Do Clients Avoid ‘Contaminated’ Offices? The Economic Consequences of Low Quality Audits

This study investigates whether local audit offices suffer financially following their association with low-quality audits. The announcement of a restatement indicates that the contracting auditor failed to detect and correct a material misstatement. Therefore, I predict that office reputation suffers following restatements of previously audited financial information. As the frequency of restatement announcements increases, the perceived pervasiveness of systematic audit failures (‘contamination’) within the office will increase accordingly. I document that contaminated offices (Big 4 and non-Big 4) suffer a decline in market share relative to their peers. Furthermore, when examining auditor retention decisions at the individual client level, I find that clients are more likely to dismiss auditors associated with greater ‘contamination’ and select auditors with lower contamination. This relation is observed for both restating and non-restating clients. Overall, evidence suggests that restatements impair a local office’s reputation and that the cost of a restatement extends beyond the restating engagement.