The Costs of Audit Failures to Engagement Partners

This project investigates the consequences of audit failures on engagement partners in the Chinese market, a market in which engagement partner names and personal data are publicly available. An audit failure occurs if engagement partners are implicated in the financial fraud discovered by securities regulators and consequently receive a regulatory penalty. We examine whether audit failures cause economic loss to engagement partners and adversely affect their career prospects. More specifically, we determine whether sanctioned partners lose existing clients, fail to gain IPO clients, charge lower audit fees, and are more likely to leave the audit profession after involvement in accounting fraud, compared with matched, non-sanctioned partners. Moreover, we investigate whether the effects of audit failures on engagement partners vary with their seniority and political connectedness.This project contributes to the auditing literature in two important ways. First, the findings of this project helps understand whether and how reputational mechanisms work in countries in which demand for high-quality audits is relatively weak and competition for audit services is high. Although the literature shows that, in developed markets, audit firms with tainted reputations incur economic loss (Weber et al., 2008; Skinner and Srinivasan, 2012), it is far from clear whether this is true in the Chinese market, where public companies are likely to avoid high-quality auditors (DeFond et al., 2000). Second, this study helps understand the determinants of audit quality at the individual auditor level. A growing literature examines individual audit quality, and shows that economic dependence, expertise, experience, and political affiliation may matter (Gul et al., 2012). However, evidence that reputational concerns may motivate individual auditors to improve audit quality is rare.Our work is timely amid the current policy debate in the US and other countries on whether the identity of engagement partners should be publicly disclosed. Proponents of the requirement to disclose engagement partner names argue that such disclosure will motivate auditors to improve audit quality out of personal reputational concern. Our findings can be useful to regulators in their assessment of this argument.