Does Auditor Reputation Matter? The Case of KPMG Germany and ComROAD AG



    1. Sloan School of Management, Massachusetts Institute of Technology
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    1. School of Business, University of Connecticut
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    1. Leventhal School of Accounting, University of Southern California. We thank Liesbeth Bruynseels, Sung Gon Chung, Victoria Dickinson, Ron Guymon, Debra Jeter, Bruce Johnson, Bill Kinney, S. P. Kothari, Ling Lei, Roger Meuwissen, Reiner Quick, Doug Skinner, Ross Watts, David Weber, Jerry Zimmerman, two anonymous reviewers, and participants at the 2006 AAA Auditing Midyear Conference, Boston University, University of Chicago, University of Florida, Georgetown University, University of Iowa, Massachusetts Institute of Technology, Michigan State University, Penn State University, Tilberg University, University of Connecticut, University of Southern California, and University of Texas.
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We study the stock and audit market effects associated with a widely publicized accounting scandal involving a public company (ComROAD AG) and a large, reputable audit firm (KPMG) in a country (Germany) that has long provided auditors with substantial protection from shareholder legal liability. We use this event to study whether an auditor's reputation helps to ensure audit quality, a rationale for which recent literature and events provide scant support. Given the absence of a strong insurance rationale for audit quality, Germany permits a relatively clean test of whether auditor reputation matters. We find that KPMG's clients sustain negative abnormal returns of 3% at events pertaining to ComROAD, and that these returns are more negative for companies that are likely to have higher demands for audit quality. We also find an increase in the number of clients that drop KPMG in the year of the ComROAD scandal (mostly smaller, recently public companies that are similar to ComROAD). Overall, our results provide support for the reputation rationale for audit quality.