Audit Partners’ Risk Tolerance and the Impact on Audit Quality

Abstract

Relying on their history of legal infractions to measure individuals’ risk tolerance, we examine the association between engagement partners’ risk appetites and audit quality in the U.S. Criminology and economics research links criminal activity with enduring personality traits that capture an individual’s risk tolerance. Our evidence supports the prediction that partners known to engage in risky off-the-job behaviors conduct lower quality audits. Specifically, we find that clients of partners with prior legal infractions exhibit greater propensity to misstate, fewer material weaknesses, and less timely loss recognition, while also paying lower audit fees and completing the audit earlier. We also document that risk-tolerant partners are more likely to pursue alternative sources of benefit by attracting larger non-audit fees from their audit clients. Reflecting that Big 4 firms have robust quality control systems and more standardized audit procedures that narrow the scope for partner characteristics to matter, we largely find that the Big 4 better constrain risk-tolerant partners from undermining audit quality. In additional cross-sectional analyses, we generally find supportive evidence that the impact of partners’ risk tolerance on audit quality subsides in offices with industry expertise, offices that are closer to the audit firm’s national office, and offices in the same city as the SEC. Collectively, our analysis contributes to emerging research on the role that individual partner characteristics play in shaping audit outcomes.