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    Do Clients Avoid “Contaminated” Offices? The Economic Con...
    research summary posted January 20, 2016 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.02 Dismissal Decisions – impact of restatements, disagreements, fees, mergers, 12.0 Accountants’ Reports and Reporting, 12.03 Restatements 
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    Title:
    Do Clients Avoid “Contaminated” Offices? The Economic Consequences of Low-Quality Audits.
    Practical Implications:

    The results of this study are important to audit regulators and auditors as the PCAOB considers disclosure of additional audit quality indicators. The results of this study indicate that clients do respond to publicly available indications of audit quality as they avoid audit firm offices that are associated with restatements. Additionally, auditors may be interested in the findings of this study as it relates to the economic implications of contaminated offices. The findings of this study provide evidence about the importance of local office reputation as client retention and new client additions decrease when offices are associated with audit failures.

    Citation:

    Swanquist, Q.T. and R.L. Whited. 2015. Do Clients Avoid “Contaminated” Offices? The Economic Consequences of Low-Quality Audits. The Accounting Review 90(6): 2537-2570.

    Keywords:
    auditor reputation, audit offices restatements
    Purpose of the Study:

    Audit firms have an incentive to protect their reputational capital in order to maintain and improve their economic circumstances. A client restatement is a common public signal that may negatively impact the audit firm’s reputation for audit quality. Previous research suggests that office-level characteristics in particular contribute to audit quality. Therefore, when restatements occur, the audit firm office involved in the restatement is likely to be “contaminated” and suffer the most from reputational and economic damage. Specifically, the authors:

    • Examine the effect of local office contamination (measured as client restatement announcements) on local office market share.
    • Examine the effect of local office contamination on client retention and client acquisition in the local office.
    • Examine the relationship between contamination and changes in local office market share in the face of differing levels of competition.

    Additionally, the authors use their findings to demonstrate how clients perceive and react to public information related to audit quality which is a recent focus of the PCAOB.

    Design/Method/ Approach:

    The authors proxy for contamination within an office using the number of restatements announced by an office’s clients during the year. They collected office location, audit fees, restatement announcements, and auditor dismissals from several Audit Analytics databases. Client financial reporting data were obtained from Compustat, and the metropolitan statistical area information was obtained from the U.S. Census Bureau’s website. The information collected on these audit offices and related clients was for years 2003-2011.

    Findings:
    • The authors find that contaminated offices lose market share following client restatement announcements. In addition, there are significant economic penalties associated with signals of audit failure.
    • The authors find that the percentage of clients dismissing their auditor increases with office contamination (both for clients that had a restatement and those that did not have a restatement). Similarly, clients selecting a new auditor are less likely to select one from a contaminated office. This suggests that the reduction in market share is a result of the auditor’s impaired ability to both retain and attract clients.
    • The authors find that the negative consequences of contamination are reduced in geographies where there is low competition among auditors and for larger clients.
    • The authors provide some evidence that though Big 4 and non-Big 4 offices are affected by contamination; the impact is diminished for Big 4 offices.
       
    Category:
    Accountants' Reporting, Auditor Selection and Auditor Changes
    Sub-category:
    Dismissal Decisions – impact of restatements - disagreements - fees - mergers etc, Restatements