on the Impact of Solicitation on
Realignment Decisions

Panel A: Descriptive Size Comparisons

Chaney, Jeter and Shaw-Client-Auditor Realignment and Restrictions on Auditor Solicitation 197

Big 8 to Big 8 Non-

Banned Big 8 to Big 8
Markets:
Mean size (in
Millions) $ $ 68.465
Median size 131.63 8.779
1
124.2
13

Allowed
Markets:
$ $ 84.789
Mean 119.82 9.141
size 1
Median 101.1
size 90

Panel B: Logistic Regression Results

R = ao + aIDS = a2DS*Sz + a3GrowA + a4L1RA + a5LiNFin + a
Mktshr + a.Si:e
+ a Recint + a Invint + aJOFor + e

Predic Parameter Stand

ted Estimate ard
Varia 0.2 Probab
0.00
Interc -
DS + 0.54 0.1 0.00
DS*S - 0.1 0.01
Grow + 0.10 0.0 0.03
~RA + 0.14 0.0 0.00
~NFi + 0.08 0.0 0.0]
n 5 4
Mkts
Size 0.27
- 0.4
0.0 0.50
0.00
Recin 0.00 0.0 0.32
Invint - 0.4 0.04
For - 0.1 0.38
0.04 4
Samp Size
Model R 12,4
0.1927
Model Chi- 130.71
198 The Accounting Review, July 1997

Model .00
Concordant 66.8%
Pairs
All definitions are the same as those in table 3, with the
exception of DS*Sz defined as follows: Sz 1 if the firm
is in the bottom size quartile of the Big 8 sample; 0
otherwise;
DS*Sz = 1 if the firm in in the bottom size quartile and if direct
solicitation allowed; 0 otherwise.
markets) and to provide insight into the effects of increased
competition on client-auditor alignment. Proponents of direct solicitation
claim that clients make more informed choices when audit firms are
allowed to self-select and solicit prospecti ve clients, while opponents
argue that auditors in allowed markets will resort to cutthroat competition
to lure or keep clients, leading to a decline in audit quality. However,
for such a decline in audit quality to occur, economic incentives must
exist for auditors to reduce their level of effort. Jeter and Shaw (1995)
suggest that such incentives do not exist, as both the incumbent and the
nonincumbent are motivated to optimize their total costs of providing
the audit plus any potential litigation and reputation damage.
Nonetheless, the possibility remains that ourresults could be attributable to
nonincumbents offering lower bids because they are willing to assume
greater risk and provide a lower quality audit. In this regard, however, it is
important to recall that Jeter and Shaw (1995) provide evidence that
auditors in the allowed market are more likely than those in the banned
market to issue a nonstandard report when such a report is warranted.
This evidence suggests that at least one dimension of audit quality is
not impaired in the allowed market.
We have argued that solicitation can make a difference in realignment
decisions if clients in
banned states do not invite nonincumbents to submit proposals and if net
economies are available (i. e., the cost savings from switching auditors
exceeds any transactions costs incurred in re- alignment). Our empirical
finding that realignment occurs with significantly greater frequency in
the allowed market suggests that these two conditions are frequently
satisfied; that is, clients do not always invite, and clients are sometimes
misaligned. The evidence presented here suggests that allowing direct
solicitation in the audit market leads to improved client-auditor alignment
and
reduced inefficiencies.
 APPENDIX
Institutional Background
The debate over the costs and benefits of alternative solicitation
policies was initiated by the
U.S. Senate Subcommittee on Reports, Accounting and Management
(Metcalf Committee,
1977). One area of concern discussed in their report was the
restriction of the "free tlow of information" by bans on advertising
and solicitation within the profession. Restricting these activities was
viewed as detrimental to the public interest because users of accounting
services were deprived of information needed to "properly evaluate the
types, amounts, and prices of services offered by the accounting
profession."
The AICPA's Commission on Auditors' Responsibilities, the Cohen
Commission (1978), was less enthusiastic about lifting bans on
advertising and solicitation, expressing concern about the profession's
ability to create a balance of professionalism and independence in a
highly competitive environment. The Commission asserted that
pressures to acquire or maintain audit clients affect adversely the quality
of work performed by individuals auditing particular clients because
accounting firms often cut costs to the point where the integrity of the
independent audit is impaired.
Professional groups (e.g., the AICPA) and the courts distinguish
between advertising and direct uninvited solicitation as follows: direct
solicitation is defined as targeting specific clients or client groups, while
advertising is solicitation of a general nature. The question of the legality
of bans on advertising by professional groups was decided by the Supreme
Court, which held that bans on advertising by groups including
pharmacists and attorneys violated first amendment protection of
commercial speech. In the late seventies, the state boards of accountancy
and the American Institute of Certified Public Accountants (AICPA)
removed bans on advertising as well as most of the restrictions on
advertising activities other than those which convey "false,
misleading, or deceptive messages" (Rule 502, AICPA Code of
Professional Ethics, 1978).
 In contrast to the Supreme Court's rulings on advertising, the Court
held in 1978 in Ohralik v. Ohio State Bar (a case involving bans on
direct uninvited solicitation by lawyers) that first amendment protection
does not extend to bans on direct uninvited solicitation. The Court argued
that direct uninvited solicitation leads to deception of consumers;
since direct solicitation is targeted to a specific client or client group
rather than to the general public, misleading inferences are more likely
than in advertisement because fewer people see the claims. Thus,
professional accounting groups, e.g., the AICPA, the National Association
of State Boards of Accountancy (NASBA) and state boards of
accountancy, were left to choose their own policies on direct
solicitation. The AICPA continued to ban the practice (thus prohibiting its
members from directly soliciting clients) until 1979 when, in response
to a threat by the Justice Department to file a complaint, the
membership of the AICPA voted to allow direct uninvited solicitation.
Nonetheless many state boards retained their bans well beyond 1979.
The Justice Department
threatened action against several state boards of accountancy and filed
a complaint against the Louisiana State Board of Accountancy, charging
the Board with engaging in a combination and conspiracy in unreasonable
restraint of interstate trade and commerce in violation of Section One of
the Sherman Act. A U.S. District Court dismissed this suit in 1987, finding
that the State Board was exempt from antitrust laws under the state
action exemption doctrine because the state legislature authorized,
reviewed and approved the rules. However, in 1989, Florida's ban on oral
direct uninvited solicitation was held to be unconstitutional by a federal
appeals court. In the early
1990s, all remaining states lifted their bans on direct solicitation. In
1993 the Supreme Court upheld the 1989 decision of the federal appeals
court.

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