Does size matter? The influence of large clients on office-level auditor reporting decisions
Journal of Accounting and Economics (2000)
The Research Question (RQ)
How does client size affect the office-level auditors' reporting decisions?
Economic dependence is defined as an incentive that auditors may compromise their independence to retain clients who pay for their services. Common sense tells us that the larger clients' size and smaller number of clients will increase extend of economic dependence. In other words, big audit firms, with more clients, are more likely to audit independently and report high quality results. However, this paper focuses on the office-level of big audit firms. As decision-making unit, audit offices may be greatly affected by the size of the clients.
Reputation protection is a self-interested incentive that auditee would love to do to mitigate audit risk and minimize the litigation costs.
The purpose of this paper is to study the tradeoff between these two incentives. Two empirical questions are investigated.
The discretion with respect to the size of the accounting accruals;
The discretion with respect to the going concern audit reports.
Reputation protection (costs) overweighs the economic dependence (benefits) for office-level audit firms to treat clients favorably. Economic dependence from large clients does not affect the office-level auditors report proper decisions.
However, reputation protection leads auditors to report conservatism. Big clients would love to accept a going concern audit report.
Large client individually represents only at most 0.2% of the auditors' revenue on the firm-level but 8%-100% on the office-level. Office-level auditors are the main beneficiaries of the revenue but not the main suffer of the reputation and litigation costs. The asymmetry in gains and losses let us assume that the economic dependence dominates the litigation costs...