Reputational Implications for Partners after a Major Audit Failure: Evidence from China

Xianjie He (First Author), Oliver Meng Rui (Participant Author), Jeffrey Pittman (Participant Author)

Research output: Contribution to journalJournal

29 Citations (Web of Science)

Abstract

We analyze whether audit partners suffered damage to their professional reputations with the demise of Zhongtianqin (ZTQ), formerly the largest audit firm in China, after an audit failure enabled a major client, Yinguangxia (YGX), to fraudulently exaggerate its earnings in a high-profile scandal resembling the Andersen–Enron events in the US. This involves evaluating whether the reputational damage sustained by partners implicated in the scandal spreads to other partners in the same audit firm. We isolate whether impaired reputation impedes partners who were not complicit in the ZTQ–YGX events from attracting new clients or keeping existing ones. Our evidence implies that the market shares of these partners fell after ZTQ’s collapse, supporting that guiltless partners’ reputations were tarnished. We also find that these partners are less likely to be employed by reputable audit firms. The clients of these partners tend to have lower earnings response coefficients, implying that investors downgrade the perceived quality of their audits. Moreover, compared to a matched sample, the former ZTQ partners tend to charge lower audit fees after the firm’s collapse. Finally, we exploit the unique structure of ZTQ to provide evidence consistent with the prediction that the former partners from the branch that handled the YGX audits experienced worse damage to their reputations. In a setting with minimal auditor discipline stemming from civil litigation, our results lend support to the intuition that partners’ reputation concerns motivate them to protect audit quality by closely monitoring other partners in the firm.
Original languageEnglish
Pages (from-to)703-722
JournalJournal of Business Ethics
Volume138
Issue number4
DOIs
Publication statusPublished - 2016

Corresponding author email

oliver@ceibs.edu

Project name

中国股票市场股权结构宽度对股价及其同步性的影响研究

Project sponsor

国家自然科学基金

Project No.

71372203

Keywords

  • Audit failure
  • Audit quality
  • Partners’ reputation

Indexed by

  • FT
  • ABDC-A
  • Scopus
  • SSCI

Fingerprint

Dive into the research topics of 'Reputational Implications for Partners after a Major Audit Failure: Evidence from China'. Together they form a unique fingerprint.

Cite this