The Role of Auditor Portfolios: Evidence from the Financial Crisis

• In Event: Responses to Risk Factors

Abstract

We study the role of auditor portfolios on audit output using a sample of commercial banks in the setting of the recent financial crisis. We find that audit firms become more conservative across all client-banks in their portfolio when one of those banks fails (as deemed by FDIC). Specifically, auditors require the surviving clients in the portfolio to accrue larger loan loss provisions, especially when the audit client is more visible. We also find that auditors experiencing a failure in their portfolio charge higher audit fees during the financial crisis. Furthermore, we find evidence that auditors’ response to client failure may have been overly conservative since the conservative reporting loan loss provisions reverse when auditors do not experience a client failure after experiencing one the year prior. These results are consistent with auditors perceiving higher risk of litigation and reputational concerns when one client fails, and altering their audit behavior across all other remaining clients.

Author

• Scott Judd, University of Illinois at Chicago