Working Papers Auditor-Client Fit: A New Measure of Audit Quality with Tzachi Zach

We develop a new audit quality metric that is based on topical compatibility between the auditor and its clients, by combining the results of PCAOB inspections with clients’ disclosures of their critical accounting policies. Our process yields an input-based metric that is free from the influences of clients’ financial reporting systems and innate characteristics. We show that auditor fit is related to several traditional proxies of financial reporting quality. We find that auditor fit is negatively associated with abnormal accruals and the F-Score, and that improvements in auditor fit are associated with significant reductions in F-Scores and increases in audit fees. These results demonstrate that our auditor fit measure indeed captures aspects of audit quality. We then show that auditor fit is positively associated with abnormal discretionary expenditures, a measure of real earnings management. This is consistent with stronger auditor oversight imposing higher costs on accrual earnings management, and thus leading to higher levels of real earnings management. Our tests of firms that beat a prominent earnings benchmark reveal lower levels of abnormal accruals in the presence of a higher-fit auditor.

Auditing on the Edge: Spillover Effects of Having an Exposed Client with Stavriana Hadjigavriel

We investigate whether audit-clients that are under negative media exposure can cause negative spillover effects to other clients that share the same auditor as them. Using a sample of fraud-related events in the US between 2005-2020, we examine variations in the audit quality of the affected audit offices, i.e audit offices that have a client exposed to negative media coverage. We find that, if the accusation date of the exposed client falls within the fiscal year-end and the issuance of audit opinion of another client who shares the same auditor, then this client faces a drop in his audit quality in comparison to the other clients that belong to the same portfolio. Moreover; we show that the results are not more pronounced if the media accused clients trigger an SEC enforcement action (3.7% of the accused clients receive an SEC enforcement action), indicating that the results are not driven by the existence of fraud but rather by the media visibility. Results hold under a number of robustness checks.

Clients’ Financial Misconduct and Their Reactions to Auditors’ PCAOB Inspection Results

This study investigates the consequences of firms’ misconduct-related exposure to regulatory scrutiny driven by their auditors’ PCAOB inspection results. Using a text-based measure, I explore this exposure during the period of misconduct and the presence of exposure avoidance by clients. The findings point to some potential unintended consequences of increasing transparency in the audit industry.