Client Conservatism and Auditor-Client Contracting

Abstract: Auditors risk costly litigation and loss of reputation when they are associated with clients that engage in substandard financial reporting, and prior research argues that accounting conservatism reduces managements ‟ tendency to misreport. Thus, we predict that client conservatism affects auditor-client contracting by reducing auditor litigation and reputation risk. Consistent with our predictions, we find that conservative audit clients are less likely to trigger auditor litigation or issue accounting restatements; and that auditors of conservative clients charge lower audit fees, issue fewer going concern opinions, and resign less frequently. Taken together, these findings are consistent with client accounting conservatism playing an important role in auditor-client contracting an