Auditors under Fire: The Effects of Audit Errors on the Career Prospects of Individual Auditors

This study shows that auditors who sign the audit reports of public clients face negative career consequences when there are audit errors involved. Specifically, we find that signing auditors in China are downgraded to auditing private clients or leave the firm after they issue modified audit opinions to financial statements that contain no misstatements (Type I audit error) or fail to warn about a client’s restatement in advance (Type II audit error). Further analyses show that auditors with Type II audit error are more likely to be penalized when they are employed by larger audit firms or when such errors occur with more important clients. However, those with Type I audit error are more likely to be penalized when they are employed by smaller firms or located in a more competitive market. Notably, we find that audit firms’ disciplinary action against auditors reflects their determination to improve audit quality, as their client restatements decrease more than those of non-disciplining firms. Finally, disciplining auditors is also helpful in restoring audit firms’ reputation and preventing the market share loss associated with client restatements. In sum, our findings suggest that individual auditors in China face adverse career consequences when they produce poor quality audits.