Audit Firm Reputational Consequences of Alleged Non-GAAP Misconduct by Clients

• In Event: Restatements

Abstract

This study examines whether U.S. audit firms experience reputational damage when clients are accused of misconduct with negligible connection to auditor responsibilities. We find no evidence that non-GAAP securities fraud class actions, our proxy for such misconduct, result in litigation risk for auditors or for non-sued clients of the auditor. While auditors have minimal, if any, responsibility related to this type of fraud, the halo effect suggests that they could be perceived as “guilty by association.” We find audit fees are lower in the year following suit announcement for the auditor’s clients in the same city-industry as the sued client. This effect does not exist for clients of other auditors in the same city-industry. The effect is stronger when suits are severe, unrelated to earnings guidance, or do not reference SEC filings. Overall, results provide direct evidence that reputation is an important incentive for U.S. audit firms.

Authors

• Dain C Donelson, University of Texas at Austin

• Matthew Ege, Texas A&M University

• Justin Leiby, University of Florida