Implications of Audit Office Resource Allocation Shocks: Evidence from Late 10-K Filings

• In Event: Audit Office Pricing and Quality

Abstract

Prior literature examines consequences (e.g., negative market reactions, higher subsequent audit fees, and debt covenant violations) audit clients face arising from missed regulatory due dates. These clients likely pressure the auditor to provide additional resources to perform the audit. This paper examines whether an audit office resource allocation shock stemming from late-filing clients is associated with the audit quality of the other timely-filing clients in that audit office. I find that timely-filing clients are more likely to subsequently restate their financial statements when there are late-filing clients in the same audit office. Using audit fees as a proxy for audit effort (resource allocation), I also find evidence consistent with auditors allocating resources from timely-filing clients to late-filing clients. Subsequent tests indicate that office size mitigates the association between late-filing clients and audit quality of the timely-filing clients and that the timely-filing clients are more likely to subsequently dismiss the auditor, even if the client does not eventually restate their financial statements. Taken together, these findings support the argument that the observed relation between misstatements and late-filing clients can be linked, at least in part, to the implications of shocks to office-level resource allocation plans. Thus, my findings highlight an important factor for auditors to consider for their client acceptance and continuance decisions. These findings also have implications for standard setters considering the costs associated with regulatory due dates.

Author

• Stuart Dearden, University of Nebraska-Lincoln