The purpose of this study is to examine how auditors would react when there are exogenous negative shocks to their client portfolios.
Using a sample of 31,256 firm-year observations (2001–2016), the authors investigate whether industry shocks to a subset of an auditor’s clients distract the auditor and affect the professional skepticism applied in the audits of other clients.
The authors find that clients of distracted auditors are more likely to meet or beat analyst consensus forecasts, suggesting that auditors’ professional skepticism is compromised by distractive events. The cross-sectional analyses reveal that the negative impact of the distractive events on audit quality is more pronounced when the distracted auditors audit less important clients, face lower third-party legal liabilities and experience higher growth. Using an alternative measure of audit quality, the additional analysis shows that clients of distracted auditors exhibit a higher probability of restating their earnings in subsequent years. Overall, the empirical evidence suggests that when distracted, auditors render lower quality audit.
The study complements recent work by Cassell et al. (2019), which shows that the 2008–2009 financial crisis affected the quality of the audits of nonbank clients of bank-specialized auditors. While Cassell et al. (2019) focus on one shock (financial crisis) to one industry (i.e. the financial services industry), the study examines more frequent shocks over a wide range of industries to identify the potential effects of distractive events, improving the generalizability of the findings to all industries and all auditors (specialist and nonspecialist) in nonrecession periods.
