The Contagion Effect of Low-Quality Audits

49 Pages Posted: 20 Jun 2012 Last revised: 4 Oct 2012

See all articles by Jere R. Francis

Jere R. Francis

Maastricht University

Paul N. Michas

University of Arizona - Eller College of Management

Multiple version iconThere are 2 versions of this paper

Date Written: October 4, 2012

Abstract

We investigate if the existence of low-quality audits in an audit office indicates the presence of a contagion effect on the quality of other (concurrent) audits conducted by the office. A low-quality audit is defined as the presence of one or more clients with overstated earnings that were subsequently corrected by a downward restatement. We document that the quality of audited earnings (abnormal accruals) is lower for clients in these office-years (when the misreporting occurred) compared to a control sample of office-years with no restatements. This effect lasts for up to five subsequent years, indicating that audit firms do not immediately rectify the problems that caused contagion. We also find that an office-year with client misreporting is likely to have subsequent (new) client restatements over the next five fiscal years. Overall, the evidence suggests that certain audit offices have systematic audit quality problems and that these problems persist over time.

Keywords: auditing, office, audit quality, contagion

JEL Classification: M41

Suggested Citation

Francis, Jere R. and Michas, Paul N., The Contagion Effect of Low-Quality Audits (October 4, 2012). Available at SSRN: https://ssrn.com/abstract=2087709 or http://dx.doi.org/10.2139/ssrn.2087709

Jere R. Francis

Maastricht University ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands

Paul N. Michas (Contact Author)

University of Arizona - Eller College of Management ( email )

Tucson, AZ 85721
United States

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