Reputation Recognition and Audit Outcomes: Evidence from Chinese Auditors

Abstract

Reputation has long been recognized as an important mechanism to mitigate opportunistic behavior in the audit market. However, whether and how reputation motivates auditors to provide high-quality audits is empirically not clear. We exploit the Chinese audit market, where a group of auditors is titled “senior CPAs.” Representing the highest professional recognition, the designation of senior CPA enhances auditors’ reputation in an observable manner. Based on a difference-in-differences design, we find that, following the senior-CPA designation, auditors improve audit quality in terms of audit reporting and audited financial statements. Such a reputation effect is more pronounced in regions with more developed market institutions, but do not differ between large and small audit firms. The senior-CPA designation is also followed by several market consequences, including higher audit-fee premiums commanded and larger audit-market shares gained by the senior CPAs, and higher market valuation of earnings audited by the senior CPAs. Overall, our study provides novel evidence on how the reputation mechanism shapes auditor behavior and matters to capital market participants.