Effects of Low Audit Quality Revelation on Audit Effort, Audit Quality, and Auditor Tenure

Abstract

We provide evidence that the revelation of low-quality audits is associated with auditors exerting greater effort on clients, which received low-quality audits as well as other clients of the low-quality audit office. In a sample of 15,934 public firm-years over the period 2004−2016, we find client restatements (a proxy for low audit quality) in an audit office are positively associated with concurrent audit lag, audit fees, and a common factor of two audit effort proxies on both restating and non-restating clients. We also find that, in spite of greater auditor effort, clients which previously received a low-quality audit are subject to additional increased misstatement risk. Unsurprisingly, auditors have a higher likelihood of subsequently being dismissed by these clients. Surprisingly, auditors also have a higher likelihood of subsequently being dismissed by clients with low underlying financial reporting quality, even if those clients are not subject to additional increased misstatement risk. Our results suggest that, in contrast to prior literature demonstrating poor audit quality being contagious among clients of the same audit office, low audit quality disclosure (in the form of restatements) results in an audit effort benefit across all clients of the low-quality audit office. However, clients with low financial reporting quality appear to take advantage of public revelations of low auditor quality to shift focus away from themselves, regardless of the auditors’ subsequent effort.