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Journal of Business Ethics

, Volume 138, Issue 4, pp 703–722 | Cite as

Reputational Implications for Partners After a Major Audit Failure: Evidence from China

  • Xianjie He
  • Jeffrey Pittman
  • Oliver RuiEmail author
Article

Abstract

We analyze whether audit partners suffered damage to their professional reputations with the demise of Zhongtianqin (ZTQ), formerly the largest audit firm in China, after an audit failure enabled a major client, Yinguangxia (YGX), to fraudulently exaggerate its earnings in a high-profile scandal resembling the Andersen–Enron events in the US. This involves evaluating whether the reputational damage sustained by partners implicated in the scandal spreads to other partners in the same audit firm. We isolate whether impaired reputation impedes partners who were not complicit in the ZTQ–YGX events from attracting new clients or keeping existing ones. Our evidence implies that the market shares of these partners fell after ZTQ’s collapse, supporting that guiltless partners’ reputations were tarnished. We also find that these partners are less likely to be employed by reputable audit firms. The clients of these partners tend to have lower earnings response coefficients, implying that investors downgrade the perceived quality of their audits. Moreover, compared to a matched sample, the former ZTQ partners tend to charge lower audit fees after the firm’s collapse. Finally, we exploit the unique structure of ZTQ to provide evidence consistent with the prediction that the former partners from the branch that handled the YGX audits experienced worse damage to their reputations. In a setting with minimal auditor discipline stemming from civil litigation, our results lend support to the intuition that partners’ reputation concerns motivate them to protect audit quality by closely monitoring other partners in the firm.

Keywords

Audit failure Partners’ reputation Audit quality 

JEL Classification

G34 G32 

Notes

Acknowledgments

Our research has benefited from comments on an earlier version of this paper from participants at the Journal of Business Ethics Special Issue and Conference on Business Ethics in Greater China: Past, Present and Future in Tibet, the International Symposium on Audit Research in Tokyo, the American Accounting Association Annual Meeting in Washington, the China Accounting and Finance Review International Symposium in Shanghai and seminars at various universities. Insights from Clive Lennox and Yinqi Zhang have been particularly constructive. We appreciate financial support from Canada’s Social Sciences and Humanities Research Council. Jeffrey Pittman gratefully acknowledges Funding from the CMA Professorship and the Chair in Corporate Governance and Transparency at Memorial University. Oliver Rui acknowledges financial support of a CEIBS research grant and a grant from National Science Fund Committee of China (No. 71372203).

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Copyright information

© Springer Science+Business Media Dordrecht 2015

Authors and Affiliations

  1. 1.Shanghai University of Finance and EconomicsShanghaiChina
  2. 2.Memorial University of NewfoundlandSt. John’sCanada
  3. 3.China–Europe International Business SchoolShanghaiChina

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