Product Recalls and Audit Production

European Accounting Review, Forthcoming

47 Pages Posted: 11 Oct 2022

See all articles by Kevin H. Kim

Kevin H. Kim

Korea Advanced Institute of Science and Technology (KAIST)

Jonathan Nash

University of New Hampshire

Jonghan Park

The Chinese University of Hong Kong, Shenzhen - School of Management and Economics

Date Written: September 22, 2022

Abstract

We examine the impact of product recalls on audit production. Product recalls are events that increase engagement risk associated with greater audit effort, and by extension, greater audit quality. Consistent with this conclusion, we find firm-years with a product recall have a lower likelihood of being subsequently restated and lower levels of accrual error. While a positive association generally exists between audit effort and audit fees, prior literature shows firms experiencing economic stress negotiate lower audit fees and auditors accept lower fees to earn future returns. We expect that to increase the likelihood of retaining a client, auditors will agree to lower fees when the short-term economic stress associated with a recall injects downward pressure into fee negotiations. Supporting this conclusion, we find product recalls are associated with lower audit fees—a relation attributable to differing magnitudes of temporal fee increase. We also show the effects are transitory, the higher levels of audit quality are attributable to specialist audit offices, and the lower levels of fees are attributable to engagements where the client has greater bargaining power. While a positive association typically exists between audit effort and audit fees, our paper identifies a firm-specific event that weakens this relation.

Keywords: product recall; restatements; discretionary accruals; audit fees

JEL Classification: H22, M42

Suggested Citation

Kim, Kevin and Nash, Jonathan and Park, Jonghan, Product Recalls and Audit Production (September 22, 2022). European Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=4226989

Kevin Kim

Korea Advanced Institute of Science and Technology (KAIST) ( email )

373-1 Kusong-dong
Yuson-gu
Taejon 305-701, 130-722
Korea, Republic of (South Korea)

Jonathan Nash

University of New Hampshire ( email )

15 College Road
Durham, NH 03824
United States

Jonghan Park (Contact Author)

The Chinese University of Hong Kong, Shenzhen - School of Management and Economics ( email )

2001 Longxiang Road, Longgang District
Shenzhen, 518172
China

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