Audit Quality in the Face of a Crisis: Evidence from the Audit Inspection Scandal

Abstract

This paper examines the 2017 audit inspection scandal involving the PCAOB and KPMG — one of the few publicized breaches of “tone at the top” at a Big Four firm. With the backdrop of an egregious violation of professional ethics by leaders of KPMG, we study how the scandal affected KPMG and its clients. Using a differences-in-differences approach, we find that audit quality at KPMG increased after the scandal compared to other Big 4 firms. We also find that KPMG was successful in preventing client desertions. Clients most closely tied to the scandal experienced a decline in audit and non-audit fees. Overall, we document operational improvements at KPMG in response to the scandal, along with some possible sacrifices in revenue generation.

Keywords: KPMG scandal, PCAOB, audit quality

JEL Classification: G14, G38, K22, M41, M42, M48