Economic Consequences of Auditor Reputation Loss: Evidence from the Auditor Inspection Scandal

Abstract

We examine whether the 2017 audit inspection scandal affected KPMG's client relationships and audit quality. Using the trial transcripts, we construct a novel dataset of KPMG clients whose audit engagements were compromised by information leakage from the PCAOB (Transcript Sample). We then examine KPMG's response to this regulatory data theft scandal. Our findings suggest an increased departure rate following the public revelation of the scandal of clients in the Transcript Sample but not in the broad portfolio of KPMG clients. While KPMG's audit fees do not appear to have changed, we find a reduction of KPMG's non-audit fees, which is concentrated in the Transcript Sample clients. Finally, we find that the quality of loan loss provisions of banking clients in the Transcript Sample decreased after the scandal. Overall, our results suggest the audit inspection scandal has imposed costs on both KPMG and its PCAOB-inspected clients whose identities were exposed.