Client Political Connections and Auditor Reporting Decisions

This project investigates how client political connections affect auditor reporting decisions in the United States. Following Goldman et al. (2009), we define a firm as politically connected if one or more of its directors had held a political position.We posit that auditors may be more likely to issue going-concern opinions to politically connected clients, for two reasons. First, politically connected firms may receive more media coverage, which may cause auditors to be more conservative in their audit reporting decisions for such clients (the visibility argument). Second, political connections may increase connected firms’ business risk, which in turn may increase the litigation risk faced by auditors (the risk argument).While these two arguments have similar predictions, their implications for audit quality differ. The visibility argument suggests that auditors are unduly affected by press coverage on client firms and therefore are over-conservative in auditing politically connected clients. As such, a higher likelihood of issuing going-concern opinions to such clients may not suggest higher quality audits. In contrast, the risk argument suggests that auditors recognize that politically connected firms have higher failure risk, and are therefore more likely to issue warning signals, i.e., going-concern opinions to investors. In the latter case, higher probability of going-concern opinion issuance represents higher audit quality.We design four additional tests to evaluate the relative importance of the two arguments discussed above. First, we examine whether political connection effects on audit opinions vary between election and non-election years. Second, we examine whether auditors are more likely to issue going-concern opinions to politically connected firms when events such as delisting, bankruptcy, or shareholder lawsuits are absent in the near future. Third, we directly compare press coverage between politically connected and matched, non-connected firms to determine whether politically connected firms indeed receive more attention from the media. Finally, we investigate whether politically connected firms are more likely to go bankrupt, be delisted, or be sued by shareholders in the near future.The findings from this work will help to explain how political factors and public attention on client firms affect auditor judgment and decision making in the U.S. The auditing literature mostly examines how political factors shape auditor behavior in international settings (e.g., Guedhami et al., 2013) or developing countries (e.g., Wang et al. (2008) and Chan et al. (2006) for the Chinese case). Our work extends this literature by providing U.S. evidence.