Do Clients Avoid 'Contaminated' Offices? The Economic Consequences of Low Quality Audits

Posted: 14 Mar 2015 Last revised: 15 Mar 2016

See all articles by Quinn Thomas Swanquist

Quinn Thomas Swanquist

University of Alabama - Culverhouse School of Accountancy

Robert Lowell Whited

North Carolina State University

Date Written: March 12, 2015

Abstract

This study investigates whether the market for audit clients penalizes auditors following association with low quality audits. Specifically, we examine whether audit offices experience a loss in local market share following client restatements. We document that the frequency of restatement announcements within an office-year ('contamination') is inversely related to subsequent year over year change in local market share. Further analysis indicates that restatements impair the office's ability to both attract and retain audit clients. We find that this effect is strongest in high competition markets and diminished in low competition markets. We also examine auditor retention decisions at the client level and find that the likelihood of auditor dismissal increases with contamination, even for non-restating clients. We also find that, on average, clients dismissing their auditor select less contaminated audit offices. Taken together, our results suggest that market forces penalize auditors for association with audit failures, thereby providing an incentive to maintain high quality audits and protect reputational capital.

Keywords: Restatements, Auditor Dismissals, Auditor Reputation, Audit Office

Suggested Citation

Swanquist, Quinn Thomas and Whited, Robert Lowell, Do Clients Avoid 'Contaminated' Offices? The Economic Consequences of Low Quality Audits (March 12, 2015). Accounting Review, Vol. 90, No. 6 (November 2015) pp. 2537-2570. Available at SSRN: https://ssrn.com/abstract=2577382

Quinn Thomas Swanquist

University of Alabama - Culverhouse School of Accountancy ( email )

Tuscaloosa, AL 35487
United States

Robert Lowell Whited (Contact Author)

North Carolina State University ( email )

Raleigh, NC 27695
United States

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