Auditors’ Response to Client Corruption: Evidence from Google Document Frequency

Abstract

The heated debate on auditors’ responsibility to detect client illegal activity and the related protracted standard‐setting implementation underscores an urgent need to understand how auditors respond to client‐specific noncompliance with laws and regulations (NOCLAR). Although prior research has examined auditors’ responses to noncompliance risks in the context of foreign bribery and political corruption, these studies’ insights are limited due to a focus on regional corruption proxies or clients with observable acts of foreign corruption. Our study introduces a Google document‐frequency measure that captures both the actual and perceived prevalence of illegal acts by firms in each year. A key advantage of our time‐varying, client‐specific measure is that it provides a holistic proxy of illegality by capitalizing on widely disseminated textual information in decentralized Internet databases. We first demonstrate that our Google‐based corruption measure is a leading predictor of client noncompliance risks, offering incremental predictive power beyond regional corruption proxies. We then predict and find that auditors’ input and output behavior is associated with this novel measure. Specifically, in response to client corruption, auditors adjust their production inputs and charge higher audit fees. Related to audit output, we find that financial restatements and auditor decision errors are more prevalent for corrupt clients. This evidence suggests that, although auditors appropriately price for noncompliance risk, their execution of the audit does not fully adjust for the risk identified.