What Are the Audit-Related Implications of Firm Profitability?

Abstract

This study examines the implications of firm profitability, as a potential indication of audit-related risk, to audit quality, auditor reporting, auditor continuance decisions, and audit pricing in the post-SOX environment. Using a sample of non-financial public companies over the period 2005 – 2017, I find that profitability: is an important determinant of audit quality among profit firms; informs auditor reporting decisions such that when firm profitability is lower, auditors are more likely to report internal control weaknesses and express substantial doubt about the client’s ability to continue as a going concern; and, is an important consideration in audit pricing only for profit firms. These inferences continue to hold when I address the potentially endogenous nature of firm profitability, use first difference estimation that captures changes in firm profitability, and assess the importance of profitability relative to other predictors. I contribute to practice and to the auditing literature by providing a focused, contemporary examination of firm profitability in the audit setting. My results suggest that low firm profitability may not be as timely and reliable of an indication of risk as predominantly believed.