The Contagion Effect of Low-Quality Audits along Individual Auditors

Abstract

Francis and Michas (2013) discover that the occurrence of an audit failure actually signals a more systematic problem with audit quality at the affected office. Using the Chinese setting where the identities of engagement auditors are revealed in audit reports, this study further explores whether the phenomenon of contagion is isolated to some specific auditors in an office or it indeed is an office-wide problem. We follow Francis and Michas (2013) to define an audit failure as an instance where a client firm subsequently makes a downward restatement of audited earnings. While we find similar evidence of contagion of low quality audits at office locations experiencing audit failures, the contagion effect actually is confined to the (other) audits performed by those specific auditors who are involved in audit failures, and it does not spread to the same-office auditors not involved in failures. We further find that the contagion effect is attenuated among female auditors, and for auditors with an accounting degree, with longer auditing experience, and with industry expertise. Our results suggest that the documented contagion effect of low quality audits is an individual auditor-level, rather than office-level, phenomenon. This underscores the importance of engagement auditor identification and the usefulness of disclosing auditors’ personal characteristics.

Keywords: contagion effect; individual auditors; audit failures; audit quality; auditor characteristics

JEL Classification: M42-auditing