Economic Consequences of Auditor Reputation Loss: Evidence from the Auditors’ Inspections Scandal

• In Event: Auditor Ethics and Independence

Abstract

We examine the response of an audit firm to potential failures in its quality control system and the effects of these failures on its client relationships and quality of audits. Using the 2017 audit inspection scandal involving the PCAOB and KPMG as our setting, we assess the response of KPMG as it pertains to its overall client base. Importantly, we construct a novel data set of KPMG clients whose engagements have been compromised by information leakage from the PCAOB (Transcript Sample) and examine whether these particular clients have been differentially affected by the scandal. We find that the audit fees KPMG charged the clients in the Transcript Sample decrease following the revelation of the scandal, but we do not find a similar effect in KPMG’s other clients. We also document a reduction of KPMG’s non-audit fees across its entire client base. Finally, we find that the likelihood of issuing a going concern opinion in poor performing clients and the quality of loan-loss provisions in banking clients decrease after the scandal. Overall, our results suggest that the audit inspection scandal caused KPMG to take real actions in an effort to retain clients.

Authors

• Francine McKenna, American University

• Mikhail Pevzner, University of Baltimore

• Amy Genson Sheneman, The Ohio State University

• Tzachi Zach, The Ohio State University