Audit partner ethnicity and salient audit phenomena

Abstract

Motivated by ongoing dialog at the national level on racial (in)equality, we examine the relations between audit partner ethnicity (audit partners of Asian, Black, or Hispanic origin) and three salient audit phenomena. Specifically, we examine whether there is a difference in financial reporting quality between the clients of ethnic minority audit partners (EMAPs, hereafter) and those of White partners, whether EMAPs face a different work environment than their White counterparts, and how EMAPs are treated in the audit firm. We find that clients of EMAPs, on average, have earnings that are more predictive of future cash flows, have smaller unsigned discretionary accruals, and are less likely to receive a comment letter from the U.S. Securities and Exchange Commission than clients of White partners. We also find weak evidence that clients of EMAPs have more persistent earnings, lower signed discretionary accruals, and higher audit fees. We do not find evidence of differences in restatement likelihood between the clients of EMAPs and those of White partners. Overall, these results provide some evidence that clients of EMAPs have higher financial reporting quality. Next, we find that, compared to White partners, EMAPs are more likely to work in offices that are smaller, earn lower audit fees, are non-Big 4, and have no prestigious clients. Finally, we find that EMAPs are more likely to be in charge of engagements with clients whose top management (but not whose audit committee) has ethnic representation. We find no evidence that EMAPs are less likely to be engaged with prestigious or important clients. However, we find that, following a financial restatement, EMAPs are more likely than White audit partners to be replaced. Collectively, our findings suggest that even though EMAPs 1) tend to work in less desirable offices, 2) have a client alignment that is affected by ethnic representation in the client's top management, 3) face more severe consequences after audit failure, they are associated with some properties of higher audit quality. This study is one of the first to broadly examine important aspects of the work of EMAPs. We believe that our findings will be of interest to audit firms, audit clients, other related parties, and society at large, especially given audit firms' efforts to improve ethnic diversity.