Auditor sanctions and the management of riskiness of audit client portfolios

Abstract

This study examines the effect of auditor sanctions imposed on the riskiness of auditors' client portfolios. We identify auditors/audit firms that were subject to disciplinary actions by the China Securities Regulatory Commission (CSRC) and empirically examine the change in the riskiness of their client portfolios after the sanctions were imposed. The empirical results suggest a decrease in the overall clientele financial risk, measured by both aggregate bankruptcy measures and individual financial risk measures, after enforcement releases were issued. Moreover, we find that the decrease in client portfolios' risk is greater when a disciplinary action is imposed in the period of higher legal liability than when it is imposed in the period of lower legal liability. This study contributes to prior studies on the effects of audit failure on auditors' behaviour by examining the association between auditor sanctions and the management of audit client portfolios risk.