Auditor conservatism, audit quality, and real consequences for clients

Curtis Hall (), J. Scott Judd () and Jayanthi Sunder ()
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Curtis Hall: Drexel University
J. Scott Judd: University of Illinois at Chicago
Jayanthi Sunder: University of Arizona

Review of Accounting Studies, 2023, vol. 28, issue 2, No 9, 689-725

Abstract: Abstract Auditors tend to be more conservative in their audits when they face greater litigation risk. However, it is unclear whether this conservatism is always desirable or whether it can be excessive. To evaluate the usefulness of greater auditor conservatism, we examine whether auditor conservatism improves audit quality and imposes real operating consequences for clients. We examine auditor behavior in a sample of auditors’ client banks, when one of the auditor’s other client banks fails (as deemed by the FDIC). We find that auditors that experience a bank failure within their portfolio become more conservative for surviving clients. However, we find that the larger loan loss provisions at surviving clients are no more timely, are less accurate, and reverse in subsequent periods. This finding suggests that auditors’ initial portfolio-wide response to a specific client failure may be overly conservative. We also document that surviving client banks face real consequences in terms of constraints on their lending because of the auditor’s excessive conservatism. Overall, we conclude that, in some situations, auditors may overreact, leading to excessive conservatism, which in turn has adverse consequences for clients.

Keywords: Auditor conservatism; Auditor portfolios; Reporting quality; Loan loss provisions; G21; M41; M42 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s11142-021-09653-1

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