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Partner cross-contagion in audit offices and client reporting quality

John Goodwin (Department of Financial Accounting, Corvinus University of Budapest, Budapest, Hungary)
Pamela Fae Kent (Department of Accountancy, QUT, Brisbane, Australia and Department of Accounting, The University of Adelaide – North Terrace Campus, Adelaide, Australia)
Richard Kent (Department of Accounting and Finance, University of Michigan-Dearborn, Dearborn, Michigan, USA)
James Routledge (Department of Accounting, Hitotsubashi University, Tokyo, Japan)

Managerial Auditing Journal

ISSN: 0268-6902

Article publication date: 19 October 2022

Issue publication date: 3 January 2023

97

Abstract

Purpose

The purpose of this study is to examine if partner cross-contagion in audit offices is associated with client reporting quality. To this end, the authors test if the presence in an audit office of a partner with a highly aggressive style is associated with the reporting quality of other partners’ clients. Partners with a highly aggressive style are identified by their tendency to approve favorable client reporting. The authors add to the existing literature that provides limited and equivocal evidence on audit office cross-contagion.

Design/methodology/approach

Partner style is determined in an estimation period from 2010 to 2014. Aggressive style is identified when partners tend to approve favorable client reporting, which is shown by a positive value for their clients’ median discretionary accruals. Partners are considered to exhibit a highly aggressive style if they have positive median client discretionary accruals within the 90th percentile. Cross-contagion analysis is then conducted in a test period from 2015 to 2019 by determining if the presence in an office of a partner with a highly aggressive style is associated with the reporting quality of other partners’ clients. Two measures of client reporting quality used. These are the accuracy of current-period accruals in predicting period-ahead cash flows and earnings management related to benchmark beating.

Findings

This study finds partner cross-contagion of highly aggressive style in Big 4 offices that is associated with lower client reporting quality for non-Metals and Mining industry clients. This cross-contagion only occurs when the contagious partner has a very high level of aggressive style. This study finds Big 4 partners are susceptible to aggressive style cross-contagion regardless of their own idiosyncratic style. The results of this study show more cross-contagion in small Big 4 offices and mitigation of cross-contagion for economically important clients. Cross-contagion in non-Big 4 offices is observed for Metals and Mining industry clients.

Originality/value

By determining style from partners’ past clients’ discretionary accruals, this study extends prior cross-contagion research that relies on restatements to identify style. This study examines several other cross-contagion issues not addressed in prior studies. These include differences in cross-contagion for Big 4 and non-Big 4 offices and for large and small Big 4 offices, partners’ susceptibility to cross-contagion and the influence of client importance.

Keywords

Acknowledgements

Author names are listed alphabetically.

The authors appreciate helpful comments from Hiro Fukukawa, Fiona Rohde, Mark Wallis, participants at the 2021 Accounting and Finance Association of Australia and New Zealand (AFAANZ) conference and participants at the 2021 conference of The Japanese Accounting Review (TJAR).

Citation

Goodwin, J., Kent, P.F., Kent, R. and Routledge, J. (2023), "Partner cross-contagion in audit offices and client reporting quality", Managerial Auditing Journal, Vol. 38 No. 1, pp. 37-57. https://doi.org/10.1108/MAJ-11-2021-3375

Publisher

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Emerald Publishing Limited

Copyright © 2022, Emerald Publishing Limited

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