Audit Quality and Auditor Reputation: Evidence from Japan

Douglas J Skinner,Suraj Srinivasan

doi:10.2308/accr-50198

Douglas J Skinner, Suraj Srinivasan

Open Access

https://doi.org/10.2308/accr-50198

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Abstract

ABSTRACTWe study events surrounding ChuoAoyama's failed audit of Kanebo, a large Japanese cosmetics company whose management engaged in a massive accounting fraud. ChuoAoyama was PwC's Japanese affiliate and one of Japan's largest audit firms. In May 2006, the Japanese Financial Services Agency (FSA) suspended ChuoAoyama for two months for its role in the Kanebo fraud. This unprecedented action followed a series of events that seriously damaged ChuoAoyama's reputation. We use these events to provide evidence on the importance of auditors' reputation for quality in a setting where litigation plays essentially no role. Around one quarter of ChuoAoyama's clients defected from the firm after its suspension, consistent with the importance of reputation. Larger firms and those with greater growth options were more likely to leave, also consistent with the reputation argument.Data Availability: All data in the paper are publicly available from the sources described in the text.

Highlights

High-quality external auditing is a central component of well-functioning capital markets
We study the case of ChuoAoyama, PricewaterhouseCoopers’ (PwCs’) former affiliate in Japan, which was implicated in a major accounting fraud at Kanebo, a large Japanese cosmetics company
SUMMARY AND CONCLUSIONS In May 2006, the Japanese Financial Services Agency (FSA) took the unprecedented step of suspending the operations of ChuoAoyama, the PwC affiliate in Japan, for two months for its role in a major accounting fraud at Kanebo

Summary

INTRODUCTION

High-quality external auditing is a central component of well-functioning capital markets. We study the case of ChuoAoyama, PricewaterhouseCoopers’ (PwCs’) former affiliate in Japan, which was implicated in a major accounting fraud at Kanebo, a large Japanese cosmetics company This case provides a good setting for examining the importance of auditor reputation absent the confounding effects of litigation. Our findings are stronger than those in Weber et al, and exploit unusual features of the Japanese setting to further strengthen the interpretation that these results are driven by reputation There are both similarities and differences between the events at ChuoAoyama and those surrounding the demise of Arthur Andersen in the U.S The two sets of events are similar in that Andersen’s ultimate demise, which resulted from its failed audit of Enron, was preceded by problems with its audits of Waste Management, Sunbeam, and the Baptist Foundation of Arizona.

THE DOWNFALL OF CHUOAOYAMA AND EMPIRICAL PREDICTIONS

EMPIRICAL ANALYSIS Sample and Descriptive Statistics

SUMMARY AND CONCLUSIONS

D: All ChuoAoyama Clients