The Audit Firms Reputation And Its Effects On Audit Quality And Results

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The Audit Firms Reputation And Its Effects On Audit Quality And Results

Abstract

In this paper we will look at the connections between the reputations of auditors and their clients. In my research I have found in several research papers that the clients of the same auditor have very similar histories of misconduct. It is easily deduced that a client’s misconduct history and reputation is almost as important as its size. The research papers I have studied show the relationship between an auditor and their preferred client. Clients chosen by Auditors who have a history of accepting clients with records of misconduct are likely to relapse in the future regardless of any measures taken by the auditors. Reputation is how a firm’s worth is judged; firms tend to take in the same type of clients repeatedly, in a reversal of the situation. There is a correlation between firms with a past of misconduct and clients with the same.

We interpret our results within a positive assortative matching framework and conclude that auditors’ differential reputation concerns relate to their client acceptance and continuance decisions. MY CONTRIBUTION WILL BE AGAINST THIS

Introduction

Most research available focuses on the relationships between clients and their choice of auditors and why. The reverse is somewhat uncommon in that it is sometimes overlooked why auditors would select certain clients over others normally. Clients normally choose auditors by their size and reputation as a firm (DeFond and Zhang, 2014). This is the case despite clients don’t understand the differences in quality or the intermediate results of the audit. (Causholli and Knechel, 2012). An auditing firm’s reputation is normally considered one of the most important currency in today’s auditing world. Unfortunately, it is rather audit quality rather than reputation that is truly relevant. That isn’t to say reputation isn’t an important factor; because clients can only understand so much of what an auditing firm does for a business it comes down to reputation when clients are selecting a firm. Clients judge by observing the end results available to them; which is reputation, but reputation can be affected by the number of restatements that are released by a firm. The simple way clients judge an auditing firm doesn’t in any real way take into consideration what goes on during an audit. A firm could consistently produce quality work and simultaneously possess a mediocre reputation; which could eventually lead to reduced work quality. Meaning, clients often use only an auditor reputation to assess quality and fail to understand the relationship they have with a firm. The auditors protect their reputation by carefully selecting the clients they choose accept and over other. Due to this an auditor’s clients are more likely to be similar in terms of the history of misconduct.

Certain auditors fous on similar clients with a history of misconduct (Egan, Matvos, and Seru, 2018). This study makes use of U.S. Broker-Dealer Market (BD) setting as there are more records available, and those sent to the SEC are of public record.

This is not to say that all clients and auditors with a history of misconduct pair with the other. Auditors who deal with extremely public clients are far less likely to perform in such a way as to damage their reputation further. This means that auditors who have only minor instances of misconduct on their record are the least inclined to accept client with a history of continuous misconduct. By using a data from employment records of BD’s it’s possible to notice the positive matching correlation of auditors and clients. This also showcases the reluctance of auditors to accept BD’s with a history misconduct in a public market. It shows that auditors without a history of misconduct will not stay with BD’s who do have a history of misconduct.

Setting, Data, and Summary Statistics

Auditors with a history of misconduct also seem to be able to negatively affect clients and increase their chances of future misconduct. There should be research indicating this negative correlation and how auditor preference can impact clients. The data also shows a correlation between the reputation of the auditor and their clients they choose to accept.

Research Design

The conclusions reached in this paper are determined studying research that uses the BD’s in place of the clients and studying their correlation with auditors. The clients are sorted by size from smallest to largest; while the auditors are sorted by their size and the size of their clients. The idea was that if the size is irrelevant, clients of all sizes would match with the larger firms. This turned out to be mostly the opposite with less than 20% of auditors and clients matching. For large auditors matching with larger clients, as well as the opposite there was a 50%.

The percentage of client misconduct is measured by the percent of client advisors with a history misconduct. The percentages are used to organize the clients from smallest to largest in terms of misconduct on record. The auditors are assigned using their average rates of misconduct in the prior year. The percentage of clients with high histories of misconduct and auditors with low histories is slightly less than 20%; while the percentage is 42% for clients and auditors with matching histories of misconduct. It was also found that the relationship between the client’s history of misconduct and the auditor’s history is 50% as important as the two matching in terms of size.

An auditor’s and client’s choices alone seem to create a clear pattern; with a significantly greater chance of a high misconduct auditor matching with a low misconduct client (27%) than the opposite of a low misconduct auditor matching with high misconduct client (19.29). This suggests that an auditor holds far greater say over who they form relationships with than the client. This doesn’t consider the length of time these auditors and clients stay together; this is likely because a high misconduct client can have on an auditor’s reputation. This is supported by the research which shows that low misconduct auditors separate from a high misconduct client far sooner than a high misconduct auditor and a low misconduct client. It can also be inferred that auditors have a greater control over who they select regardless of client reputation. This is because auditors with a better reputation and therefore larger and more prone to some misconduct can selectively choose their low reputation clients. The result of this research is that an auditor history decides the future conduct of their clients.

The size of the audit firm must be considered as the research shows that two high misconduct auditors and clients can have very different percentages of misconduct depending on how large the audit firm is. This research can be used as an early warning system for investors who are looking into the audit. Audit firms with a high history of misconduct have a greater chance of having a higher misconduct percent the larger they are. This is definitely a relationship to research in this case, the influence audit firms can have over their clients in this case is significant and could be potentially be leveraged and the auditor’s role in this relationship studied.

Reference List

Causholli, M., & Knechel, W. (2012). An examination of the credence attributes of an audit. Accounting Horizons, 631-656.
Curtis, Q., Donelson D., Hopkins, J. (2019). Revealing Corporate Financial Misreporting. Contemporary Accountng Research, 1337-1372