Reputational Implications for Partners after a Major Audit Failure: Evidence from China

52 Pages Posted: 1 Mar 2012 Last revised: 27 Sep 2018

See all articles by Xianjie He

Xianjie He

Shanghai University of Finance and Economics - School of Accountancy

Jeffrey Pittman

Memorial University of Newfoundland (MNU) - Faculty of Business Administration

Oliver M. Rui

China Europe International Business School (CEIBS)

Date Written: December 18, 2013

Abstract

We analyze whether audit partners suffered damage to their professional reputations with the demise of Zhongtianqin (ZTQ), formerly the largest audit firm in China, after an audit failure enabled a major client, Yinguangxia (YGX), to fraudulently exaggerate its earnings in a high-profile scandal resembling the Andersen-Enron events in the U.S. This involves evaluating whether the reputational damage sustained by partners implicated in the scandal spreads to other partners in the same audit firm. We isolate whether impaired reputation impedes partners who were not complicit in the ZTQ-YGX events from attracting new clients or keeping existing ones. Our evidence implies that the market shares of these partners fell after ZTQ’s collapse, supporting that guiltless partners’ reputations were tarnished. We also find that these partners are less likely to be employed by reputable audit firms. The clients of these partners tend to have lower earnings response coefficients, implying that investors downgrade the perceived quality of their audits. Moreover, compared to a matched sample, the former ZTQ partners tend to charge lower audit fees after the firm’s collapse. Finally, we exploit the unique structure of ZTQ to provide evidence consistent with the prediction that the former partners from the branch that handled the YGX audits experienced worse damage to their reputations. In a setting with minimal auditor discipline stemming from civil litigation, our results lend support to the intuition that partners’ reputation concerns motivate them to protect audit quality by closely monitoring other partners in the firm.

Keywords: Audit failure, Partners’ reputation, Audit quality

JEL Classification: G34, G32

Suggested Citation

He, Xianjie and Pittman, Jeffrey A. and Rui, Oliver M., Reputational Implications for Partners after a Major Audit Failure: Evidence from China (December 18, 2013). Available at SSRN: https://ssrn.com/abstract=2013104 or http://dx.doi.org/10.2139/ssrn.2013104

Xianjie He

Shanghai University of Finance and Economics - School of Accountancy ( email )

No. 777 Guoding Road, Shanghai
Shanghai, 200433
China

Jeffrey A. Pittman (Contact Author)

Memorial University of Newfoundland (MNU) - Faculty of Business Administration ( email )

St. John's, Newfoundland A1B 3X5
Canada
709-737-3100 (Phone)
709-737-7680 (Fax)

Oliver M. Rui

China Europe International Business School (CEIBS) ( email )

699 Hong Feng Road
Pudong
Shanghai 201206
China
86-21-28905618 (Phone)
86-21-28905620 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
354
Abstract Views
2,430
rank
82,719
PlumX Metrics