Audit Firm Reputation and Perceived Audit Quality: Evidence from Envelopegate
46 Pages Posted: 10 Sep 2018 Last revised: 26 Sep 2018
Date Written: May 2, 2018
We study market reaction to “Envelopegate,” a term coined by social media users to describe PwC’s error made during an engagement with the Academy of Motion Picture Arts and Sciences. We use this event to provide evidence on the importance of audit firms’ reputation incentives to provide audit quality. Prior US-based event studies examine extreme audit failures that damage auditor reputation and expose the audit firm to significant litigation claims, making it difficult to disentangle the reputation rationale from the litigation rationale for audit quality. Envelopegate is a unique event that damaged PwC’s reputation for audit quality without exposing the firm to substantial litigation costs. We predict and find a significant negative market response to Envelopegate for PwC clients, supporting the reputation rationale in a US setting where litigation concerns are minimized. We find that clients requiring higher audit quality experience lower returns, providing further support for the reputation rationale.
Keywords: auditor reputation; audit quality
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