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Auditor conservatism, audit quality, and real consequences for clients
Journal article   Peer reviewed

Auditor conservatism, audit quality, and real consequences for clients

Curtis Hall, J. Scott Judd and Jayanthi Sunder
Review of accounting studies
18 Oct 2021
DOI: https://doi.org/10.1007/s11142-021-09653-1

Abstract

Business & Economics Business, Finance Social Sciences
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.

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19 Record Views
6 citations in Web of Science
4 citations in Scopus

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Collaboration types
Domestic collaboration
Web of Science research areas
Business, Finance
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