The consequence of audit failure on audit firms: evidence from IPO approval in China

Abstract

ABSTRACTThis paper examines a potential adverse consequence of audit failure. We study whether and how the audit firm’s audit failure impacts its client’s Initial Public Offering (IPO) rejection rate. Our empirical results show that the client’s IPO application rejection rates increases significantly after the audit failure. The significant increase in the IPO rejection rate holds regardless whether the audit firm is subject to regulatory sanctions on the audit failure or not. However, the sanctioned audit firm’s clients experience significantly higher IPO rejection rates than the non-sanctioned audit firm’s clients. Our further analysis reveals that the adverse outcome on clients’ IPO application varies by types of audit firm and by board of IPO listing.