Do non-audit service failures impair auditor reputation? An analysis of KPMG advisory service scandals in Germany

Abstract

Big Four accounting firms increasingly focus on non-audit services. Failures in these services may impair the accounting firm’s reputation as an auditor. They may negatively affect the Big Four, its clients, and client stakeholders. From the perspective of critical scholarship, it is vital to understand whether potentially marginalized actors that auditors are meant to protect (e.g., the general public) bear adverse consequences from non-audit failures. Low litigation settings, such as Germany, are of particular interest in this context because they rely on reputation risks to motivate Big Four auditors to provide high-quality services. Accordingly, we analyze two events of observable non-audit service deficiencies of KPMG Germany. We first use an event study and show that KPMG’s audit clients suffer negative capital market reactions after the NAS failure events. We then ask whether KPMG, having caused the events, also faces adverse consequences. Moreover, we explore theoretical mechanisms behind the observed capital market reactions. Using the Eisenhardt Method, we deeply engage with extensive quantitative data sets and explore auditor switches, audit pricing, and clients’ earnings management. The analyses do not reveal significant negative consequences for KPMG. Earnings management data provides some limited indication that KPMG allows clients more opportunistic accounting choices. Overall, our analysis suggests that reputation may be insufficient to discipline Big Four auditors from acting opportunistically at the cost of less powerful actors in low litigation settings.