The Impact of Client Bankruptcies on Auditors’ Judgment and Future Audit Engagements

The extant literature provides little evidence on how individual auditors’ auditing styles and client management decisions develop over time. In this study, we investigate whether and how engagements with bankrupt clients (i.e., bankruptcy experiences) affect auditors’ behavior in their future engagements. Using a large sample of Swedish auditors-in-charge (AICs), we find that AICs’ bankruptcy experiences are positively related to the issuance of going-concern opinions to financially distressed clients, audit fees, and clients’ earnings quality. Our evidence implies that such experiences increase AICs’ conservatism and professional skepticism and contribute to higher audit quality. We also show that AICs with more bankruptcy experiences develop a more conservative client management strategy—they are less (more) likely to accept (resign from) financially distressed clients. Furthermore, more salient and recent bankruptcy experiences have a stronger impact on AICs’ decision-making. Overall, our findings indicate that AICs who have experienced client bankruptcies deliver higher audit quality and exhibit greater conservatism in client selection, providing novel evidence on how individual auditors’ auditing styles are shaped by their professional experiences