Don't Make Me Look Bad: How the Audit Market Penalizes Auditors for Doing Their Job
42 Pages Posted: 8 Aug 2018 Last revised: 14 Aug 2019
Date Written: August 7, 2018
We examine whether the audit market penalizes auditors for providing investors with value-relevant information that is critical of management (i.e., internal control material weakness (ICMW)). While prior research has examined how the receipt of an ICMW increases the likelihood that a client leaves their auditor, we examine the reputational impact of an office issuing ICMWs by focusing on clients that receive clean internal control opinions. We predict and find that audit offices that issue more ICMWs experience lower client and fee growth. We also find that the decrease is stronger when the ICMW is associated with a more visible client and when the ICMW is more severe. In supplemental analyses we find evidence consistent with clients avoiding auditors with a reputation for issuing ICMWs in their auditor selection decisions. Our results indicate that, on average, the market for audit services penalizes auditors for disclosing information critical of management in their audit opinions, which undermines the value of direct-to-investor auditor communications and provides insight into potential longer-term implications of the recently enacted expanded auditor’s report.
Keywords: audit market competition, auditor reputation, internal control weakness
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